UK: Pensions Update

Last Updated: 16 February 2011
Article by Caoimhe O'Neill

CONTENTS

  • Nortel/Lehman Brothers decision strengthens regulators powers
  • The Government issues its first CPI Revaluation/Indexation Order
  • Pensions Regulator issues revised guidance on "Inducements" now called "Incentives"
  • Government introduces "Fixed Protection"
  • The Government clarifies its position on abolition of contracting out by defined contribution schemes
  • Government consults on the impact of CPI on private pension schemes
  • End of compulsory annuity purchase at age 75
  • Early Access to pension saving

Nortel/Lehman Brothers decision strengthens Regulators powers

On 10 December the High Court gave its decision on the appeal by the administrators the Lehmans and Nortel Group concerning the validity of the imposition by the Pensions Regulator of Financial Support Directions ("FSD") and Contribution Notices ("CNs") upon companies that were in administration or insolvent liquidation.

The key issue was to establish whether the cost of complying with the FSD or the monetary obligation enforced by a CN is a provable debt (and whether the Regulator stands as another unsecured creditor) or an expense. The Court in particular looked at what priority on insolvency Parliament had intended to give the Regulator when imposing these financial obligations.

The administrators of Lehmans and Nortel had argued that the orders simply created a non-provable claim against the target companies and therefore, could only be payable if there was a surplus available after the full payment to all unsecured creditors. The Regulator argued that the cost of complying with such liabilities was an expense of administration or liquidation.

The Court concluded that where an FSD or CN were imposed on a target company before insolvency started, then this would simply create a provable debt on the insolvency and therefore, the Regulator would stand as an unsecured creditor. However, if the obligation were issued after the commencement of administration/insolvency it could not be a provable debt and therefore would be considered to be an expense of the winding up and take super priority above other creditors.

The case is interesting to note because it appears to suggest that if the Regulator imposes an FSD or a CN upon a party after it commences administration/ insolvency that obligation takes higher priority than if the same obligation had been imposed by the Regulatory prior to the commencement of insolvency. The case clearly suggests that the Regulator is nearly always better off imposing its powers after the commencement of the administration/insolvency process upon a party after it commences rather than before. The Judge stated that that Parliament may want to consider dealing with this discrepancy as it could be perceived that an FSD or CN imposed after the commencement of a winding up is potentially unfair to the targets' other creditors and potentially inconsistent with the decisions taken around the Pensions Act 2004 to not generally elevate employers pension claims over the claims of other creditors. We understand the decision is to be appealed.

The Government issues its first CPI Revaluation/Indexation Order

The Occupational Pension Schemes (Revaluation) Order 2010 has been laid before parliament on 8 December. This Order which deals with increases in pensions in payment and revaluation of deferred pensions by reference to a reference period of 1 January 2010. This is the first Order to calculate the increase by going forward by reference to CPI (the Consumer Prices Index) rather than RPI (the Retail Prices Index).

Pensions Regulator issues revised guidance on "inducements" now called "incentives"

The Guidance itself is designed to address both incentive exercises (such as cash induced transfer requests) and the modification of defined benefits (for example the surrender of non-statutory pension increases). The guidance is an update of the Regulator's previous position set out in its guidance dealing with inducement offers (incentives being the Regulator's preferred word to inducements).

While the Guidance is simply that, Regulator guidance, this version does have a number of areas which suggest that the Regulator is taking a much more pessimistic attitude to such exercises. In particular, the Regulator advises Trustees that their starting position should be that an incentive exercise is not in members' best interests and should therefore be approached cautiously by all parties.

The Guidance sets out the five principles that must be adopted before such exercises should be completed. These are:

  1. Clear, fair and not misleading information
  2. Open and transparent communications
  3. The specific management of conflicts of interest
  4. The Trustees being consulted at all points during the process
  5. Independent financial advice should be recommended, and "in almost all circumstance the structure of the offer should require the member to take financial advice"

While the Guidance is correct that the Regulator does have a duty to protect members' interests, ultimately, whether individuals wish to transfer out of their pension scheme is really a matter for them in exercise of the statutory right to take cash equivalent transfer. However, it is probable that trustees (who are likely to feel bound to comply with the guidance) will take a more cautious approach.

The revised Guidance is therefore likely to make the planning and putting into place of such incentive arrangements more difficult for employers. While we do not believe that ultimately, the guidance can have any impact upon whether companies do seek to put in place incentive schemes, particularly those designed outside of the pension arrangement, it is worth employers and trustees noting the terms of the guidance should they wish to consider such an exercise.

