Proposed increase in the pension regulator's anti-avoidance powers

Why is the Government proposing change?

The Government has noted that recent developments in the administration of occupational pension schemes (particularly the growth of the 'non-insured' buyout market) have seen "the launch of business models that look to sever the link between employer and scheme, and operate well-funded occupational pensions schemes for profit but to the possible detriment of scheme members."  The Government has stated that in light of these developments, amendments to the Regulator's powers would be helpful, as experience has shown that there are acts that present risks for member benefits which may not currently trigger the issue of a Contribution Notice (CN). The government has also taken the opportunity to strength the financial support direction regulations.

 

The Regulator's Existing Anti-Avoidance Powers: A Quick Reminder

 

The Pensions Act 2004 gave the Regulator the power to issue CNs and financial support directions (FSD) in circumstances where pensions liabilities are or could be avoided by a party.  Since being introduced, these powers have been rarely used by the Regulator but parties involved in corporate deals in particular have needed to consider the risks of the Regulator exercising its powers in response to a proposed transaction. 

A CN requires an amount up to and including an employer debt due to be paid to the scheme by a scheme employer or an associated or connected person (which can be a corporate or an individual). A CN can be issued where such a person was a party to an act or a deliberate failure to act and one of the main purposes of the act (or failure to act) was either avoiding a debt to a pension scheme or preventing such a debt being due. Importantly, the intention behind the act or failure to act is essential and the Regulator cannot currently issue a CN if debt avoidance / reduction was not one of the main purposes. There is also currently a "safe harbour": the Regulator cannot issue a CN if it is satisfied that a party was acting in good faith.

An FSD may be issued by the Regulator to entities that are connected or associated with an employer within a group which is either a service company, or is insufficiently resourced and participates in an underfunded defined benefit (DB) scheme.  Under the existing regime, the Regulator must identify a single 'person' (usually a corporate) which has available assets to fill the gap between the employer's resource and the required level of resource. Currently the Regulator cannot issue an FSD unless there is a single person with sufficient available resource to "fill the gap" even if, two connected persons would together have sufficient available resource.

 

Amendments to Regulator's power to issue CNs

 

The Government is proposing that CNs may be issued by the Regulator where the "effect of an act is materially detrimental to a scheme's ability to pay members' current and future benefits".  This would be a major change to the current test. The Regulator's power to issue a CN would no longer be limited to situations where the party's intention was to avoid or reduce a debt. In addition, it appears that the protection offered by the 'good faith safe harbour' is going to be withdrawn. 

The Government also intends to ensure that the use of the Regulator's moral hazard powers is not frustrated by 'bulk transfers' of members between pension schemes and will amend the Regulator's power in relation to CNs in order to achieve this. The Government is proposing to clarify that the issue of a CN can be triggered by a series of acts and not just a single act.  This amendment will be retrospective to 27 April 2004.

 

Amendments to Regulator's power to issue FSDs

 

The Government has proposed that the resources of a whole group of companies can be considered by the Regulator when debating whether to issue an FSD, rather than the present requirement for the Regulator to identify a single entity which has sufficient resources to cover scheme debt.

 

Effective Date of the Amendments

 

Following consultation, it is proposed that all of the amendments will take effect from 14 April 2008, except for the 'series of acts' amendment which will be effective back to 27 April 2004 (the effective date of the CN legislation).

 

Response of the Regulator

 

The Regulator has welcomed the Government proposals, with chief executive Tony Hobman stating:

"We welcome the package of changes to legislation proposed by DWP, which will enable us to better protect members where their benefits are at risk. I believe our record to date provides comfort that we will continue to act in a risk-based way, using our powers as a last resort."

 

Comment

 

When they were introduced in 2004, the anti-avoidance powers were viewed as a potentially powerful deterrent to parties considering transactions which might jeopardise the security of pension scheme assets. Although the powers have rarely been used by the Regulator, their existence has influenced behaviour amongst sponsors of pension schemes and it is strongly arguable that, as a consequence, they have minimised claims on the PPF. This was the main purpose of the anti-avoidance provisions. 

 

The new test – the motive

 

The proposed changes relating to CNs reflect a concern that times have changed and that the anti-avoidance powers are no longer sufficiently wide reaching, whether in their actual application or in the range of behaviour which they are capable of influencing.

