European pensions directive takes shape
After a quiet few months the European pensions directive (IORP2) – see for example Pensions Bulletin 2015/33 – is progressing again. Last week the Economic and Monetary Affairs Committee of the European Parliament voted through the latest version of the directive and we may be getting close to a “final” version.
First, it is important to note that the directive continues to include a statement to the effect that the EU should not develop any quantitative capital requirements for pension schemes. If this survives into the final directive then it may block any attempt by the European Commission to put solvency for pensions back on the table for the foreseeable future.
The directive is nevertheless a substantial piece of regulation which will, if implemented in the UK, requires significant changes to the governance and communications of occupational pension schemes.
We look at some of the most important changes in the most recent version below.
Cross-border activity
Currently “IORP1” requires DB schemes which operate in more than one EU country to be “fully funded at all times”. When this rule was first brought in in the UK at the end of 2005 it was a great inconvenience to many schemes. One active member working in Paris could cause the scheme to be subject to the immediate full funding requirement and so schemes had to ensure that they had no such members.
Earlier in the IORP2 legislative process this requirement was proposed for relaxation (see Pensions Bulletin 2014/40). It is now intended that cross-border schemes will be able to address shortfalls through a recovery plan so long as “the interests of members and beneficiaries are fully protected”.
Comment
We hope that this time the relaxation survives into the final directive as the full funding requirement operates as a bureaucratic trap for schemes. It is also an impediment to any employers who would like to explore properly operating a DB scheme cross-border.
Small scheme exemption
Schemes with less than 100 members are already exempted from IORP requirements. A further de minimis is introduced so that schemes with technical provisions of less than €25m may also be exempted.
Investment
As before, schemes are required to invest in accordance with the “prudent person” rule. What is new is that it is now stated that assets must be invested in the best long-term interests of members as a whole. Furthermore, the prudent person rule is not to be interpreted so as to prevent schemes from taking into account the potential long-term impact of investment decisions on environmental, social, governance or ethical factors. There is also now a governance requirement that requires “environmental, social and governance [although not ethical] factors related to investment assets to be considered in investment decisions” and for this to “involve relevant stakeholders and … be subject to regular internal review”.
Comment
The latter is significant. There is currently no legal requirement for UK pension schemes to take environmental, social and governance factors into account. It looks like this will be imposed by the EU.
Fit and proper
The requirement for appropriate qualifications now applies to the trustee body collectively. There was a concern previously that each individual trustee must be qualified. This will still apply to trustees carrying out “key functions” (see below).
Key functions
Pension schemes will be obliged to “incorporate” three “key functions” – namely a risk management function, an internal audit function and an actuarial function.
- The risk management function is largely as set out in earlier versions of the directive although now with the addition of a reporting obligation to the pensions regulator and including an explicit reference to social and environmental investment risks. There is also a requirement to monitor how the risk management system is performing by undertaking regular risk assessments (now called the “own risk assessment”) and the scope of the risk assessment is further refined
- The internal audit function now seems wider than previously envisaged. Previously it appeared to be limited to auditing the internal controls system and other elements of the system of governance. Now it seems to be wider and more amorphous
- The actuarial function, required for DB schemes, is, as before, one of oversight of the actuarial management of pension schemes, which now includes comparing the assumptions used for calculating technical provisions with experience
There are some detailed provisions about who can perform these functions and whoever it is will have whistleblowing obligations towards the pensions regulator.
Comment
Not, we suspect, coincidentally, these governance requirements seem to mesh to an extent with the Pensions Regulator’s recent initiative on integrated risk management (see Pensions Bulletin 2015/52). Whether from the UK Regulator or via IORP2 it is clear that more formalised approaches to governance and risk management will be at centre stage over the next few years and that whatever approaches are adopted by UK trustees will have to be compliant with the EU legislation.
Depository/custodian
We seem to be arriving at a landing where for both DB and DC schemes there is provision for pension regulators to require schemes to appoint a custodian, where there is not one already.
Comment
This seems to be sensible and it is good that the direction of travel seems to be against the blanket imposition of a depository requirement on particular categories of scheme.
Information for members
The directive now provides for a much simpler and less prescriptive universal “pension benefit statement” to be provided to all members annually.
