Pensions Bulletin 2014/52

The PPF finalises the 2015/16 levy

The Pension Protection Fund (PPF) has confirmed that the 2015/16 pension protection levy will go ahead with no material alteration from its October proposals (see Pensions Bulletin 2014/41). The 2015/16 levy year is the first in which the Experian-based insolvency risk model will be used – leading to a large redistribution of PPF levies amongst schemes.

The pension protection levy estimate for 2015/16 will be that which was proposed in October – ie £635m – and it will be divided between schemes as proposed then.

The risk-based element of the levy is to be calculated with reference to a scheme’s underfunding risk and insolvency risk as follows:

• A scheme’s “underfunding risk” is determined by examining its assets and liabilities (with market volatilities smoothed over a five year period ending on 31 March 2015) and is taken as the larger shortfall between the smoothed figures and those that have been smoothed but also subject to stresses to allow for investment and funding risks. Schemes with PPF liabilities of £1.5 billion or more will have to carry out their own bespoke stress calculations for investment risk (other schemes can choose to do so). Underfunding risk, and by association the risk-based levy, is zero if there is no shortfall in both unstressed and stressed scenarios
• A scheme’s insolvency risk is determined by taking the sponsoring employers’ “PPF-specific” risk scores on the last working day of each month and averaging over the six months to 31 March 2015. The average is then converted into an insolvency probability by reference to a table that is split into ten insolvency bands

In supporting documentation the PPF has published:

• Its conclusions on the consultation in the form of a policy statement
• The final determination that sets in stone the 2015/16 levy calculation, together with a number of appendices
• Standard form contingent asset agreements for use by schemes entering new agreements
• A number of certificates such as that relating to asset backed contributions
• Guidance material including the levy practice guidance, the asset backed contributions guidance, the bespoke stress calculation guidance, the block transfer guidance and the contingent asset guidance in final form. A new guide on Officer’s certificates certifying secured charges and certain other matters has also been included

As a result of considering responses to the consultation, some small changes have been made to the proposals. The more material of those include:

• The entry conditions for the large and complex scorecard have been altered so they will not capture businesses that file abbreviated accounts or whose only subsidiaries are dormant. Non-UK companies will not be automatically allocated to the large and complex scorecard if Experian has sufficient information to make an alternative assignment
• Experian will allow non-UK businesses not having employee numbers captured from their accounts the opportunity to provide the information to them, and will allow entities publishing or certifying full-time equivalent numbers to opt to have these reflected in the Experian scoring
• Mortgages are excluded on immateriality grounds where either the company, or wider corporate group, has an investment grade credit rating, or where the aggregate amount of the charge(s) is less than 0.5% of total assets. Any changes will be backdated to 31 October 2014 when the first PPF specific scores were produced

The deadlines for providing information to the PPF are as follows:

• 5pm on 31 March 2015 for the compulsory submission of scheme returns (including any voluntary section 179 valuations)
• 5pm on 31 March 2015 for certification of asset backed contributions (to the PPF)
• 5pm on 31 March 2015 for certification of mortgages (to Experian)
• 5pm on 31 March 2015 for certification or re-certification of contingent assets
• 5pm on 30 April 2015 for certification of deficit-reduction contributions
• 29 May 2015 for confirmation of legal advice on last man standing schemes’ status (to PPF); and
• 5pm on 30 June 2015 for certification of full block transfers that have taken place before 1 April 2015

Comment

Once again it is time to take up the many opportunities, old and new, for effective levy reduction that are available. These include sending in deficit reduction certificates and certifying new contingent assets or re-certifying existing ones. For some schemes the certification of asset backed contributions will need to be newly considered. As ever, the completion of the asset side of the annual scheme return needs careful consideration and for some schemes it may be beneficial to undertake a bespoke stress calculation.

But for many the focus will be on effective monitoring of employers’ Experian insolvency risk scores and ensuring information used is correct, given that the switch from D&B will deliver a significant number of winners and losers.

Taxation of Pensions Act receives Royal Assent – LCP explanatory guide released

Following a speedy passage through Parliament, the Taxation of Pensions Act 2014 has received Royal Assent. This is the key piece of the legislative jigsaw to give effect to the post 5 April 2015 flexibilities on taking retirement income from money purchase arrangements. This important Act is summarised in LCP’s guide to the Taxation of Pensions Act 2014 – which explains the legislation underpinning these sweeping reforms.

The implications of these reforms are unexpected and far-reaching. Our website contains material setting out our analysis and comments (including our quarterly updates, videos and guides) on some of the consequences for all types of pension provision.

