Reclassifying DC benefits – Sackers’ response to consultation

Background

The DWP’s consultation on the draft Regulations that provide transitional, supplementary and consequential measures supporting the commencement of section 29 of the Pensions Act 2011 seeks views on the Government’s proposals for implementing changes to the classification of DC benefitsfollowing the decision of the Supreme Court in Houldsworth v Bridge Trustees in July 2011.

In this response:

• General comments
• Winding-up
  
• Employer debt
• Revaluation, indexation and preservation of benefits
• Transfers
• Scheme surpluses
  
• The Pension Protection Fund
  
• Additional voluntary contributions
• Underpins

General comments

Numbers of schemes affected by the changes

Whilst the consultation notes that, to date, the DWP has been unable to clarify the number of schemes affected by the enactment of section 29, it states (at paragraph 7 of the consultation) that of approximately 40,000 private sector occupational pension schemes in the UK, “approximately 2% describe themselves as hybrid schemes meaning that they include both money purchase and non-money purchase benefits”.

Our experience indicates that, in practice, this percentage is likely to be significantly higher, with many schemes potentially affected by the changes.  As we explore in more detail below, most DB schemes offer AVCs on a DC basis and underpins are particularly common.

Action taken on the basis of the law in force

Our main concern with a number of the proposals in the consultation on wind-ups and employer debt is that the Government, in issuing the consultation proposals, has assumed that all schemes have been operating as if the changes to the definition of “money purchase benefits” were effective from 28 July 2011 (the day after the decision in the Bridge Trustees case).  Despite theDWP’s statement on the definition of money purchase benefits on 27 July 2011 (the July Statement) following the judgment of the Supreme Court in the Bridge Trustees case in which the legislative aim was stated, the law did not change on that date.  Indeed, the Pensions Act 2011, in which the change to the definition was included, did not receive Royal Assent until 3 November 2011.

At present, the original definition of “money purchase benefits”, as considered and interpreted  by the Supreme Court in the Bridge Trustees case remains in force.  Until the primary legislation and the regulations made under it are in force, it is not possible for trustees to be advised or act definitively.  In many cases, trustees have been operating their schemes on the basis of the law currently in force.  In a number of situations, had they done otherwise, they would not have been able to benefit from the available statutory discharges.

For these reasons, and as we explain in more detail below, we consider that the operation of section 29 should not be retrospective.

Costs

Question 1 addresses the cost efficiency of the proposals.  We assume for this purpose that the Government is examining the overall approach.  Account should, however, be taken of the fact that the action needed in respect of any scheme will depend on its rules and/or any action taken in the run-up to the implementation of section 29, should implementation of the legislation be retrospective.

As such, all fees for schemes, including legal fees, for reviewing rules and action taken and implementing any changes required as a result, are likely to vary significantly, but the real challenge will be in the actuarial work and communication with members.

Taking employer debt as a key example, fees for advice, including actuarial and legal fees, could be significantly reduced if the provisions were not applied retrospectively.

Cash balance definition

Please note that Condition 2, in the definition of “cash balance scheme” in draft Regulation 2, requires that the promise is made “under the scheme”. We consider that this may not be wide enough to encompass contractual promises. We would therefore suggest a minor amendment, to encompass arrangements outside the rules.

Timing

We understand that the Government wishes to bring the proposed changes into force from 6 April 2014 and for this reason has imposed a short, six week, consultation period.

Given the potential ramifications of the changes proposed, the complexity of the issues outlined in the consultation document, and the number of schemes likely to be affected, we consider that this period has been insufficient.

Winding-up

The draft Regulations draw a distinction between those schemes that went into wind-up before and after the decision in the Bridge Trustees case.  As we have explained above, we believe that many trustees will have acted on the basis of the law currently in force, even after the DWP’s July Statement.

The consultation provides that:

• For schemes which began winding-up before the date of the July Statement, both those which are considered to be entirely money purchase and those which include benefits that are affected by section 29, the regulations include transitional provisions that validate the winding-up decisions made by trustees.
• Schemes which began winding-up after the date of the statement and which did not meet the conditions set out in draft regulations 8 and 9, the benefits secured on wind-up would need to be revisited.

Reopening wind-ups

In our view, for a number of reasons it is not proportionate  to re-open any wind-ups which have been completed in any event, including:

• the need to carry out complex calculations to address the re-designated benefits and the costs that this would involve (such as advisers’ fees).  In some cases the employer and/or the trustees may also have ceased to exist; and
• the loss of protections afforded in terms of the statutory discharge for trustees who have acted in accordance with the law in force at the time they completed the winding-up, arising purely as a result of the Government’s decision to change the law retrospectively.

When is a wind-up completed?

The consultation asks at what stage a wind-up is almost to the point of being completed (question 13).  This is obviously a difficult line to draw, but a reasonable approach, in our view, would be to offer protection from the new legislation for all schemes which began winding-up immediately before the present consultation was published and which have completed winding-up within six months of that date.

The consultation also asks how it can be objectively determined that a wind-up has been completed (question 14).  In our view, this is when all assets of the scheme in question have been applied in accordance with the trust deed and rules and applicable legislation.

PPF intervention

We welcome the Government’s approach that will allow schemes which have been given directions by the PPF to designate benefits as money purchase or DB, to continue to take account of such directions.

Employer debt

This is a key issue for schemes.

We welcome the easement that will afford protection in relation to employer debt events that have occurred on or before 27 July 2011.

