Home > News > 2004 > February 2004 > Simplicity, Security and Choice - The Pensions Bill 2004
Simplicity, Security and Choice - The Pensions Bill 2004
On 12 February 2004 the Secretary of State for Work and Pensions, Andrew Smith, published the Pensions Bill, to be known as the Pensions Act 2004, designed to protect members of defined benefit pension schemes and intended to make it easier for companies to run these schemes.
Barnett Waddingham Reaction
We were under the impression that the Government was aware of the dangers of increasing costs for pension scheme sponsors, and over-regulation. This Bill will make both these burdens worse: it is a political over-reaction to a difficult but different problem, namely a fairer way of using assets when a pension scheme winds up and has a shortfall. We have a sense of déjà vu - the Pensions Act 1995 was a political over-reaction to Maxwell.
The Pensions Protection Fund ("PPF") will add to costs and it is likely to hasten the trend towards money purchase pension provision. Many more people will have poorer pensions in the future as a result of this Bill. It is not possible to increase security and reduce costs at the same time. We do not agree with Government that the Bill will save UK businesses £130 million a year. The Bill will not encourage a single employer to re-open their defined benefit scheme never mind start up a new one!
The Government is unwilling to stand behind the PPF and there will be no guarantee that it will work. It could take just one company with a large pension scheme to become insolvent for the PPF to become untenable. If we have to have a PPF, it would have been wiser to start with less ambitious compensation.
The provisions on scheme-specific funding are vague. Annual actuarial reports will be an additional cost for schemes. The requirements for trustee expertise may be a problem for recruiting and retaining some trustees.
The change to the LPI requirement is welcome although it is not retrospective and we would have preferred the rule to be removed altogether as Pickering had recommended.
At A Glance
- A new "Pensions Protection Fund" to guarantee a minimum pension when the scheme of an insolvent employer is in shortfall
- MFR will be replaced by a scheme-specific funding requirement
- Schemes will require an annual funding report from the actuary
- A tougher pensions regulator
- The cap on LPI pension increases reduced to 2.5% for the future
- Pension scheme trustees to be "knowledgeable"
Improved Protection for Members
Pensions Protection Fund
The Bill establishes a compensation scheme to be known as the "Pensions Protection Fund" ("PPF"). No implementation date is yet set, although we understand that the target remains April 2005. This will cover defined benefit schemes in the private sector where the sponsoring employer becomes insolvent and the scheme is unable to buy out the PPF level of benefits. Each defined benefit scheme will be required to pay a levy designed to cover the costs of the PPF.
The total levy will consist of a basic rate payable by all schemes based on membership, together with a risk-based premium, which will comprise at least half of the total levy. We understand that the risk based levy will initially be based on three primary factors; the scheme's funding level, its investment strategy and the risk of the sponsoring company becoming insolvent. There will also be a separate "administration" levy and a "fraud" levy (which replaces the existing Pensions Compensation Board premium and will also be paid by money purchase schemes). To allow the PPF to be set up as soon as possible the risk-based levy will not apply in the first year (to give all parties time to produce and collate the necessary risk assessment data). The levy will be paid by scheme trustees.
The PPF will pay out 100% of retirement benefits to members over their scheme's Normal Pension Age (defined as the earliest age at which the pension becomes payable without reduction) or those who have retired due to ill health or become entitled to a spouse's pension. It will also pay out 90% of retirement benefits to the remaining members, subject to a cap, initially set at £25,000pa payable from age 65. This cap will be "actuarially" adjusted for members taking pension before or after age 65. The cap will increase annually in line with earnings inflation.
The revaluation of pensions prior to retirement will be indexed to price inflation up to 5%pa, and compensation for pensions in payment earned post-1997 will be indexed to price inflation up to 2.5%pa. The PPF will not give increases to pensions for service pre-1997. Dependants' pensions will be included for spouses and civil partners and will be 50% of the member's PPF benefit in all cases.
