Home > News > 2003 > July 2003 > Simplicity, security and choice
Simplicity, security and choice
Barnett Waddingham's response to the recent White Paper.
Working and saving for retirement
Action on occupational pensions
Summary
On 11 June 2003 the Secretary of State for Work and Pensions, Andrew Smith, announced new measures designed to protect members of defined benefit pension schemes and intended to make it easier for companies to run these schemes. This follows the publication of the Green Paper on 17 December 2002 and over 800 responses (including Barnett Waddingham's) received during the subsequent consultation period. The announcements are the first step in the process of Government reform of non-State pensions and these will be added to over the coming months. The main features are:
- The Government will introduce a Pensions Protection Fund to guarantee members a specified minimum level of pension if the sponsoring employer becomes insolvent.
- Solvent employers who wind-up their pension schemes will be required to meet the pension promise in full.
- The order in which a pension scheme's assets are distributed on wind-up will be made it fairer for non-pensioners.
- Introduction of a new pensions regulator.
- Changes to simplify, and reduce the burden of, pension provision for employers and providers in conjunction with the increased protection for members as follows: (a) Reducing the cap on mandatory indexation of pensions in payment from 5 per cent to 2.5 per cent per annum - this will not apply to current pensioners; and (b) Allowing schemes to modify members' accrued rights, subject to maintaining the actuarial value of those rights.
The Government has also set out its plans to allow individuals to take control of their retirement planning and to increase the amount being saved in the future.
Barnett Waddingham reaction
Whilst the Government has been receptive to some of the suggested changes, it is not true when they say that they have "listened to the pension scheme members, employers and the pensions industry". We have all asked for reforms to State pensions and we have been totally ignored. The reforms are not "reducing the burden on companies who run schemes" - the Pensions Protection Fund will only add to costs and it is likely to hasten the trend towards defined contribution pension provision. It is simply not possible to increase security and reduce costs at the same time. Furthermore, the proposed reforms will cost a great deal more than the £155 million a year the Government estimates employers could save. The Government has made a knee-jerk reaction to the many damaging press stories recently about members losing a significant proportion of their benefits when schemes wind-up and, in our view, this is reflected in the proposals, some of which appear ill-judged.
The Government is unwilling to stand behind the Pensions Protection Fund and consequently there can be no absolute guarantee that the scheme will work. It would just take one company with a very large pension scheme to become insolvent for the cost of funding the Pension Protection Fund to become untenable.
The requirement for solvent employers to ensure there are sufficient funds in the scheme to meet the full costs of securing the pension promise is subject to an important proviso. The trustees can exercise their fiduciary duties and agree a lower amount if insistence on the full amount of the payment would put the company itself at risk. Consequently, trustees may increasingly find themselves in a very difficult position deciding whether to compromise the amount of the payment from the employer knowing that failure to do otherwise might lead to loss of jobs.
The change to the LPI requirement is not sufficient. We would have preferred the rule to be removed altogether. Although unclear, it is probable that the change will only apply to pension earned in the future by current active members and future new entrants. Consequently there will be no relaxation for benefits earned to date which is at odds with the Government's goal of simplifying the administration of schemes.
We also welcome the proposals to amend the way in which a scheme's assets are distributed on scheme wind-up and to link these to the time that a member has been in the scheme. However, this will not in itself lead to any more funds being available. Barnett Waddingham has developed an idea linking both the priority order, the potentially high costs of securing benefits and the compensation fund and we have arranged a meeting with the Department of Work and Pensions to explore further details of our proposals which we believe will lead to a more palatable solution for all.
Improved protection for members
Pensions Protection Fund
The Government will establish a compensation scheme to be known as the "Pensions Protection Fund". This will protect defined benefit schemes in the private sector where the sponsoring employer becomes insolvent and the scheme is unable to meet its liabilities. Each defined benefit scheme would be required to pay a premium to cover the costs of the Pensions Protection Fund.
The total premium will consist of a flat rate levy payable by all schemes together with a risk-based premium where schemes which are underfunded will pay a higher premium compared with those schemes that are well funded. A common funding standard will need to be introduced to calculate the amount of risk-based premium due which will introduce further costs for schemes.