Next steps
The next stage in the process is that the European Parliament will vote on the amended text at a plenary session which we understand to be currently scheduled for next month. After this it goes into “trilogue” negotiations between the European Council, Commission and Parliament. Our current expectation is that this will result in the directive being adopted as EU law before the end of June, when the current Dutch presidency of the EU ends, although this could slip.
The directive currently specifies an 18 month transposition period for its new elements to be implemented into UK law, so it is possible that this new raft of governance and disclosure requirements could become UK legal/regulatory requirements before the end of next year.
Which benefits with guarantees are safeguarded benefits?
This is the question that a factsheet published by the Department for Work and Pensions on 27 January 2016 seeks to address, in response to concerns that there is uncertainty as to when the “appropriate independent advice” requirements apply for those seeking to flexibly access their benefits under the DC freedom and choice reforms.
Since 6 April 2015 the law has provided that a safeguarded benefit is any benefit other than a money purchase benefit or a cash balance benefit. The guidance (which whilst intended to be helpful has no legal status) seeks to turn this negative definition into a positive by asserting that in practice “safeguarded benefits are any benefits which include some form of guarantee or promise during the accumulation phase about the rate of secure pension income that the member (or their survivors) will receive, or will have an option to receive”.
Having taken this step, what follows in the guidance appears perfectly logical. So, according to the guidance:
- A pension plan with a guaranteed annuity rate (GAR) option that expires at a specific point in the future (for example when the member turns 60) is a safeguarded benefit until the GAR expires. Where there are multiple GARs expiring at different specific points in the future the benefit is a safeguarded benefit until all the GARs have expired – in each case so long as there are no other safeguards attaching to the benefits
- Where the trustees hold, as an asset of the scheme, an insurance policy which includes a GAR, and the scheme rules provide that the member is entitled to the benefits that the policy will provide (but the scheme rules do not themselves promise the GAR), the presence of the GAR does not make the benefits safeguarded benefits (however, the guidance recognises that it may not always be clear cut that the benefit being promised by the scheme is money purchase and so legal advice may be necessary)
- Where a person has a single policy under which a guarantee (such as a GAR) is available in respect of only a portion of the benefits under the policy, that portion of the benefits to which the option of the GAR applies will be safeguarded but the remainder will not
For good measure the guidance also covers those benefits on which there is little doubt that they fall within the definition – such as final salary benefits.
The guidance also usefully explains that there are a number of guarantees that will not result in the benefits being safeguarded because they do not contain a guarantee about the rate of income that may be provided. So guaranteed lump sums and guaranteed investment returns during the accumulation phase do not by themselves make the benefit a safeguarded benefit.
Comment
This is useful and concise guidance and may help to end misapprehensions of what it takes for a benefit to be a safeguarded benefit. Although it does not cover every imaginable benefit design, it is likely to be referenced whenever there are disputes as to whether or not a benefit is a safeguarded benefit.
HMRC consults on tapered annual allowance information requirements
The introduction of the tapered annual allowance in just over two months means changes are needed to the reporting of information to scheme members and HM Revenue & Customs if they are to remain meaningful and practical. HMRC is consulting on its proposed changes in the draft Registered Pension Scheme (Provision of Information) (Amendment) Regulations 2016.
Firstly, the provisions for 2016/17 onwards:
- Currently Scheme Administrators are required to provide a member with a “pension savings statement” if their annual allowance usage in the scheme (their “pension input amount”) exceeds the annual allowance for the year. This also triggers a report to HMRC within the Annual Event Report. This trigger continues to appear in the 2016/17 requirements
- Added to this for 2016/17 onwards is any member whose “pensionable earnings” for the tax year exceeds £110,000. “Pensionable earnings” is defined as “the member’s salary, wages or fee in respect of the employment to which the public service pension scheme or occupational pension scheme relates”
The draft regulations also propose changes to the pension savings statement relating to the use of the 2015/16 annual allowance in the light of the special transitional annual allowance test applying (ahead of all pension input periods being aligned to a tax year basis):
- The trigger for automatically issuing a 2015/16 statement is if a member has a total pension input amount in a scheme (across all the pension input periods that end in 2015/16 following the various pension input period realignments) exceeding £40,000 (this despite the special “£0/£80,000” pre-alignment and post-alignment provisions for that year); and
- Where this trigger applies (or on request) the pension input amount must be split into the part counting as falling into the pre- and post-alignment “mini tax years”
There is a very short consultation period, ending on 17 February 2016.
