Reed Smith Client Alert

How the time flies. With 2013 having now drawn to a close, the attention of pension trustees and employers has turned to what pensions issues 2014 may bring. We have discussed some of the likely “agenda items” below.

GMP Equalisation

In January 2010 the DWP announced its conclusion that GMPs should be equalised regardless of whether or not a comparator can be identified.

Then, after two years of pensions practitioners nervously speculating on what this might mean in practice, in 2012 the DWP consulted on draft legislation and a methodology on how to equalise GMPs. However, the proposed methodology was criticised by many as being costly, administratively complex and failing to cover divorce, death and other cases. GMP conversion (i.e., a process whereby GMPs are simply converted to “normal” scheme benefits) seems to be the pension industry’s preferred solution to the issue, on the assumption that steps need to be taken at all. Responding to this feedback, the DWP is considering publishing statutory guidance on how the GMP conversion process may be used alongside GMP equalisation.

In February 2013 the Pensions Minister, Steve Webb, announced that a pack of legislative changes on GMP equalisation would be put forward in Spring 2014, and that no further announcement would be issued until then.
Many of our pension trustee clients are adopting a “wait and see” approach, sensibly intending to implement GMP equalisation only once the legislation becomes clear. Spring 2014 is just around the corner, so we expect GMP equalisation to be a major discussion point for trustees and employers this year.

Pensions Tax Changes

With effect from 6 April 2014, the annual allowance will reduce from £50,000 to £40,000 and the lifetime allowance from £1.5 million to £1.25 million.

Two new forms of transitional protection – “fixed protection 2014” and “individual protection 2014” – will be available for affected individuals who have not already registered for primary, enhanced or fixed protection.

Claiming fixed protection 2014 will give an individual a lifetime allowance of the greater of £1.5 million and the standard lifetime allowance (i.e., £1.25 million on 6 April 2014), but this protection will be lost if the individual accrues any further pension benefits.

Claiming individual protection 2014 will give an individual a lifetime allowance equal to the value of his or her pension savings on 5 April 2014, subject to an overall maximum £1.5 million lifetime allowance. In contrast to fixed protection 2014, the individual will not lose this protection if he or she continues to accrue further pension benefits, subject to the £1.5 million cap.

The Impact of the ‘Money Purchase Benefits’ Definition Change

The new statutory definition of “money purchase benefits” included in the Pensions Act 2011 was introduced by the DWP to ensure that a funding deficit could not arise in relation to money purchase benefits, effectively, to negate the effects of the 2011 Supreme Court decision in Houldworth and another v Bridge Trustees Ltd. However, the new definition has not yet been brought into force.

In October 2013 the DWP opened a consultation on draft Regulations in relation to the new definition. If the consultation progresses as planned by the DWP, the Regulations will come into force on 6 April 2014 with retrospective effect (in many cases) from 1 January 1997.

In practice, the new definition will mean that some benefits previously treated by schemes as money purchase will now be re-classified as defined benefit. For example, schemes with any of the following features may be affected:

  • A guarantee in the accumulation phase (i.e., the period in which contributions build up in members’ pension accounts) e.g., some form of guaranteed amount linked to salary, interest rate or investment yield on contributions
  • A pension in payment paid directly from the scheme derived from money purchase benefits, unless this is backed by a matching insurance policy
  • Where money purchase benefits are underpinned by a GMP (or any other defined benefit-type benefit)

If benefits formerly treated as money purchase are re-classified as defined benefit then there are far-reaching consequences. Such benefits will, for example, become subject to the employer debt, scheme-specific funding and PPF levy regimes.

The draft Regulations provide some comfort by introducing transitional provisions giving affected schemes time to comply with these resulting regulatory requirements. In some circumstances the retrospective nature of the amendments is also limited so that trustees will not need to revisit past decisions. For example, the draft Regulations provide that:

  • Schemes that commenced winding up on or before 27 July 2011 (the date of the Supreme Court decision) will not have to revisit past decisions
  • Schemes will not have to revisit historic section 75 employer debt calculations where the trigger event occurred on or before 27 July 2011
  • Schemes will not have to revisit transfers completed before 6 April 2014
  • The scheme-specific funding requirements will be disapplied in relation to periods before 6th April 2014.