The compensation fund will pay out a maximum of 100 per cent of pensions in payment and 90 per cent of other benefits. It is not clear how the other benefits will be secured, although this is likely to be in the form of a deferred annuity. It is proposed that the salary used to calculate any benefits payable from the compensation scheme is to be capped. The Government suggests that this cap may be in the region of £50,000 per annum.
There are two key risks here. First, that an employer could deliberately choose to fund to a lower level or trustees could invest in a higher risk portfolio than appropriate because of the existence of the Pensions Protection Fund. Secondly, directors could be tempted to wind a company up in order to avoid a debt in an underfunded scheme.
Changes to the "debt on the employer" calculations where the sponsoring company is solvent.
The future winding-up debt on the employer will be significantly higher under the new proposals. Those employers who have closed their schemes but have not yet started to wind-up would be affected by this. We are extremely concerned at the proposed increased burden on employers and fear that this would result in further schemes closing to benefit accrual.
Currently, if a solvent employer winds up an underfunded defined benefit scheme it is required to ensure that the scheme has sufficient money to secure in full the pensions of current pensioners, and a transfer value for non-retired members calculated on the MFR basis. The Government has announced that in future the employer will have to ensure that there are sufficient funds to meet in full the costs of insuring the accrued rights of all scheme members. The trustees would be able to agree a lower payment if they considered it to be in the best interests of the scheme and its members.
The Government has published draft regulations intended to formalise these proposals. These regulations will be backdated to 11 June 2003 and accordingly there will be no "window of opportunity" for employers to terminate their contributions to a scheme to take advantage of the current method of determining the debt. The Government stated that trustees of schemes currently in wind-up will be able to take advantage of the new provisions although this is not reflected in the draft regulations. It has subsequently emerged that this is not the intention and schemes currently in wind-up will be unaffected. The Government has also stated that the ability of employers to remove surplus from a scheme will no longer be allowed unless the scheme is able to secure fully its accrued liabilities with an insurance company.
Barnett Waddingham will be commenting on the draft regulations before the end of the consultation period on 22 July 2003. Some details need to be clarified, in particular:
- Will the new method of calculation apply if trustees force a scheme into wind-up when they cannot agree an appropriate level of contributions from the employer?
- Will the new method apply to employers leaving multi-employer schemes?
Change in the priority order of scheme assets on wind-up
At present, pensioners have priority when it comes to distributing a scheme's assets on wind-up, after all expenses and other costs have been set aside. The benefits of those members not yet receiving pensions rank as a lower priority and there is no differentiation between members who have been in the scheme for a number of years and are approaching retirement age and younger members who have been in the scheme for a short period of time, or between current active and deferred members.
Given that the Pensions Protection Fund is unlikely to come onto the statute books until April 2005 at the earliest, and that in cases of wind-up where the employer is solvent the full buy-out requirement may not be met, the Government has set out proposals to share out a scheme's assets in as fair a manner as possible between all members. It intends to issue draft regulations over the Summer and expects them to come into force in the Autumn of 2003.
The Government intends that pensioners will still rank first as they are clearly the least able to generate a replacement for their income. For employees still working the degree of protection will reflect the length of time a member has been in the scheme, with those who have been in the longest receiving the most protection. The rights of non-pensioners will also be prioritised over the annual increases to existing pensions in payment. It is not clear whether these proposed changes will only affect schemes that go into wind-up in the future or schemes already in the process of winding-up.
A new system of regulation
A new pensions regulator will be introduced to tackle fraud, bad governance and poor administration and will encourage best practice through an increased education and guidance role. This will be a much more risk-focused and pro-active regulator than is currently the case. In addition the new regulator will be given the power to issue codes of practice where the Government's proposed consolidation of existing pensions legislation can be expressed in general terms.
Legislation will be introduced which will require that trustees become familiar with the issues relating to all of their responsibilities, not just their investment duties. Codes of practice are likely to provide guidance in this regard.
Miscellaneous
Over the last 18 months the Government has been consulting on extending the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) to pensions. The Government is concerned that an excessive burden is not placed on any new employer. The Government proposes an obligation to match employee contributions up to a level of 6 per cent of salary to a Stakeholder pension.
Members of a scheme who leave after three months and do not have entitlement to a deferred pension will be given an alternative of a cash equivalent transfer value which they must transfer out of the scheme to another approved pension arrangement. This will give people who frequently change jobs an opportunity to build up their own pension savings and is likely to have a proportionately greater impact on the overall level of women's savings.
