UK: The Pensions Bill

The much-awaited Pensions Bill, following on from the Green Paper of December 2002 and the Command Paper of 11 June 2003,was issued on 12 February 2004.

The Bill is a massive document: 248 clauses and 12 schedules, running to a total of 235 pages (ignoring the equally lengthy Explanatory Notes and rumours of more to come).The impact assessment alone runs to 46 pages. The Green Paper was entitled ‘Simplicity, security and choice ’.The very bulk of the Bill suggests that the first of those concepts has received rather little attention.

Even so, it is striking how much the Bill does not contain. There are no amendments to section 67 of the Pensions Act 1995 (restrictions on the amendment power),no wider powers for the Pensions Ombudsman, no significant amendments to section 75 of the Pensions Act 1995 (debt on the employer on winding up),no changes to provide members with immediate vesting rights and no provisions relating to tax simplification. Further clauses or separate legislation may still be in the pipeline since the DWP has not formally dropped the original proposals on these issues.

The Government estimates that the Bill will result in annual savings to business of approximately £130m. The separate tax reforms, if implemented, are expected to result in additional annual savings of £80m. Some may treat these figures with scepticism, especially since the Government estimates that the annual funding costs for the Pensions Protection Fund alone will be approximately £300m.

The only clear savings for businesses derive from the lowering of statutory pension increases from 5%Limited Price Indexation (LPI)to 2.5%LPI (i.e. the greater of annual inflation and 2.5%pa). Although the Government has made much of the potential savings, this change will only apply in respect of future pension accrual and funding assumptions now generally allow for low inflation. As a result, this change may have a relatively small impact – unless inflation rises.

In order to comply with the new statutory standards, trustees will need to understand the new funding objective and to prepare a statement of funding principles and a policy on scheme administration. The new Pensions Regulator ’s Codes of Practice will become essential reading. Trustees will have a lot to learn and training will be essential.

Of particular interest are the provisions regarding the new statutory funding objective, which will replace the Minimum Funding Requirement (MFR). Once that objective is introduced, all aspects of funding will need to be agreed between trustees and employers. This should lead to some interesting negotiations –and some interesting referrals to the Pensions Regulator where no agreement can be reached.

The new Pensions Regulator will take over all of Opra ’s functions as well as some additional ones. Like Opra, the Regulator will seek to ensure compliance with pensions legislation. Unlike Opra, it will have a remit to promote, and improve the understanding of, good administration of work-based pension schemes (e.g. by issuing Codes of Practice)and to pre-empt situations which may lead to compensation being payable from the Pension Protection Fund. The DWP has announced that the new Pensions Regulator will adopt a ‘pro-active approach that in general adopts a light touch ’.The Pensions Regulator will not ‘overburden employers who provide pension schemes ’,but will give employers of well-administered and funded schemes ‘the freedom to continue supporting their schemes without being subject to constant, intrusive and burdensome regulation ’.This remains to be seen.

The Pensions Regulator is to be given extensive powers, significantly greater than the powers granted to Opra. In particular, the Pensions Regulator will have wide powers to gather information, enter business premises and issue improvement notices directing persons to take specific steps to ensure compliance with pensions legislation. It will be able to wind up schemes, and appoint, suspend and prohibit trustees in a greater range of circumstances than Opra. It will have power to issue ‘freezing orders ’preventing certain steps being taken under a scheme, and benefits accruing, while it investigates problems.

The details in the Bill concerning the constitution of the Pensions Regulator show that a good deal of thought has gone into ensuring that it complies with requirements under the Convention of the European Court of Human Rights. A Pensions Regulator Tribunal will be created to deal with disputes with the Pensions Regulator and complainants will have the right of appeal on a point of law from the Tribunal to the Court of Appeal.

Whistleblowing duties will be extended: trustees, employers, administrators, professional advisers and ‘persons otherwise involved in advising trustees ’will have a duty to whistleblow in respect of any breach of law which is likely to be materially significant to the exercise of any of the Regulator ’s functions. Although, for the first time, legal advisers will have a duty to whistleblow, this duty will be restricted by legal professional privilege.

Schemes other than money purchase schemes will be subject to the new statutory funding objective, which will replace the MFR. Assets and liabilities are to be calculated on a basis which has yet to be prescribed, but it will be scheme-specific, unlike the MFR.

Trustees will need to prepare and maintain a statement of funding principles (in addition to the statement of investment principles),setting out their policy for meeting the statutory funding objective. They will also need to prepare valuations and schedules of contributions on the new basis.