Given the DWP’s proposed 6 April 2014 implementation date, we would recommend that trustees and employers of potentially affected schemes consider the possible impact of the new definition and draft Regulations as soon as possible.

The Pensions Regulator’s New Statutory Objective and Approach to Regulating Defined Benefit Schemes

On 2 December 2013, the Pensions Regulator published for consultation a draft revised code of practice on defined benefit funding, together with a draft funding policy and regulatory strategy for defined benefit schemes. The consultation runs until 7 February 2014 and the Regulator anticipates that the new code will be in force by July 2014, applying to schemes undertaking valuations from that time.

The consultation sets out how the Regulator intends to balance its proposed new statutory objective, applicable to the exercise of the Regulator’s functions in a defined benefit scheme funding context only, “to minimise any adverse impact on the sustainable growth of an employer” against its other statutory objectives.

The existing code of practice on defined benefit funding is largely concerned with the process of agreeing scheme specific funding within the 15-month statutory deadline, whereas the draft revised code instead focuses on a more principles-based and outcome-focussed approach. A key theme of the revised code is that trustees should adopt an integrated approach to risk management. Key scheme risks, namely employer covenant, investment and funding, are interlinked and should be considered “in the round”. The Regulator acknowledges that it has moved away from its old discrete triggers (such as recovery plan lengths and discount rates) and instead will adopt a “broad suite of risk indicators” built around these key risk areas.

The draft revised code states that trustees should ensure that any funding shortfall (on an appropriate funding basis) is eliminated “as quickly as the employer can reasonably afford”. In doing so, trustees should seek balance so as not to (i) unreasonably impact on the employer’s sustainable growth and investment plans and it ability to support the scheme; (ii) compromise the needs of the scheme; or (iii) take excessive or unnecessary risks.

Defined Ambition

At the end of 2013 the DWP consulted on proposals for a new category of “defined ambition” pensions as a way of sharing costs and risks more equally between employers and members. The DWP’s intention is to consult on draft legislation in the coming months.

“Flexible Defined Benefit” Models

The DWP has proposed the following three new “flexible defined benefit” models:

  • Removing the statutory requirement for the indexation of pensions in payment
  • Allowing employers to convert a member’s defined benefit pension to money purchase and transfer it to a nominated money purchase pension fund if the member leaves employment before retirement
  • Giving employers greater flexibility to adjust the normal retirement age under the scheme

These models are likely to attract those employers who still have a defined benefit scheme open to future accrual, particularly in the context of contracting out (and, therefore, the associated National Insurance contribution rebate) being abolished in 2016.
For each of these models the DWP’s stated intention is that the accrued benefits of members would not be affected.

“Money Purchase Plus” Models

The DWP also considered different forms of guarantees within money purchase schemes that could provide greater certainty for members about their accumulated pension income while they are still saving, without adding to employer liabilities.
The paper also explored introducing a collective money purchase model, which is commonly used in the Netherlands. This “CDC” model offers an alternative approach to risk sharing as assets are pooled between members and should therefore create “more stable outcomes”.

Scottish Independence

On 18 September 2014 the Scottish electorate will vote on whether Scotland should become independent of the UK.

As the law currently stands, if Scotland becomes independent any UK occupational pension scheme with members located in both (i) Scotland; and (ii) England or Wales, would likely become a “cross-border scheme” for the purposes of EU legislation. “Cross-border” schemes with defined benefits need to be fully funded (on a technical provisions basis) at all times; employers would therefore need to make good any funding shortfall immediately. In addition, such schemes would be required to have annual (rather than the usual triennial) valuations.

One way of avoiding these funding consequences would be to segregate existing schemes into separate Scottish and English sections. However, this is a complex and timely process.

It is possible that in practice the EU would legislate to introduce an exception to the cross-border requirements in the circumstances. However, there has been no indication to date that it intends to do so.

Another potential issue arising from Scottish independence relates to asset-backed contribution (ABC) structures. Several pension schemes have put in place ABC structures in the past few years. In practice, Scottish limited partnerships have often been used to exploit a loophole in the employer-related investment legislation. However, this loophole could be lost if Scotland leaves the UK. The documentation governing a particular ABC structure may already contemplate Scottish independence, but it is also possible that the issue was simply not addressed when the documentation was drafted.

If you are interested in exploring any of the issues raised in this alert further, we would be happy to discuss them with you.


Client Alert 2014-005