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EU Referendum: change inevitable for pension schemes - leave or remain

Published by Tyron Potts on

In a previous blog we set out what we expect 'Brexit' might mean for pension schemes, which included a focus on some of the wider economic impacts.  In this blog we explore in more detail some of the potential legislative issues should the British public vote to leave the European Union (EU) or remain a member.

Whichever way the referendum result goes, the legislative impact from a pensions point of view is more likely to be realised in the medium- to long-term than immediately, as the UK seeks to reposition itself in global financial and trade markets and, if needed, negotiates an exit agreement.

Equalisation of GMP may no longer be required?

It is a founding principle of the EU that people should receive equal pay for equal work, regardless of gender.

It is a founding principle of the EU that people should receive equal pay for equal work, regardless of gender.  Many trustees remember getting to grips with this in a pensions context in the wake of the Barber judgement in 1990 and have spent more than a quarter of a century dealing with the fall-out.

The Barber judgement required pension schemes to adopt equal normal retirement ages for men and women.  It is a complex legal issue and many court cases have attempted to clarify exactly what is required of pension schemes and their trustees.

One unresolved issue is the treatment of guaranteed minimum pensions (GMPs).  GMPs are a minimum benefit which a (formerly) contracted-out scheme was required to provide to members who gave up part of their rights to state pension between 1978 and 1997.  GMPs accrued at a faster rate for women, and were paid earlier, reflecting the earlier State Pension Age for many women.  Due to differences in pension increases and other factors, this can affect the amount paid to a member.

State benefits are generally exempt from the equalisation rules under EU law and some have argued that as GMP replaces an unequal state benefit, it is not necessary to equalise pensions for the effect of GMPs, as long as the overall pension is equalised.  The government takes a different view and the Department for Work and Pensions (DWP) has previously maintained that schemes have been required – under UK law – to equalise for the effect of GMPs since 1990.

£8+bn

UK net contribution to EU budget in 2015

£10bn

potential cost to UK pension schemes if required to equalise for effect of GMPs

Furthermore, following a case in European law, the government confirmed its intention to lay regulations which would mean that there would be no need for a contracted-out scheme to have a comparator of the opposite sex in order to demonstrate inequality – so a scheme which had only ever had male members, for example, would still be required to equalise for the effect of GMPs.

It is not likely that the government would seek to reappraise equal treatment legislation already enshrined in UK law, such as equal normal retirement ages, gender-neutral annuity rates and other anti-discrimination rules.  However, if the referendum result is to leave the EU, it is possible that the issue of equalising for GMPs may become less pressing – and the planned regulations could sit on the government’s 'too difficult' pile for a while longer.

PPF compensation levels may be reviewed?

The UK fought a hard-won victory against European plans to introduce stricter funding requirements on pension schemes. It now appears that the battle was won, but perhaps not the war.

The Pension Protection Fund (PPF) was set up to provide compensation for people whose employer became insolvent, leaving behind a pension scheme unable to pay benefits in full.  PPF compensation is set at a level which aims to protect a certain level of benefits, targeted at those who are least likely to be able to make up a shortfall in their expected pension.

This benefit is usually less than the member would have received from the pension scheme, recognising the burden of funding the PPF falls on the employers sponsoring the remaining defined benefit pension schemes.  A long-serving, highly paid member could feasibly end up with PPF compensation worth less than half of their scheme benefit, when you take into account the compensation cap, the 10% reduction applying to members who have yet to reach retirement age and lower pension increases.

Following the collapse of Irish firm Waterford Crystal, the Court of Justice of the European Communities held that EU insolvency law required member states to protect at least 50% of the value of members’ accrued pension benefits.

Perhaps prompted by this, the government set out plans to increase the cap on PPF compensation for long-serving employees.  The cap was to rise by 3% a year for each year above 20 years’ service.  However, the legislation – set out in the Pensions Act 2014 – has yet to be brought into effect – with no indication from the government as to when, or whether, it will be soon.

If the UK were to leave the EU, it is unlikely that PPF compensation would be reduced.  It is probable that the long service cap will be implemented either way, as a matter of public interest, especially given recent high-profile business failures.  If the UK remains in the EU though, it is possible that PPF compensation may have to be increased in future – if a later EU judgement finds that even 50% of benefits guaranteed is not sufficient.

Funding requirements may increase?

The UK fought a hard-won victory against European plans to introduce stricter funding requirements on pension schemes.  It now appears that the battle was won, but perhaps not the war.  Pension scheme funding is in the spotlight as some household names’ schemes fall into the PPF.  Whether the vote is to leave or remain, we can expect further action on pension scheme solvency – driven either by the UK government acting alone or in partnership with Europe.

While solvency was dropped from the EU pensions directive, now making its tortuous way into law, other provisions in the directive could still affect UK schemes.  These reportedly may include:

  • trustees being required to hold professional qualifications
  • defined contribution schemes needing to appoint a depository
  • a standardised pension benefit statement
  • a prescribed form of risk evaluation for pensions
Employers and trustees currently running cross-border schemes will be watching the referendum result with trepidation. If the UK leaves the EU, they could potentially need to restructure their schemes.

The UK could potentially leave the EU before it is required to enshrine these provisions in national law.  However, depending on the exit negotiations, the UK may still be required to comply.  Furthermore, as part of exit negotiations, the UK might have to agree to implement any future changes to the pensions directive – without being able to influence its drafting.  UK opposition was key to the solvency proposals being dropped.

Action for cross-border schemes?

Cross-border pension schemes are another hot topic.  European legislators are currently debating whether or not to remove or relax the requirement for such schemes to be fully-funded at all times – or indeed whether this should be extended to other schemes in future.

Employers and trustees currently running cross-border schemes will be watching the referendum result with trepidation.  If the UK leaves the EU, they could potentially need to restructure their schemes.  It may not be possible to carry on running the scheme as before, depending of course on the terms of the UK’s exit.

Exit strategy will be key

Of fundamental importance, as set out in our previous blog, are the negotiations over the UK’s continued association with the EU in the event of a Brexit.

If the UK votes instead to remain in the EU, the issue of Brexit might not go away.  A narrow lead might give future governments cause to hold a new referendum – as has been mooted in the case of Scottish independence.

In the meantime, pension scheme trustees and employers can only be sure of one thing – uncertainty.

Rowan Harris contributed to the writing of this blog post


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About the author

  • Tyron Potts

    Tyron advises trustees of UK defined benefit (DB) pension schemes on scheme funding, governance matters and winding up. He also advises employers on pension benefit design and accounting for pension costs in corporate accounts under a number of local and international accounting standards.

    View Biography

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