Simplicity security and choice: working and saving for retirement

The White Paper heralds another big shake up for pensions law. In particular, many employers will be worried about how the impact of the improved protection for members will affect them. The changes to the calculation of pension deficits on winding up, on which we commented in our earlier briefing note (New regulations will increase employers' liabilities) could see many companies' credit ratings hit hard.

In this note we comment on the issues the other proposed changes give rise to for employers and trustees.

Important changes to existing practices

This will be established to protect defined benefit scheme members whose employers become insolvent. Companies will pay a flat rate premium to the fund. There will also be an additional risk based premium dependent on an individual scheme's funding position. The coverage of the fund will be limited to paying 100% of pensions in payment and 90% for deferred and active members. There will also be a salary cap of between £40,000 - £60,000.

The aim is to discourage companies from maintaining underfunded schemes (the risk based premium) and from winding up the company in order to avoid the debt on a pension scheme (salary capping is likely to hit those who are decision makers in the company). Some employers may decide that it will still be cheaper to pay higher risk based premiums than to fully fund the scheme. There appears to be a paradox in that underfunded schemes will be paying a higher premium as opposed to higher contributions. It is not clear how the premiums will be calculated or how they will be invested. The Government's expectation that the cost of this fund will be covered by a move into gilts seems misplaced. A lack of Government backing for the fund could also limit its effectiveness.

The aim is to allocate benefits more fairly between pensioners and active and deferred members. Draft regulations will be published during this summer and are expected to come into force this autumn. Priority will be tied more closely to the length of scheme membership. Pension increases will enjoy a lower level of priority at an earlier date than they would otherwise have done.

This will have the effect of moving pension increases down the priority order more quickly than was previously intended (from 2007 they were scheduled to move to the bottom of the priority list). Trustees should consider buying out pensioner benefits now to beat the regulations. If the deficiency regulations model is followed, these changes could take effect from the date the draft regulations are published so this needs immediate consideration. The imminent changes, the profile of the membership and the funding position of the scheme will be amongst the other relevant factors.

Extending Transfer of undertakings (protection of employment) (TUPE) to private sector transfers The Government's aim is to ensure that workers who already enjoy pension contributions will not have them taken away because of a takeover or transfer. The proposal is for employers to make matching contributions of up to 6% to a stakeholder scheme.

This is the lowest level of commitment canvassed in the Green Paper. The extent to which employers may be able to vary the contributions in the future is not clear. The proposal means that it will no longer be possible to ignore Transfer of undertakings (protection of employment) issues on a business acquisition. It does not, though, affect Beckmann issues1 which will remain the potentially more significant issue in this area.

Section 67 of the Pensions Act 1995 will be amended so that scheme rules can be changed where a number of conditions are satisfied. In particular: the total actuarial value of members rights at the point of any change must be maintained; pensions in payment may not be reduced; there may be no conversion to defined contribution; and members must be consulted prior to the change.

This looks uncannily like the legal position before section 67, with the addition of the consultation requirement. Wider changes could, presumably, be made with member consent, but there is no mention of this in the White Paper. The basis of the test will be crucial. Is the test by reference to an individual or a scheme as a whole? It is not clear yet what consultation will require; simply prior notice, as in the context of changes to statements of investment principles; or a more meaningful dialogue, intended to achieve consensus? The EU Information and Consultation Directive could have an impact here and suggests that the latter approach may be more likely.

There is a proposal to replace the minimum funding requirement (MFR) with a scheme specific funding requirement. The proposals (which are largely as trailed in the Green Paper) will require the employer, actuary and trustees to develop a funding strategy for individual schemes. There is no specific timetable set for this.

Actuaries have been very concerned about the prospect of having responsibility for setting contribution rates on this scheme specific basis. The White Paper suggests that it will be trustees' responsibility. This, coupled with the changes to the calculation of the debt on the employer,² will reduce the significance of the precise wording of a scheme's contribution rule but strengthen the position of trustees who do not control contribution rates. This is because the White Paper suggests that if no agreement is reached, trustees may have the power to wind up. Trustees with the power to make a buy-out demand may still wish to do so where there are concerns about the long term solvency of the participating employers, particularly if they lack the power to trigger a wind-up under the scheme rules.

The proposal is that employees who have been members of a scheme for at least three months and who leave within the current vesting period (which may be up to two years) must be offered the choice of a refund of contributions less tax or a cash-equivalent transfer value.

