Reclassifying DC benefits following Bridge Trustees

Introduction

The DWP has published a consultation paper on reclassifying DC benefitsfollowing the Bridge Trustees case. The Supreme Court’s July 2011 decision in the Bridge Trustees concluded that it was possible for certain benefits to be within the definition of “money purchase benefits” despite there being a potential mismatch between assets and liabilities. The DWP immediately announced that it would legislate to reverse this decision – with retrospective effect.

Whether benefits are classified as DB or DC makes important differences to:

• the protections offered by legislation on a wind up
• whether or not the scheme funding and employer debt requirements apply
• the availability of the PPF.

In this Alert:

• Old definition of money purchase benefits
  
• New definition of money purchase benefits
  
• The new definition in practice
  
• What does the consultation cover ?
  
• When will the changes come into force?

Old definition of money purchase benefits

Historically, money purchase benefits have been defined as “benefits the rate or amount of which is calculated by reference to a payment or payments made by the member or by any other person in respect of the member”. In the Bridge case, this was held to include DC benefits with a guaranteed rate of return and a pension secured within the scheme using a member’s DC pot (known as an in-scheme annuity).

New definition of money purchase benefits

The Pensions Act 2011 (which is not yet in force) will introduce a new definition of money purchase benefits which will provide that a benefit is only DC if:

• before it comes into payment, its rate or amount is calculated solely by reference to assets which (because of the nature of the calculation) must necessarily suffice for the purposes of its provision to or in respect of the member;
• once in payment, the pension is secured by an annuity or an insurance policy with an insurance company and, at all times before coming into payment, the member’s benefits met the test outlined above.

In effect, this definition is designed to ensure that a DC benefit cannot create a deficit. The change will impact on a range of pension protection legislation, wherever references are made to money purchase benefits.

The new definition in practice

Trustees will need to consider their benefit structures to establish whether any benefits will be affected by the new definition. The following are all examples of benefits which may have been considered DC in the past but which may now need to be reclassified as DB following the introduction of the new definition of money purchase benefits.

• In-scheme annuities – many schemes offer an option for a DC member to secure their benefits within the scheme rather than externally at retirement. Despite the possibility of a funding deficit arising (as the assets provided by the member could ultimately be insufficient to fund the promises made by the scheme), in Bridge Trustees the Supreme Court concluded that these benefits counted as DC. But, under the new definition, these benefits would be regarded as DB.
• DB benefits with a DC underpin – the intention is that if the underpin bites these will be DC, if not they will be DB.
• DC benefits with a DB underpin, typically on a GMP or reference scheme test basis – again, if the underpin bites these will be DB, if not DC.
• DC benefits with a guaranteed investment rate – the intention is that these benefits would be DB.

What does the consultation cover ?

Retrospection is the key issue dealt with by the consultation, as the changes to the definition of money purchase benefits under the Pensions Act 2011 are intended to be retrospective back to 1 January 1997.

But the DWP accepts that retrospection to this extent may be difficult to implement as the classification of benefits is crucial to the protections afforded by legislation. So, the DWP is now consulting on whether the changes will be retrospective to 1997 for all areas of legislation protecting member benefits.

There are a wide raft of issues covered by the DWP consultation. Under the DWP’s proposals, among other things, schemes which under the new definition will be regarded as DB (and which were previously considered to be DC) will be required to take the following steps:

• choose an effective date for a scheme funding valuation within 12 months of the changes coming into force (and then submit their first valuations in the normal timescale of 15 months after the effective date)
• calculate employer debts on any employer exits on or after 28 July 2011, the date of the Supreme Court judgment in Bridge Trustees (with certain exceptions)
• pay PPF levies from 2015/16 (but note that members will not qualify for PPF compensation before 1 April 2015)
• apply the new definition for wind-ups which commenced on or after 28 July 2011.

If the proposals go ahead as planned, trustees will need to take action to assess whether any decisions will need to be reconsidered in light of the changes. Trustees will also need to ensure that they are ready to implement the future changes from April 2014.

When will the changes come into force?

The consultation runs for 6 weeks until 12 December 2013. The intention is that the new definition of money purchase benefits will come into force on 6 April 2014, although this timescale seems tight given the complexity of the issues.