Anti-avoidance

In relation to employer debt events after 27 July 2011, we understand that the Government may be concerned that the change in law could lead to action taken to avoid a debt. In particular that some debts may have been triggered in the wake of the July Statement with a view to ensuring that calculations are done before the new legislation comes into force.  We have seen no evidence of schemes acting in this way.  We have also had no suggestion from employers remaining in corporate group multi-employer schemes after exits that they are particularly concerned about the potential for additional liability after the date of the change.

If certain conditions are met these debt events will not need to be revisited.  However, in reality, trustees will only be able to assess whether those conditions are met if they revisit the debt event.  In practice, trustees are likely to feel they need to revisit existing employer exits and will need as a minimum legal and actuarial advice to do so.  These costs could be avoided if the definition was not applied retrospectively.

We therefore do not think it proportionate for the new definition to apply retrospectively for these debt events.

Management of debts

We support the consultation proposal that is designed to ensure that where regulated apportionment arrangements or approved withdrawal arrangements have been implemented with TPR’s approval, these do not need to be revisited.  In our view, this is both a reasonable approach and a useful one for trustees and employers.  We would welcome the extension of this transitional protection to other mechanisms for managing employer debt, including flexible apportionment, scheme apportionment and withdrawal arrangements that have been agreed prior to the publication of the present consultation.

In any event, in many cases the exiting employers may no longer exist as a legal entity on which to call for the payment of additional liabilities or the renegotiation of arrangement already in place to deal with employer debts.

However, we consider that employer debt calculations that have already been carried out, including those carried out on or after 27 July 2011, should not need to be revisited as they have been done on the basis of the law in force at the time.  Had trustees not operated on this basis, and instead based their calculations on the July Statement, they would have been ineligible for a statutory discharge under the legislation.

There may also have been a risk to schemes in these circumstances of invalidating their eligibility for PPF entry, by compromising any debt arising.  This could arise where the balance of liabilities between the employers is altered by the inclusion of the relevant benefits, so that the departing employer has a smaller share of the overall liabilities and therefore taking responsibility for a smaller proportion of any “orphans”. But in most cases, we would expect that the change to the definition of money purchase benefits would tend to increase the debt.

Proportionality

In the event that DWP does pursue this approach, we welcome the tracking of the “former employer” provisions set out in regulation 9 of The Occupational Pension Schemes (Employer Debt) Regulations 2005, so that further recovery would not be sought if disproportionate.

Revaluation, indexation and preservation of benefits

Where an individual has selected an internal annuity, we agree that trustees should not be required to revisit pension increases on a DB basis in respect of benefits originally classified within the scheme as money purchase.

Transfers

We would welcome further consideration of the position for schemes which, as a result of section 29, may find they have incorrectly calculated underpin benefits.  An easement for schemes in this position may be appropriate.

Scheme surpluses

This is another area in which trustees have, in our experience, made decisions and acted upon the law as it was in force at the time.  We do not see any benefit in revisiting decisions made on this basis before the publication of the consultation.

The Pension Protection Fund

The consultation proposes that schemes affected by section 29 will not be treated as eligible for the PPF for any period before 1 April 2015.

We understand the need to give schemes falling within this category the time to make arrangements to comply with the requirements of the PPF and to prepare to make PPF levy payments.  However, under the requirements of the Insolvency Directive (Directive 2008/94/EC), individuals who now find themselves with DB benefits under the new legislation, must be able to benefit from some form of protection of their DB benefit.  While the risk of calls on the PPF following the reclassification of such benefits is likely to be small, delaying the availability of the PPF until 1 April 2015 could mean that the UK is in breach of its obligations under the Insolvency Directive, unless alternative arrangements are put in place.  The consultation does not address what measures the Government intends to put in place to ensure that individuals in this position are protected in the interim.

Subject to our comments about the interim period, the proposals set out in chapter 11 relating to the PPF appear to be reasonable.

Additional voluntary contributions

The consultation notes that some schemes offer members the option of making money purchase AVCs alongside their DB pension and on retirement to use these contributions to take a pension from scheme funds rather than buying a pension from an external provider.

Our experience is that, because AVCs were previously a compulsory benefit, many have retained the option to provide this facility.  We consider it likely that in most cases, where DC AVCs have been internally annuitised with main scheme DB benefits, the AVCs have been treated, and funded for, as DB benefits. In the period since 2006, AVCs have often been used to provide the pension commencement lump sum up top the 25% limit, and the main scheme DB benefits have been annuitised, making this even less of an issue for pensions being put into payment after 2006. It is therefore appreciated that the Government is proposing that  schemes that have previously treated internal annuities in these circumstances as DB benefits, should not have to revisit decisions.

Underpins

In our experience, underpin benefits are extremely common and, as such, will be a consideration for a great many trustees who will need to ascertain whether the benefits in their scheme are affected by section 29.  To illustrate this, and to demonstrate why we consider the DWP to have underestimated the number of schemes that are likely to be affected by the new legislation, we have set out below some examples of the types of underpin that are operated by the schemes we advise.

Examples

Examples of the different types of underpin used by schemes advised by our firm:

• Cash balance
• Underpin for protected rights, converted to DC on operation of underpin
• GMP underpin
• Unit price guarantee
• Cash balance scheme provides for both internal annuitisation and open market option
• Value for money underpin (DB with a DC underpin)
• Reference scheme test underpin
• Investment return guarantee
• Leaving service test creates new DB benefit.