This strikes a balance between the desire for immediate vesting and concerns regarding the extra administrative burden. Members will now get either a refund of their contributions or a transfer of their benefits. There is a small potential increase in cost if members choose the transfer value option.

There is a proposal to reduce the level of limited price indexation for pensions in payment from retail prices index (RPI) up to 5% to RPI up to 2.5%.

The White Paper is not clear whether this will be limited to future accrual. It does though say that there will be no change to pensions in payment.

There is a proposal to require employees to consult before implementing major pensions changes. Nothing has yet been drafted.

It is not clear what consult means but reference is made to the EU Information and Consultation Directive. This contemplates consultation taking place "with a view to reaching an agreement on decisions", suggesting that more than simply prior notice will be required.

There will be a new regulator to replace occupatioanl pension regulatory authority (OPRA) with power to issue codes of practice. The aim is to simplify new legislation and reduce the need for detailed regulations. It is intended that the Codes will have evidential value in proceedings.

Practitioners will obviously still rely on legislation and where there are discrepancies between the codes and the legislation, the legislation will take precedence. The Pensions Ombudsman has previously expressed himself to be sceptical of codes of practice which lack clear industry wide consensus, so the risk is that this proposal has little effect.

Legislation will be introduced requiring trustees to be familiar with all areas that their duties fall under. This could include record keeping, skills audits, training, qualifications and experience.

This is likely to be counter- productive. Trustees who presently are paying attention to the above do not need these measures and those who currently are not may well ignore the provisions. It may further deter individuals from becoming trustees. This may be particularly relevant to member nominated trustees (MNTs).

Possible changes rejected

Two possible changes suggested in the Pickering Report have been dismissed. Compulsory pension scheme membership is rejected, as is the suggested abolition of the requirement for schemes to provide for surviving spouses of scheme members.

A white elephant?

The White Paper describes how the Government will work with the National Association of Pensions Fund (NAPF) and the Inland Revenue to try and find a means of making multi-employer "industry" schemes more feasible. The Government believes such schemes could have a valuable role to play in assisting small and medium sized businesses provide pension savings for employees.

The Government will have to ensure that the proposed structure protects participating employers for the risk of being liable on the new buyout basis for the debts of other participating employers. We doubt that removal of the current practical difficulties with multi-employer schemes will have the effect the Government desires. Some larger schemes which choose to close rather than wind-up may see some economy of scales in merging into multi-employer schemes but we doubt this proposal will have much practical impact.

Other proposed changes

There is a proposal to simplify the administration of GMPs but little detail. There is also a proposal to simplify contracting out. This will involve relaxing the restrictions (in part) on contracted out rights forming part of a taxfree lump sum and being paid at the same time as other benefits. There are proposed changes to the commutation of contracted out benefits in certain circumstances.

MNT provisions are to be overhauled following the technical paper which accompanied the Green Paper. Under the proposal there will be new legislation which is to be backed by guidance from the pensions regulator. The intention is to achieve the objective of member referrals without too much prescription. This change is to be welcomed.

Occupational schemes will be able to choose whether to offer members the option of making additional voluntary contributions (AVCs). Where schemes do not offer this to members then the members will be able to make their own arrangements for additional contributions through stakeholder schemes or personal pension plans.

Defined benefit schemes will be required to give annual benefit statements to members. There will be a pilot scheme for employer based information as trailed in the Green Paper. If this proves to be successful then legislation may be introduced to implement it.

There is no real change to the proposals regarding older workers that were set out in the Green Paper. The Government has signalled its intention to maintain the state pension age of 65 and age discrimination legislation has not yet been implemented. Further consultation will take place during the summer of 2003. There will be greater scope for employees to carry on working for an employer whilst drawing a pension from that employer's scheme. The earliest age from which a pension can be taken will rise from 50 to 55 by 2010.

Further simplifications planned include rationalising how occupational schemes communicate with members, streamlining dispute resolution procedures, clarifying the Pensions Ombudsman's role and simplifying the treatment of pensions on divorce.

1. This is an European Court of Justice (ECJ) decision which suggests that pension entitlements payable before normal retirement age fall outside the scope of the pensions exception to Transfer of undertakings (protection of employment), and therefore pass on the sale of a business. See the Wragge & Co briefing note from July 2002 for more detail. Click Here
2. For more detail on these changes see our briefing note of 17 June 2003. Click Here