In time for Christmas 2014 – fixes for Annual Allowance problems identified in 2012

On 11 December a draft was put before Parliament of the long-awaited Order aimed at solving various snagging issues within the Annual Allowance regime. We would expect no further changes, and for the “affirmative process” to be complete and the Order to be in law in perhaps six to eight weeks.

The most eagerly awaited area covered is the repair to a problem on “bulk transfers” (as arise often as part of corporate transactions and scheme rearrangements). HM Revenue & Customs’ (HMRC) reading was that the tax law as it stood before meant that an individual having mirror-image defined benefits transferred from one scheme to another as part of a business transaction would use up some Annual Allowance if the transfer was an “underfunded amount”. The July draft for consultation had some rough edges which have been tidied in the final version. So – as per HMRC’s stated intent – this issue may have been solved satisfactorily for most “mirror image” bulk transfers, or where the benefit granted is adjusted but still equal in value (or “virtually equal”) to pre-transfer expectations. However, there are some on-going pitfalls (as well as actions that might be available to avoid the pitfalls in future).

There are several other Annual Allowance operative changes made by the Order. In general the measures are in line with the July draft (there have been some corrections on timing or where it has been spotted that the changes needed to be extended to a wider category of member).

We suggest you read our previous Pensions Bulletin 2014/31 for fuller details on what is covered by the Order – and the comments on the July draft by the Association of Consulting Actuaries (ACA) to see some of the pitfalls. The Order is accompanied by draft modified guidance pages about how HMRC intends the Order to operate in practice. HMRC’s Pension Schemes Newsletter 66 notes that it is intended that a final version of the guidance amendments will be issued closer to the time that the Order takes effect.

HMRC has indicated that it would welcome suggestions of what else should be covered and we hope several of the points raised by ACA will be picked up.

Comment

Both the change to the transfer-in provision described above and the several other issues addressed could mean revisions to past work may be needed (minimal we hope); and some changes in practice will result. But as can be seen from the ACA comments in July, the areas covered by the regulations are intricate (not least working out when changes impact and how retrospective some are). So the final guidance accompanying the Order will be essential before deciding some issues of practical application.

FCA looks to improve the annuity and retirement income market

The Financial Conduct Authority (FCA) has published the findings of its thematic review into annuity sales practices and the interim findings of a market study into retirement income.

In February 2014, the FCA found that the annuities market was not working well for most consumers (see Pensions Bulletin 2014/07) and launched a market study to look at the entire retirement income market. As a result of the new pension freedoms announced in Budget 2014, which increase the at-retirement choices facing consumers, the scope of the market study was changed to look at how the market might develop, as well as gathering evidence on how it works today. A separate piece of work was undertaken to look at annuity sales practices.

Retirement income market study

This study suggests that many consumers are missing out on a higher income by not shopping around. But interestingly, it also found that for those with average-sized pension pots and low risk appetite, the right annuity purchased on the open market offers good value for money relative to alternative drawdown strategies.

Looking to the future, the FCA is proposing a number of recommendations to improve the way firms communicate with customers about their options, the principal ones being that:

• Firms should be required to make it clear to consumers how their quote compares with other providers on the open market
• An alternative to the current system of “wake-up packs” should be introduced, to ensure clarity and consistency in the at-retirement communications provided to consumers. This should be “behaviourally-trialled” to make it as effective as possible in terms of prompting shopping around and signposting impartial guidance. The pension guidance service and firms should take account of the findings of the market study when designing tools to support decision-making
• In the longer term, a “Pensions Dashboard” should be developed, which would allow consumers to view all their lifetime pension savings in one place

The FCA is seeking views on its initial findings by 30 January 2015 and will consult at a later date if any potential rule changes are needed.

Annuity sales practices

This review found evidence indicating that although customers are usually told at some stage that they can shop around, firms are in general not reinforcing the message at key points; the conclusion being that significant improvements are required now.

Enhanced annuities were identified as the area of greatest concern as customers are often not informed that other providers may offer enhanced annuities for medical conditions or lifestyle factors that the existing provider does not underwrite. So the FCA is asking the majority of firms involved in the review to do further work to determine if the findings in relation to enhanced annuities are indicative of a more widespread problem. Following this work the FCA will take a decision on whether further action is needed.

The FCA also found examples where the Association of British Insurers (ABI) code – which is compulsory for ABI members, and sets the industry’s own benchmark for members about communicating key information to consumers clearly and consistently – is not being applied in practice. Following discussions with the ABI, the FCA has decided to consult on its own rules to replace the ABI code, which would cover all firms, not just ABI members. During any transitional period, the ABI code will remain in force for its members. The ABI had already called for and now welcomes plans to replace the code with formal regulation.