What is particularly striking about the new provisions is that trustees must obtain the employer ’s agreement to the methods and assumptions used in valuing liabilities, the schedule of contributions, the statement of funding principles, and any recovery plan to deal with a scheme deficit. For many schemes, where trustees or the actuary have had sole power in dealing with funding issues in excess of the MFR, the Bill will result in a significant change to the balance of powers between trustees and employers.

If trustees fail to reach agreement with the employer on these funding principles, they may with the employer ’s consent modify the future accrual of benefits. If they are still unable to reach agreement, they must report to the Pensions Regulator. The Pensions Regulator will then have power to modify the future accrual of benefits,to give directions as to the calculation of scheme liabilities, to determine the period within which shortfall payments are to be made, and to impose a schedule of contributions. These are sweeping new powers for the Pensions Regulator, which will need properly to balance the interests of employers and scheme members. And it will need to be braced for criticism if it gets the balance wrong. If the Regulator generally takes a stance which is perceived to be, say, pro-employer, employers may be disinclined to reach agreement with trustees and refer funding decisions to the Pensions Regulator. The Pensions Regulator may be kept very busy dealing with all this.

The Board of the Pension Protection Fund will manage the Pension Protection Fund and the Fraud Compensation Fund (taking over from the Pensions Compensation Board). The Pension Protection Fund will take over occupational pension schemes providing final salary benefits that enter winding up with a deficit and no solvent employer. Schemes that enter winding up before the Pension Protection Fund is in place will not qualify for protection.

The pension protection levy will be calculated both according to the size of the scheme and the risk of the scheme calling upon the Pension Protection Fund. The risk-based levy must take account of any scheme deficit, and it may take account of the likelihood of an insolvency event in respect of an employer and the risks associated with the scheme's investments. At least 50%of the total levies raised must be risk-based. However, the Board will not impose a risk-based levy in the first year of operation since it will need time to gather data on which the risk-based levy can be charged. Benefits payable from the Pension Protection Fund are limited to 90%of ‘protected pension ’(see below)in the case of members whose pension is in payment or who are over normal pension age. The periodic compensation cap is expected to be £25,000 per annum (to be raised in line with earnings)on attaining age 65.Members in receipt of a pension when the Pension Protection Fund takes over are not subject to the 90%limit or the periodic compensation cap.

The Pension Protection Fund will not provide the same benefits as those that would otherwise be payable under the scheme ’s own rules since the Pension Protection Fund provides standardised benefits (the ‘protected pension ’).For example, the maximum revaluation rate is 5%per annum; recent discretionary increases may be ignored; commutation is to be governed by the Board ’s own actuarial tables; and pension increases are limited to 2.5%LPI in respect of benefits accrued after 5 April 1997.

The Reconsideration Committee of the Board will have power to review certain matters and investigate certain complaints of maladministration against the Board. An Ombudsman for the Board of the Pension Protection Fund will be appointed. This new Ombudsman will deal with matters that have been reviewed by the Board and complaints of maladministration against the Board.

Most occupational pension schemes will need to have at least one-third member-nominated trustees/trustee directors. It will no longer be possible to opt out of this requirement. The new legislation is relatively non-prescriptive on the procedures trustees may adopt to comply with this requirement. Whether this means we shall be seeing the emergence of finance director member trustees remains to be seen.

The Bill provides what pension obligations will fall on an employer that acquires new employees under a TUPE transfer. If those employees were members of an occupational pension scheme, it will need to match the previous employer ’s pension contributions up to a maximum of 6%of earnings (or establish a final salary occupational pension scheme complying with certain requirements).

In the cases of Beckmann and Martin ,the European Court of Justice ruled that contractual duties to provide benefits payable on early retirement under an occupational pension scheme transferred under TUPE. It is unclear how the Bill fits in with those rulings.

The Bill contains new IDR provisions, giving trustees more flexibility over procedure. In particular, the IDR procedure will no longer need to allow for a two-stage process.

The Bill allows schemes to provide (in respect of future accrual only)annual statutory pension increases at 2.5%LPI (instead of 5%LPI).This change will not apply automatically to most schemes: a rule amendment will be required.

The Bill provides for the deferment of State pension after State pension age in return for a lump sum. This is a new option, introduced as an alternative to an increased pension.

The Bill provides that regulations can be issued requiring: trustees to provide combined pension forecasts (including scheme and State pension information);and employers to take action for the purpose of enabling employees to obtain information and advice about pensions and saving for retirement.