It is left open whether compensation payments will be paid direct from the fund or insured. It seems unlikely that insurance will be a long-term option as the compensation liabilities are likely to quickly exceed market capacity for deferred annuities, and possibly even immediate annuities as well. It is also left open as to how the required levy will be assessed, for example whether on a pay-as-you-go basis, based on a long-term valuation of accrued compensation liabilities (which may or may not depend on the investment strategy adopted by the PPF), or based on the cost of buying-out accrued compensation liabilities (assuming there is market capacity).
The DWP has clearly stated the PPF will not provide cover against events that have already happened.
In the event of any large claims being made the PPF Board have the power to alter the level of increases or in extreme cases the level of compensation.
There will be a PPF Ombudsman who will presumably settle disputes as to whether compensation is payable.
A new system of regulation
A new Pensions Regulator will replace OPRA from April 2005. It will carry forward OPRA's existing powers but with a specific aim to tackle fraud, bad governance and poor administration. It will encourage best practice through an increased education and guidance role. It will be a much more risk-focused and proactive regulator concentrating on schemes where members' benefits are most at risk. In this way, the Government hopes to control the level of risk taken on by the PPF - the new regulator will be looking to reduce the number of schemes needing the compensation.
The new regulator will be given the power to issue pension scheme "improvement notices" or "third-party notices" giving fixed timescales for trustees, employers or administrators to take action on certain issues. The regulator will also have the power to "freeze" pension schemes whilst it investigates maladministration or under funding. In extreme circumstances the regulator could order a scheme to be wound up.
Scheme-specific funding standard
The Minimum Funding Requirement ("MFR") will be replaced by a scheme-specific funding requirement. This should allow schemes greater flexibility in setting a funding strategy appropriate to their individual circumstances. The Government hopes these proposals will cover its obligations under the EU pensions directive which says that member states must prescribe a funding test. To comply with the EU deadline, the DWP hopes to have this in place by September 2005.
Under the new system every defined benefit scheme should aim to have sufficient assets to cover the scheme's liabilities, based on an actuarial valuation and certificate. This will be known as the statutory funding objective. Further regulation, and possibly guidance from the Faculty and Institute of Actuaries, will determine whether or not the valuation method and assumptions will be prescribed.
Trustees must prepare a Statement of Funding Principles which sets out the policy for ensuring that the statutory funding objective is met. This will include the valuation method and assumptions, and any deficit spreading period. It is left open as to whether a maximum spreading period will be imposed. A separate document relating to deficit contributions (known as the "recovery plan") must be submitted to the Pensions Regulator in future. This will also be referred to within the schedule of contributions.
Trustees should obtain agreement from the employer on the valuation method and assumptions used for their funding objective, recovery plan and schedule of contributions. Where the trustees cannot secure the agreement of the employer (e.g. to a deficit recovery plan) then the Bill gives the trustees an overriding power to reduce or terminate future benefit accrual, and notify members of this within one month.
Annual actuarial reports
From a future date to be announced, all defined benefit schemes will need to have either annual actuarial valuations, or triennial valuations (as at present) but with annual reports from the actuary on factors that will have affected the value of the liabilities since the previous valuation.
Changes to the debt on the employer where the sponsoring company is solvent
With effect from 11 June 2003 the Government announced that, on wind-up of a scheme, solvent employers will have to ensure there are sufficient funds to meet in full the costs of insuring the accrued rights of all scheme members. The trustees are only able to agree a lower payment if they consider it to be in the best interests of the scheme and its members. Draft regulations are to be backdated to 11 June 2003 and accordingly there is no "window of opportunity" for employers to terminate their contributions to a scheme to take advantage of the previous method of determining the debt.
The Bill attempts to clarify Section 75 of the Pensions Act 1995, and the new provisions appear to apply to any scheme which is winding-up and where the employer is solvent, irrespective of the reasons or triggers for the winding up.