Report on legacy DC schemes reveals many face high charges

Many pension savers in “legacy” defined contribution (DC) workplace schemes are facing high management charges, in some cases, excessively so. This is the key finding contained within a report issued by the Independent Project Board (IPB) following a year-long audit of such schemes administered by members of the Association of British Insurers (ABI).

The IPB – made up of representatives from pension bodies and regulators as well as the Department for Work and Pensions (DWP) – was asked to look at legacy schemes at risk of being exposed to charges over an equivalent of a 1% annual management charge and to recommend what actions need to be taken by the new Independent Governance Committees and trustees. Its interim report on the audit was published in August (see Pensions Bulletin 2014/32).

The final report found that:

• Of the £67.5bn assets under management in-scope, £42bn has charges of less than 1% in all scenarios, including “worst case” scenarios
• Between £23.2bn and £25.8bn is potentially exposed to charges of above 1%. Around half of this is potentially exposed to charges above 1.5%; between £5.6bn and £8.0bn is potentially exposed to charges above 2%; and around £0.9bn is potentially exposed to charges above 3%
• Schemes where savers are potentially exposed to the very highest charges are more likely to have complex charge structures. Nearly all such assets potentially exposed to charges of over 3% are in schemes with monthly fees or deductions from contributions
• The majority of the assets exposed to charges over 3% (£0.7bn out of £0.9bn) are held by savers with pots of less than £10,000. Of this, over 90% is held by savers that are paid-up and have stopped contributing. For such savers the impact of monthly fees can result in a very high impact of charges
• There are estimated to be 407,000 savers that have joined schemes in the last three years who could be exposed to a charge of over 1% in the future. Of these, 178,000 could be exposed to charges over 2% and 22,000 to charges over 3%
• Around £3.4bn has potential exit charges of 10% if savers leave their scheme immediately. Of this, £0.8bn is held by savers over age 55, who will be eligible to withdraw their pension savings from April 2015

The IPB is writing to the provider of each scheme where savers are potentially exposed to high charges and is recommending that providers should:

• Review their data in the light of any actions already taken to reduce charges and any qualitative factors that might justify high charges
• Identify what actions could be taken to improve outcomes for savers and what actions can be taken to stop new savers joining poor value schemes; and
• Provide the data and any further analysis and proposed actions to the relevant governance body by the end of June 2015 at the latest

The IPB is also setting out guidance for governance bodies which will have the task of evaluating whether the proposed actions are sufficient to ensure savers receive value for money in future. The IPB recommends that governance bodies agree remedial actions and an implementation plan with their provider by the end of 2015 at the latest.

The IPB further recommends that the DWP and the Financial Conduct Authority should jointly review industry-wide progress in remedying poor value schemes and publish a report by the end of 2016.

Comment

The publication of this report will increase the pressure for voluntary action to be taken to reduce the level of charging in these legacy schemes. Although this Government is fast running out of time to legislate, it is likely to be a topic on any incoming Government’s agenda should there be insufficient action over the coming months.

End of the line for Nortel regulatory actions in Canada?

We rarely report on foreign legal cases, but the judgment of the Ontario Superior Court of Justice in the Nortel litigation is worth a mention, for a number of reasons.

The Nortel telecoms business entered insolvency in 2009. The Nortel UK defined benefit pension scheme has been in an assessment period for entry into the Pension Protection Fund (PPF) since then. In 2010 the Pensions Regulator instituted regulatory measures including the intended issue of Financial Support Directions (FSDs) against certain insolvent group companies that did not participate in the schemes, including the Canadian parent company. The FSDs were issued in April 2011.

There has been endless legal wrangling (see for example Pensions Bulletin 2013/31) in the UK, US and Canadian courts about the distribution of the residual assets of the enterprise, including the status of the UK pension creditors.

In a major setback for the PPF, the UK pension trustees and the scheme members the Ontario Superior Court has held that:

• The FSDs are not “provable claims”, and thus are effectively thrown out under Canadian law on various grounds, principally that the likelihood of recovery under them was too “remote and speculative”
• While the UK pension creditors were entitled to recover £339.75m under a parent company guarantee, all other claims, including one for US$150m under another guarantee were dismissed

Comment

Not the greatest pre-Christmas reading for the Pensions Regulator, the PPF or its levy-payers. And the Nortel pensioners may now almost certainly have to look to the PPF. This looks like being the PPF’s largest entrant to date, both in terms of the number of members and possibly the size of the deficit in relation to the cost of PPF benefits, which has been estimated at around £700m before recoveries.