Government introduces "Fixed Protection"

Under the Finance Bill 2011, which will introduce the new lifetime and annual allowances, the Government has confirmed that a new protection regime will enable individuals to take advantage of the current £1.8 million lifetime allowance so long as they accrue no further benefits. Individuals that have already claimed enhanced or primary protection pre-6 April 2006 will be able to rely on the £1.8 million limit.

Therefore, if you have members that fall in this category because they have exceeded the £1.5 million but less than £1.8 million it is worth considering the impact of the Finance Bill on their future pension provision.

The Government clarifies its position on abolition of contracting out by defined contribution schemes.

On 30 November 2010 the DWP issued "Abolition of Contracting Out on a Defined Contribution Basis – Government Response to Consultation on Draft Consequential Legislation".

This paper follows the announcement of 10 March 2010, from the then Labour Government where it confirmed the abolition of contracting out on a defined contribution ("DC") basis with effect from 6 April 2012. Among the key changes the Coalition Government has now suggested it will implement to aid this process are:

  • It will amend legislation to make it clear that any transfer prior to 6 April 2012 involving benefits transferring out of a contracted out defined contribution scheme to a contracted-out salary related scheme will continue to be treated in the receiving scheme as contracted-out rights under section 9(2B) of the Pension Schemes Act 1993.
  • It will amend legislation to make it clear that schemes that are contracted out on a mixed benefits basis would have their certificate automatically amended so that the scheme would only be contracted out on a final salary basis. There was therefore no need to reissue any contracting out certificates. The Government confirmed that any information it will issue between now and April 2012 will heavily emphasise the change in contracting out post April 2012.
  • The Government confirmed that once contracting out on a DC basis is abolished, the certificates will be cancelled and any contracting out rebates accrual will cease on 6 April 2012.
  • The Government confirmed that they will create an exemption from the requirement to inform members within one month of their scheme ceasing to be contracted out on a DC basis and an exemption from the requirement to inform members within four months of the effects of the scheme ceasing to be contracting out where schemes have informed affected members and provided the required information within the year preceding the abolition date of April 2012. This then gives the scheme the ability to inform members of these changes in any regular member communication in the run up to abolition, for example in an annual benefit statement or scheme report.
  • The Government also confirmed that the implications under the Disclosure of Information Regulations should only apply to affected members i.e. members who are in active service that is contracted-out on a DC basis rather than all members.
  • Helpfully the Government have also confirmed that from April 2012 protected rights (the name given to contracted out benefits on a DC basis) shall be treated as ordinary rights under the scheme.
  • Looking at transfers, the Government clarified that because protected rights will no longer exist, any of the existing restrictions which prevent the transfer of protected rights funds will no longer apply.
  • Crucially the Government also confirmed that transfers from defined benefit contracted-out schemes to contracted-in schemes will be allowed post abolition. Safeguards will be included to ensure members are aware of the implications of such a transfer in particular that there will no longer be a requirement to provide a survivors benefit after transfer.
  • Finally, the Government confirmed that survivors of members who died before 6 April 2012 will continue to be considered protected rights and dealt with under the current legislation. Therefore survivor benefits would still need to be provided as under the old rules. However for deaths post 6 April 2012 there is no requirement to provide a survivors pension.

Government consults on the impact of CPI on private pension schemes

On 8 December 2010 the Government commenced its consultation regarding the impact of CPI on private sector pension's schemes. In summary the Government's view is as follows:

  • The Government concluded that it does not propose to introduce legislation to provide a statutory override i.e. legislation that would override schemes rules and require them to apply CPI where RPI or other forms of increase are required. The Government claims this is an unwarranted interference of the rights of employers and trustees to manage their financial affairs.
  • The Government also confirmed it had no plans to interfere with any existing buy-in or buy-out contracts by means of a statutory override where RPI had already been the agreed basis of revaluation.
  • That as GMP increases as calculated by reference to the general level of earnings, the change from RPI to CPI under the Government's Revaluation Order is not relevant. Therefore GMP's will continue to increase by reference to the current mechanism.
  • The Government clarified that the revaluation and indexation legislation does not actually specify that the increase must be by reference to any particular index. Therefore it is the discretion of the Government whether it calculates by reference to RPI, CPI or any other methods selected.
  • The Government acknowledges that without further legislation, any schemes that do not specify the basis of revaluation or state that it will be calculated by reference to overriding legislation can apply CPI straight away.
  • Schemes that specifically apply RPI will only apply CPI where CPI is greater than the RPI increase stated in the relevant scheme's rules.
  • The Government acknowledges that there are schemes where the rate is set by reference to the RPI or such other indexes that may be selected by a party, in which case that party would have the power to select to move to the CPI, subject to any fiduciary duties that may apply.
  • The Government clarified that it will amend the consultation regulations so that any change to the basis of revaluation or indexation would be a listed change requiring consultation "but only where the change would be less generous to members or members of a particular description".
  • It is interesting to note this reference to it "would be less generous" given that a straight change from RPI to CPI is not guaranteed to be less generous, only that historically it has been less generous. This proposed amendment to the consultation regulations is likely therefore to generate quite a few responses during the consultation.
  • However, the government is considering introducing modification powers i.e. powers to allow trustees to make changes to their scheme and to introduce CPI where otherwise there will be restrictions under their scheme rules. The Government states that it is finally balanced on this point and welcomes views.
  • The Government appears to be of the view that introducing such a modification power is likely to be very difficult given their restrictions under Section 67 and the balance of powers of particular schemes.