Making Provision Easier
Currently all pensions earned after 5 April 1997 are required to be increased each year in line with price inflation capped at 5% each year, a provision known as Limited Price Indexation (LPI). The Pickering Report suggested that this compulsory indexation is scrapped but the Government has decided to maintain it albeit at a lower level. In future, schemes will only be required to index pensions in payment by inflation subject to a cap of 2.5% each year. This only applies to the pension earned after the effective date of the Act, so the 5% LPI requirement remains for past service. This will mean another benefit tranche for schemes wishing to take advantage of this change and does not really fit in with the Government's stated intention of reducing administrative burdens. The LPI change is welcome but without retrospection there is nothing to help the many schemes dominated by their pensioner and deferred pensioner members.
Member Nominated Trustees ("MNTs")
From a future date to be determined all schemes must have at least one-third Member-Nominated Trustees (MNTs). This means that any existing trustee arrangements which were "opt-outs" of the existing voluntary MNT legislation will have to be revisited. MNT elections must be available to all active members (including other members is optional). This applies equally to directors of corporate trustees.
From some future date it will become a requirement for all trustees to become conversant with their Trust Deed and Rules, Statement of Investment Principles, Statement of Funding Principles and other documents recording scheme policy. It will also become a requirement for all trustees to have knowledge and understanding of pensions and trust law, general funding principles and general investment principles. The new Pensions Regulator will issue a "Code of Practice" setting out the areas of knowledge, training, experience or qualifications deemed necessary to fulfil these requirements.
Miscellaneous
Extending the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) to pensions is envisaged within the Bill. The options open to the acquiring employer are:
- Provide a defined benefit scheme offering benefits at least as great as those required to contract-out of the State Second Pension.
- Offer an occupational money purchase scheme or Stakeholder arrangement with contributions matching the employee rate up to 6%. This rate will be confirmed in future regulations.
The Bill also confirms that pension provision should continue through paid paternity and adoption leave.
The Bill clarifies that past overpayments made from the scheme to members in error can, in theory, be recovered from future payments.
In future trustees will be allowed to pay out contracted-out rights at the same time as other scheme benefits.
The Bill streamlines the requirements for an Internal Dispute Resolution Procedure, enabling a more straightforward one-stage procedure to be adopted in future.
Planning for Retirement
The Government has started a program 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. It is left open for the Government to regulate to require pension schemes to issue a combined pension forecast on a regular basis if they believe it is necessary in the future.
In addition, the Government is to pursue its pilot scheme for employer-based information on pensions. This is to evaluate the effectiveness of different forms of pension information and advice in the workplace and the Government reserves the power to regulate employers if the pilot proves successful.
State Benefits
The Bill also looks to offer people greater flexibility with their State pension and in particular it rewards those who defer taking their pension. A new lump sum option will also become available for those deferring their State benefits.
The Government's Timetable
The DWP expects the Bill to get parliamentary reading this year and to have received Royal Assent by November. It is expected that the Pensions Act 2004 will be implemented in stages with priority being given to the Pension Protection Fund and the new Pensions Regulator. It is hoped that these will be in place from April 2005.
It is hoped that several other changes, including the scheme-specific funding standard, will come into force from September 2005 to fit in with the deadline for implementing the EU directive on the supervision of occupational pension schemes.
The remaining changes will hopefully be implemented in April 2006.
What is Missing?
There were a number of items missing from the Bill and these may yet be added over the coming months. If, as expected, the proposed tax changes are confirmed in the budget we anticipate a number of additions to fit in with these changes.
We were hoping for clarification on Section 67 of the Pensions Act 1995, and GMP simplification but nothing has been included. We were also expecting legislation on transfer values for members with small pensions. We understand that these issues have been deferred for the time being.
Please speak to your usual Barnett Waddingham contact to discuss any of the above.
Barnett Waddingham, February 2004.