Auto-enrolment – Government decides the 2015/16 earnings parameters

Following consultation in October (see Pensions Bulletin 2014/42) the Department for Work and Pensions (DWP) has announced the now settled figures for 2015/16. The lower and upper limits of the qualifying earnings band will be £5,824 pa and £42,385 pa respectively, whilst the earnings trigger remains frozen at £10,000 pa.

So the lower and upper limits of the qualifying earnings band remain fixed to the lower and upper earnings limits for national insurance purposes respectively, but the earnings trigger moves away from the income tax threshold (which was reset to £10,600 in the Autumn Statement).

Comment

So the earnings trigger has bent to the pressure being exerted on it by the Government’s desire to give above inflation increases to the income tax threshold. Now that the income tax threshold link has been broken a £10,000 pa earnings trigger for auto-enrolment purposes might become quite sticky for the next few years.

Pensions Ombudsman censors a scheme suspected of pension liberation activity

The Pensions Ombudsman has made its first formal determination in a case related to pension liberation scams.

In the case in question, an employee of NHS Scotland – Mr X – was persuaded to transfer his pension rights out of the NHS Scotland Pension Scheme into the Capita Oak Pension Scheme on the promise of investment returns of 8% to 12%, even though he had no employment connection to the scheme. Mr X then began to have concerns about his decision, but was unable to get the trustee of the Capita Oak scheme – Imperial Trustee Services Ltd (ITSL) - to respond to any of his many attempts to arrange to transfer his benefits out of the scheme.

Mr X then complained to the Pensions Ombudsman that ITSL had refused to act on his request to transfer his benefits out of the Capita Oak scheme. ITSL never responded to the allegations against it and the Pensions Ombudsman’s ruling was that Mr X would have had a statutory right to transfer out of the scheme on a formal request, and that the only reason he did not make such a request was that ITSL did not reply to his initial enquiries.

The Ombudsman directed ITSL to pay a transfer value of the higher of the original amount, plus interest, and a current cash equivalent, but expressed doubts that the direction would be immediately complied with and warned that even if Mr X enforced the direction through the courts, he might not be able to recover the whole transfer value.

Early in January, the Ombudsman plans to publish a group of cases about people who have wanted to transfer out, but whose transfers have been “blocked” by their pension schemes.

Comment

While this case has not been a direct ruling on a pension liberation scam, the determination is prefaced with a discussion on pension liberation and its tone throughout implies that the Pensions Ombudsman views the Capita Oak scheme as potentially crossing this line in addition to deeming ITSL to be guilty of maladministration.

Removal of NEST restrictions a step closer

The Department for Work and Pensions has laid the draft National Employment Savings Trust (Amendment) Order 2015 before Parliament in order to give effect to its proposals to remove the annual contribution limit and transfer restrictions on the National Employment Savings Trust (NEST) with effect from 1 April 2017.

This follows the conclusion of a consultation on the draft Order and a second instrument back in October (see Pensions Bulletin 2014/42).

Statutory Money Purchase Illustrations standard updated

The Financial Reporting Council (FRC) has published a revised version (4.1) of Actuarial Standard Technical Memorandum 1 (AS TM1), which sets out how pension providers must prepare statutory money purchase illustrations (SMPIs) for pension scheme members.

The new version of AS TM1:

• Allows providers to use their judgment to determine reasonable assumptions where AS TM1 is not explicit on the assumptions that should be used (driven by the need to allow for the phasing in of future contributions under the auto-enrolment legislation)
• Specifies that spouses or civil partners of the same gender should usually be considered to be the same age; and
• Enables pension providers to more effectively take account of the impact of guaranteed annuity terms

A paper has also been published setting out the rationale for the changes.

In view of the nature of the changes and the value of incorporating them sooner, the FRC has chosen not to undertake a formal consultation (but it did obtain input from various stakeholders in developing the amendments).

Version 4.1 of AS TM1 will replace the current version (see Pensions Bulletin 2014/08) for statutory illustrations issued on or after 6 April 2015 (although earlier adoption is permitted).

Class 3A NIC regulations finalised, allowing some to buy additional state pension

The regulations laid before Parliament in October have now been finalised , that make consequential amendments to legislation concerning the introduction of Class 3A national insurance contributions (NICs) (See Pensions Bulletin 2014/42).

This means that people can now choose to buy additional state pension rights if their State Pension Age is reached before 6 April 2016 (see Pensions Bulletin 2013/53).

Christmas and New Year break

This is the last edition of the Pensions Bulletin for 2014. It will return after the Christmas and New Year break. May we wish readers a merry Christmas and a prosperous New Year!

This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you.