The Government has identified as a prime concern some of the new non-insured buyout structures in the marketplace. These structures sever the link between the corporate covenant and the scheme whilst remaining in the occupational pension regime rather than transferring to the FSA regime.

There are potential advantages to the providers who use these structures. They can provide a competitive advantage on pricing through "regulatory arbitrage". The structures avoid the need for providers to comply with the strict capital reserving requirements to which the more "traditional" insurance buyout providers are subject. Also, the occupational pension regime makes it potentially easier for these providers to access surplus in the pension scheme which, again, can enable them to price the assumption of pension scheme liabilities more competitively than traditional insurance providers. But there is potentially a major difficulty with these structures, because there will often be potential for an unmanageable conflict to arise between the interests of the provider and the scheme's beneficiaries.

The DWP has made no secret of the fact that the extension of the anti-avoidance powers is focussed primarily on ensuring that the Regulator has power to intervene where it considers that transactions of this nature are not consistent with scheme members' interests.

 

The new test – the consequences

 

The proposed changes to the CN test represent the significant move from an intent-based test to an effect-based test. This change will inevitably give more flexibility to the Regulator to intervene in the type of buyout transactions which are causing concern. But, there is also a danger of unintended consequences because the scope of the proposed new test is so wide. 

The proposed new test will create significant risk and uncertainty for the sponsors of DB pension schemes. The risk is potentially greater because of the proposal to make the changes retrospective. It is conceivable that corporate sponsors who take their responsibilities to their schemes seriously are currently committed to transactions which fall outside the scope of the anti-avoidance legislation as it stands but which could potentially expose them to the risk of a CN if the law is changed retrospectively as proposed.

A possible short term consequence of the proposed change, particularly if the Department for Work and Pensions (DWP) delays publishing the detailed consultation document, is a sharp increase in the volume of clearance applications from concerned sponsors. An increase in applications will inevitably place a strain on the Regulator's clearance team and could result in a wide scale slow down in corporate activity. This would represent a significant step backwards and could potentially swamp the Regulator's resource, rather than ensuring that the resource is available to consider carefully only those transactions where there is a genuine concern for the interests of pension scheme beneficiaries.

We would expect significant opposition to these proposals during the consultation process.

 

Removal of the good faith exemption

 

The Regulator has justified the removal of the good faith "safe harbour" because it can potentially protect sponsors who have simply failed to consider the consequences of their actions. We have sympathy for this justification but the removal will, we expect, be of greatest concern to insolvency practitioners (IPs).

The IPs duty to treat a company's creditors fairly can potentially require them to take steps to reduce the amount of debt recoverable from an employer by the scheme. The Regulator will no doubt argue that IPs can take comfort from the fact that the Regulator will still not be able to issue a CN unless it is reasonable to do so. Will the consultation document provide certainty that the Regulator will not consider it reasonable to issue a CN against an IP who reduces a debt in accordance with his duty to treat creditors fairly? This would address the biggest concern associated with this change.

 

Bulk transfers

 

The DWP has stated that it will not allow bulk transfers of members' benefits between pension schemes to frustrate the use of the anti-avoidance powers. It has not at this stage stated how the new law will achieve this. Mike O'Brien, Minister for Pensions Reform has, however, been quoted as saying:

"The proposed changes would also allow the Pensions Regulator to require an employer or associate to make additional contributions to a scheme where a 'bulk transfer' has been carried out and was detrimental to the interests of members."

There is potentially scope for difficulty in this area, particularly where one category of members (pensioners for example) is bulk transferred from a scheme. It might be the case that the position is materially improved for either the transferring or the remaining members, with the position for the other members being potentially not so good. Will the Regulator be prepared to make a judgement between the interests of different categories of member in deciding whether it is appropriate to use its anti-avoidance powers?  

 

Policy clarification

 

The fact that the law will be changed retrospectively to confirm that a CN can be issued in respect of a series of acts rather than in respect of only an individual act is simply a clarification of policy and  ought not to be controversial or problematic.

 

FSD's – taking into account the whole group

 

We consider that the proposed change is sensible in that it would correct an illogical and unnecessary restriction in the original anti-avoidance legislation.