Consultation on draft regulations relating to the abolition of DB contracting-out

Introduction

On 8 May 2014, the DWP issued a consultation asking for views on proposed legislative changes which follow on from the abolition of DB contracting-out, together with draft regulations.

In this Alert:

Key points
Contracting-out
Why is contracting-out being abolished?
Statutory modification power
How can the power be used?
Provision of information
Rules for formerly contracted-out schemes
Next steps

Key points

Provisions in the Pensions Bill 2013/14 will provide employers with a unilateral power to amend their schemes to take account of the increase in their NICs.
The consultation comprises two sets of draft regulations which set out:
- the detail of how the statutory modification power may be used

the rules which schemes that were contracted-out will need to comply with when DB contracting-out ceases.

Contracting-out

The current state pension system comprises the BSP, the additional State pension (commonly known as S2P but formerly SERPS) which is linked to earnings, and the pension credit (a means tested benefit).

It is possible for employees to “contract-out” of the additional State pension through a personal or occupational pension scheme. A contracted-out occupational pension must meet certain statutory requirements (these have changed over the years). The aim of these requirements is to ensure that employees will become eligible to receive a pension in their contracted-out scheme which is broadly equivalent to the additional State pension to which they would otherwise have been entitled.

In return for the employer providing a pension meeting the statutory minimum, both the employer and employee pay reduced rates of NICs. Employer contributions are currently reduced by 3.4% and employee contributions by 1.4%.

Why is contracting-out being abolished?

With effect from 6 April 2016, the Government intends to replace the current State pension system with a flat rate single-tier pension (see our Alert for details). A key consequence of this is that employers will cease to have the option to contract their employees out of the additional State pension on a salary-related basis. DB contracting-out will therefore also cease to exist from the same date.

Statutory modification power

One of the most significant implications of abolishing DB contracting-out is that both employers and employees will need to start paying the standard rate of NICs.

The Government recognises that this additional cost will be a blow for the sponsoring employers of the remaining open DB schemes. It has therefore decided to provide employers with a unilateral power to amend their schemes in relation to some or all of the members to take account of the increase in the employer’s NICs.

How can the power be used?

An employer may only use the statutory power to recoup the increase in its NICs by either adjusting members’ future pension accrual or future contributions. The power may be used more than once but is intended only to be available for a limited period of five years.

To ensure this condition is met, an actuary will be required to certify that the proposed amendments comply. The draft regulations therefore set out the calculations actuaries will be required to make, how they should make these, and what certification will be required.

Multi-employer schemes

In a multi-employer segregated scheme, where there is only one employer in each section, each employer will be able to amend the rules for their section. However, non-segregated multi-employer schemes and segregated schemes with multi-employer sections will need to appoint a principal employer (for the scheme as a whole in respect of the former and for each section in relation to the latter) to exercise the modification power.

Different rules for different members

Some schemes have different levels of benefits or different rates of contributions for different groups of members (referred to as different sections). Aiming to prevent cross-subsidy between sections, the DWP want the modification power to be applied to each group as if that group was a separate scheme. It will therefore be possible to make and certify amendments at “section” level.

Provision of information

Employers will need access to scheme and individual membership data to be able to make the amendments. Consequently, the regulations will place a duty on trustees to provide information to employers in connection with the use of the power. The data must be supplied within four weeks of the employer’s request and civil penalties will apply where reasonable steps are not taken to meet it.

Rules for formerly contracted-out schemes

The draft regulations set out the rules which schemes that were contracted-out on a DB basis immediately before the abolition date will need to comply with immediately afterwards.

The regulations aim to protect members’ accrued contracted-out rights and make other provisions to ensure the appropriate operation of a formerly contracted-out scheme.

Next steps

The consultation closes on 2 July 2014.

The DWP intends the majority of the provisions to come into force in April 2016. However, the statutory modification power regulations are expected to come into force in autumn 2014.

If you have any queries, please liaise with your normal contact at Sackers to ensure appropriate action is taken.