Such reference to warranted interference and the rights of employers and Trustees somewhat ignores the fact that up till 1997 pension increases were not required under statute in the first place and it was only legislation that provided a requirement to index pensions in the first place rather than agreement between trustees and employers. However, we suspect there is more likely to be issues in relation to human rights law in particular the right to protection of property behind this decision, as well as the political fallback which has led to this decision rather than anything on whether to introduce amendments.

Interestingly, and potentially more boldly for the Government, they suggest that they are considering the possibility that any scheme that has increases calculated by reference to RPI may not be required to provide a CPI underpin in any year where the CPI is higher than the RPI. The Government justifies this potential change on the basis that if RPI is generally expected to exceed RPI, members in schemes that choose to use RPI would be better off over time compared to the schemes that did not and should not benefit essentially from a ratcheting up in any years were these indexes the other way around.

In addition, the effect of not making such a change would be to increase pension costs for schemes and employers, penalising and discouraging those who choose to stick with the RPI.

The Government proposes to make this change by an amendment directly to Section 51(2) of the Pensions Act 1955. Consultation is due to run from 8 December 2010 to 2 March 2011.

End of compulsory annuity purchase at age 75

The Finance Bill 2011 also seeks to end the legal requirement for annuities to be purchased by the age of 75. Under the draft bill, where an individual can prove that he will secure a minimum income through pension benefits of £20,000 per annum he will be able to take advantage of draw down provisions contained within the regulations. However, funds remaining in the individual's pension arrangements on death after the age of 75 will face a 55% tax charge but no inheritance tax will apply. This is designed to avoid individuals using their pension arrangements as tax shelters. Schemes will be provided with overriding powers to make payments under the new legislation even if they are not permitted by their scheme rules.

Early access to pension saving

On 13 December Mark Hoban MP, Financial Secretary to the Treasury kicked off a consultation with the pensions industry with respect to whether allowing individuals early access to their pension saving was both beneficial to the individuals and a way of making pension saving a more attractive option to individuals. Among the concepts being consulted upon are as follows:

  • Is it likely that allowing individuals to draw benefits prior to retirement would be beneficial to overall pension saving and not be outweighed by a decline in overall pension saving.
  • Is it beneficial to allow individuals access to their DC funds held in pension schemes where financial crisis arrives as a result of unemployment or threat of repossession of their home and they have no other liquid savings. However the Government acknowledges that individuals who do not have "spare" money available in case of hardship are also likely for individuals who have no or limited pension saving. Therefore this may not be the solution to the problem.
  • In particular the Government is looking for comments on the following questions:
  1. Would allowing early access to pension saving in situations such as acute hardship help a significant proportion of people in such circumstances?
  2. Is there an argument for early access as a way of promoting intergenerational redistribution of pension's wealth in cases where the pension saver's relatives face financial difficulties?
  3. Would this create a risk for the individual's income on retirement?
  • The models being considered are a loan model: in which the pension scheme would loan money to the individual, permanent withdrawal, under which the individual would be allowed to withdraw certain monies from the pension scheme in limited circumstances permanently; early access to the 25% tax free lump sum and finally a feeder fund model under which other tax free savings such as ISA's could be linked up to the pension scheme for the purposes of.
  • The Government is also looking at other possibilities for being more flexible with the pension tax rules to allow better saving. In particular the Government is also after comments with respect to trivial commutation limit of £18,000 on for all occupational schemes and the £2,000 limit on trivial commutation from individual arrangements. In addition the Government is also consulting with respect to any changes which will allow transfer of pension benefits to be much easier to facilitate.
  • Any individual wishing to make a comment is required to write to the Treasury by 25 February 2011

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Caoimhe O'Neill
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