Comment
The 2015/16 proposals seem not unreasonable adjustments. But there are several questions about the intent of the 2016/17 onwards proposals, in a world where “high income” individuals will have an annual allowance less than £40,000 of an amount that the scheme will not know.
With regard to the “pensionable earnings” group, we hope the intent is that it means member’s pensionable salary on which accrual is based – something the scheme will know. But if (as drafted) it is intended to cover a member’s salary with the sponsoring employer then that requires a whole new burdensome process of information provision from the employer. In its Newsletter 75 HMRC says that it is “particularly interested in your comments on how pensionable income is defined”. We hope this means the definition could well change.
We also hope that HMRC intends the core trigger to mean if the pension input amount exceeds the core annual allowance that applies for those who are not “high income” – ie the plain £40,000. As currently drafted it centres round a personal annual allowance which the scheme cannot know.
It has always been the case that these pension savings statement triggers do not pick up all people who actually have an annual allowance charge to pay, and pick up many who do not – so the triggers create just a “line in the sand group” and some members have to self-identify and ask for information. We think the draft regulations intend to continue this principle. Inevitably they have to cause more pension savings statements to be issued – but they need to be honed to avoid causing pension schemes disproportionate work. The short consultation window needs to be used to good effect (even as we head towards the unknown future due to be announced on 16 March).
DC market shows signs of further consolidation amidst strong growth
The Pensions Regulator’s seventh edition of its survey of occupational DC trust-based schemes and memberships shows further evidence of an increased concentration of the DC market by the largest schemes.
The Regulator reports that the number of DC schemes with 5,000 members or more has increased from 80 to 120 since December 2013 and that 86% of DC savers are now to be found in such schemes.
The number of DC members has increased significantly again, with 2.3 million new members since last year’s report (see Pensions Bulletin 2015/06), bringing the total to 6.9 million.
The Regulator goes on to say that there has been a 90% increase in DC memberships of multi-employer schemes with the survey showing that of those savers in schemes being used for automatic enrolment, 76% are in master trusts. The Regulator acknowledges that this poses some risk associated with regulatory arbitrage as master trusts are “subject to far less regulatory scrutiny than ... contract-based providers”.
As in previous years the survey is based on information supplied via the scheme registration and scheme return processes and was extracted as at 31 December 2015.
Comment
These figures are no surprise and give a clue as to where the Regulator will be focussing its resources in order to drive up standards of governance and administration. However, and as the Regulator acknowledges, it cannot ignore those who will remain members of smaller and increasingly closed DC schemes, for whom many surveys have shown that better member outcomes may be prejudiced by operational and other standards that are lacking.
ACA says it is time to pull together to boost retirement incomes
The Association of Consulting Actuaries focuses on employers’ views on pension taxation and how they are reacting to the end of contracting out in the second report of its 2015 pension trends survey, before going on to make a plea for increased retirement savings.
Amongst the report’s findings are the following:
- 81% of employers are concerned at the level of pension spending they are incurring with 43% looking to target 6% or less of payroll on pensions
- 31% of employers say the reduction in tax relief and complexities of the regime have caused employees on higher incomes to leave their schemes
- Only 13% of employers say that if pensions were taxed like ISAs, with a top-up from Government during accumulation, that this would boost pension saving; and
- 20% of employers running defined benefit schemes at present open to future accrual say they will close their scheme following contracting out ending in April 2016
On this last point the ACA is concerned that 5 April 2016 will mark a further wave of defined benefit closures to future accrual, exacerbating a worrying drift downwards in median pension contributions revealed in its first report (see Pensions Bulletin 2015/44).
Returning to the theme developed in its first report, the ACA says that now is the time to “pull together” to convince employers and employees alike to save more to improve retirement income particularly for those in receipt of lower workplace incomes, with the Government reviewing in a joined-up way its pension strategy, spending plans, tax policies and incentives to help make this happen.
Comment
The need to make greater retirement savings has been flagged by the ACA and others a number of times, but at present there appears to be no appetite within the Government to broach this issue, let alone take it forwards.
Triple lock will apply to the new State Pension
A government minister has confirmed that the new State Pension will increase in line with the greater of national average earnings, inflation and 2.5%, seemingly during the course of this Parliament.
In response to questions on pensioner incomes, Shailesh Vara, the Parliamentary Under-Secretary of State for Work and Pensions, stated that the Government will triple lock the Basic and new State Pension amongst other measures designed to assist older people.