The Government intends to introduce a requirement on employers to consult employees before making changes to pension schemes and are looking at the best means of achieving this alongside the EU information and consultation directive.
Making provision easier
LPI
Currently all pensions earned after 5 April 1997 are required to be increased each year in line with price inflation capped at 5 per cent each year, a provision known as Limited Price Indexation (LPI). The Pickering Report suggested that this compulsory indexation be scrapped but the Government has decided to maintain it although at a lower level to reflect the reduced expectation of future price inflation. In future, schemes will only be required to index pensions in payment by inflation subject to a cap of 2.5 per cent each year.
The Government has stated that this will not affect pensions currently in payment but it is not clear whether this only applies to the pension to be earned in future for current members or all of their pension. If the former is to apply then this would mean at least two different types of pension increases for these members and this does not really fit with the Government's stated intention of reducing administrative burdens. The LPI change is not helpful - without retrospection there is nothing here to help the many mature schemes with significant pensioner and deferred pensioner liabilities and if inflation remains at current low levels there is little difference between having 5% LPI or 2.5% LPI.
Section 67
The Government has stated its intention to amend Section 67 of the Pensions Act 1995 which restricts schemes' abilities to change the accrued rights of members without their consent. It is proposed that these will be allowed provided that:
- The scheme rules contain the necessary powers.
- The trustees approve the change.
- It is not a switch from final salary to money purchase.
- The total actuarial value of members' accrued rights at the point of change is not reduced.
- Pensions already in payment are not reduced.
- Members are consulted before the change is made.
These proposals will allow schemes the flexibility to alter their benefits and to change them as their workforce and their needs change without altering the value of their pension package. This is most welcome but will require some difficult actuarial judgments to be made when calculating the value of different benefit structures.
Miscellaneous
The Government proposes that pension schemes should not be required to offer members a facility to make additional voluntary contributions.
The Government has decided to opt for the more radical of the two options it proposed for Member Nominated Trustees in the Green Paper, and will focus solely on the outcome rather than the process. Minimum requirements will be set out in legislation backed by guidance from the new Pensions Regulator.
The Government has stated that it will simplify the way pension schemes have to communicate with their members, make some changes to simplify the operation of contracting-out, streamline the Internal Dispute Resolution procedure, clarify the existing jurisdiction of the Pensions Ombudsman, and simplify the treatment of pensions on divorce.
Planning for retirement
From April 2003, everyone who is a member of a money purchase scheme will receive a statutory money purchase illustration. The Government is keen to expand this initiative so that members of all types of schemes receive information of this kind and it will legislate to require defined benefit schemes to issue annual statements to their members.
The Government has started a programme of issuing State pension forecasts at regular intervals and to complement this it wishes private sector schemes to provide State pension forecasts along with scheme-specific forecasts. This will be done, in the first instance, by encouraging voluntary participation. However, the Government will legislate to require pension schemes to issue a combined pension forecast on a regular basis if they believe it is necessary in the future. They will also continue to develop a web-based retirement planner and this is expected to be available some time in 2004.
The Government is to pursue a pilot scheme for employer-based information on pensions as suggested in the Green Paper. This is to evaluate the effectiveness of different forms of pension information and advice in the workplace and the Government will seek legislative powers to allow them to apply the learning from this pilot to all employers if the pilot proves successful.
The Government has also repeated its desire to outlaw age discrimination and to increase the earliest age by which a pension may be taken from an occupational scheme to age 55 by 2010.
Things that will not change
One of the recommendations of the Pickering Report was that pension schemes should not have to provide benefits for surviving spouses of scheme members. The Government has stated that it does not intend to make any changes as a result of this recommendation as it would have a major impact on the incomes of retired women who traditionally rely upon their husbands to provide for their retirement.
The Government has also decided not to allow employers to make compulsory membership of their occupational pension scheme a condition of employment for all new members. It has also stated that it remains committed to maintaining the State Pension Age at 65.
The Government's timetable
The Government also issued a timetable outlining its plans. Further consultations on a number of key issues are expected during the Summer, with details of the planned reforms to pension scheme taxation expected in the Autumn. It is expected that any changes, other than those to the winding-up of pension schemes where a solvent employer exists and to the priority order, will be effective from April 2005.
Please speak to your usual Barnett Waddingham contact to discuss any of the above.
Barnett Waddingham, July 2003.