Consultation on consequential amendments resulting from the abolition of protected right: Sackers’ Response

Background

On 28 July 2010, the DWP published a consultation, draft consequential legislation in relation to the abolition of contracting out on a DC basis. The four sets of draft regulations are designed to implement certain consequential amendments to give effect to the abolition provisions contained in both the Pensions Act 2007 and Pensions Act 2008.

In this response:

• Transfers
  
• Salary related schemes contracted-out on a protected rights basis
  
• Entrenched protected rights provisions
  

Transfers

The Consultation proposes the removal of all references relating to transfers between contracted-out DB and contracted-out DC schemes.  This is on the basis that contracted-out DC benefits will no longer exist and, as a result, such transfers will no longer be possible post-abolition.

Transfers are currently permitted from a contracted-out salary related-scheme to another contracted-out salary-related scheme, to a contracted-out money purchase scheme, or to an appropriate personal pension.  Post-abolition, members of schemes which are contracted-out on a salary-related basis (which includes both DC and DB schemes) will have fewer transfer options if the regulations are adopted as drafted.

Of course, salary-related schemes with GMPs will have the option to convert these into ordinary DB benefits using the GMP conversion process, and subsequently transfer benefits to a non-contracted-out arrangement.  However, this will not assist schemes which hold post-1997 reference scheme test benefits.  In any event, GMP conversion is a lengthy and complicated process.

As has been widely reported in the press, the inability to transfer contracted-out benefits to a DC scheme will also be a potential issue for any employers who are contemplating the option of de-risking by making available enhanced transfer values to members who transfer their benefits out of the scheme.  It will also be an issue more generally, for individual members wishing to transfer their benefits.

Salary related schemes contracted-out on a protected rights basis

A number of DB schemes are contracted-out on a DC basis.  From 6 April 2012, such schemes will automatically become contracted-in.

The options for schemes in these circumstances are to:

• accept that the scheme will no longer be contracted-out.  However, schemes in this situation will need to review their funding strategy.  As members will start to accrue state pension benefits at a higher rate and pay higher NI contributions, such schemes will no longer receive NI rebates.  Consequently, sponsoring employers will need to decide whether they will make up this funding shortfall, or whether scheme benefits will need to be reduced going forward; or
• remain contracted-out by changing the contracting-out basis, so that a scheme becomes contracted-out on the reference scheme test basis.  As the Consultation proposes deleting the facility to switch the mode of contracting-out, this will need to be achieved ahead of the abolition date, or from that date schemes will need to contract-out afresh on the alternative basis.

Entrenched protected rights provisions

If a scheme contracts-out, the trustees are required to ensure that the rules incorporate appropriate contracting-out rules. Therefore, contracted-out DC schemes have generally included protected rights provisions in their rules.  For such schemes therefore, the removal of protected rights provisions from legislation will not automatically lead to their removal from particular schemes’ rules – they will need to take active steps to achieve this.

In connection with this, the draft regulations propose amendments to the requirements for alterations to the rules of contracted-out schemes under regulation 42 of the Occupational Pension Schemes (Contracting-out) Regulations 1996 (at draft regulation 4(12) of the Pensions Act 2007 (Abolition of Contracting-out for Defined Contribution Pension Schemes) (Consequential Amendments) Regulations 2011).  However, they do not address the restrictions in section 67 of the Pensions Act 1995, which could cause difficulties for trustees and employers in connection with the removal of protected rights restrictions where they have been drafted into scheme rules.  Similarly, schemes in this situation may encounter difficulties removing protected rights provisions from their rules if their amendment power prevents them from doing so.

It would therefore be helpful for schemes if these issues could be addressed by a carve-out from section 67 and a statutory override to assist schemes with restrictive amendment powers.