Comment
We have been wondering about this for a while. There seems to have been a general assumption that the triple lock will apply to the new State Pension which starts this April and some noises from government that this will be the case. But we now have a clear policy statement which is welcome, at least in terms of having certainty.
In the short term the additional cost will be relatively small as it will affect only that part of the new State Pension above the Basic State Pension for those reaching State Pension Age in the next few years, during which earnings growth could well exceed both inflation and 2.5%. But there is no doubt that the triple lock is an expensive policy in the long run.
Incentive exercises code of practice updated
The industry-wide group that issued a voluntary Code of Good Practice for employers, trustees and advisors when carrying out incentive exercises has issued a new edition. This follows a review into the effectiveness of the Code since it was launched in June 2012 (see Pensions Bulletin 2012/25).
The Incentive Exercises Monitoring Board reports that the 2012 Code has been well received by the industry, with trustees and employers clearly wanting to comply with it, despite its voluntary nature. The Board believes that the Code has resulted in better behaviours, better run exercises and less risk of members being disadvantaged.
In the new version the Principles have been left largely unchanged, but the body of the Code has been updated to reflect the changing environment. “Boundary examples” have also been introduced to help illustrate how the Code could and should be applied in practice.
The Board reports that Winding Up Lump Sums remain under review, with a promise to consult during 2016 on whether to now include them within the Code and if so which type.
Comment
This is a good result for the Code and shows what can be achieved through voluntary means. The alternative of a regulated solution would have been too blunt an instrument. The threat remains, but hopefully the Department for Work and Pensions will be relieved that for now at least, this is one area where they do not need to reach for the parliamentary draftsman.
Charges and Governance – draft amending regulations published
The draft Occupational Pension Schemes (Scheme Administration) (Amendment) Regulations 2016, which will tidy up the Charges and Governance Regulations 2015, have been published and will come into force on 6 April 2016. There are some changes from those issued for consultation (as part of a wider package of changes to pension regulations – see Pensions Bulletin 2015/49). One of these is that the Secretary of State will be required to undertake a review, at not more than five yearly intervals, of the Governance section of the Scheme Administration regulations.
The Department for Work and Pensions has also published the response to that part of the consultation which covered charges and governance. In it, the DWP particularly notes the responses regarding master trusts and agrees that “it is essential that the right protections are in place for master trusts in order to address the potential for members to lose out”.
The DWP is undertaking longer term work on regulation, deregulation and member protection and aims to set out its next steps for future work on this in the coming months.
Auto-enrolment earnings parameters – draft Order published
The draft Automatic Enrolment (Earnings Trigger and Qualifying Earnings Band) Order 2016, which will give effect to the 2016/17 earnings parameters agreed in December (see Pensions Bulletin 2015/53), has been published.
Regulator consults on its innovation plan
As part of the Government’s plan to raise UK productivity, the Pensions Regulator, along with other regulators, is required to consult on and publish “innovation plans” by spring 2016. These plans will specifically set out:
- An assessment of how new technology is likely to shape the sectors being regulated
- How legislation and enforcement frameworks could adapt to new technologies and disruptive business models to encourage growth; and
- Actions for how regulators could better utilise new technologies to generate efficiency savings and reduce burdens on business
Accordingly the Pensions Regulator is now consulting on its innovation plan.
The consultation document sets out the Regulator’s thoughts (formulated in conjunction with the Department for Work and Pensions) under these three headings, with the Regulator posing three specific questions for those who wish to respond. Consultation closes on 12 February 2016.
Comment
An odd title to what is little more than a statement containing future gazing and more prosaic plans to improve the Regulator’s website and related matters. It is far from clear how any of this will raise UK productivity – certainly insofar as the regulated community is concerned.
PPF levy ceiling and compensation cap rise in line with average earnings
The ceiling that the estimated overall pension protection levy cannot rise above has been increased by 3.6%. This is the substance of an Order made by the Department for Work and Pensions.
The Pension Protection Fund and Occupational Pension Schemes (Levy Ceiling and Compensation Cap) Order 2016 (SI 2016/82) provides that the ceiling for the 2016/17 pension protection levy will be £981,724,264. The increase follows that of the general level of earnings – and is by reference to the year ending July 2015.
The same Order also provides that the PPF compensation cap rises to £37,420.42 from 1 April 2016.
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.
