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Pensions Bulletin 2014/50

Pensions & benefits

Autumn Statement – the revolution in money purchase death benefits keeps rolling on

The Chancellor, George Osborne, delivered his Autumn Statement to the House of Commons on Wednesday. For pensions, following the announcement in the March Budget of revolution, this time it was a matter of tweaks, albeit important ones:

  • Referring back to the already announced significant reductions in “death tax” payable on unused money purchase (MP) pension pots (see Pensions Bulletin 2014/47), the Chancellor announced an extension (already leaked in the press last week) that “From April 2015, beneficiaries of individuals who die under the age of 75 with a joint life or guaranteed term annuity will be able to receive any future payments from such policies tax free. The tax rules will also be changed to allow joint life annuities to be passed on to any beneficiary”. We understand that the intention is also that dependant’s/nominee annuities purchased from unused MP funds of those who die under age 75 will be income tax free
  • The Government has decided following informal consultation that the upper age limit at which tax relief can be claimed on pension contributions will remain at 75

Turning to non-pension matters – and leaving the major reform of stamp duty on residential property for others to comment on – we note that:

  • The Chancellor announced that from 3 December “if an ISA saver in a marriage or civil partnership dies, their spouse or civil partner will inherit their ISA tax advantages. From 6 April 2015, surviving spouses will be able to invest as much into their own ISA as their spouse used to have, on top of their usual allowance”. The ISA limit will also be raised from £15,000 to £15,240 for 2015/16
  • The Chancellor also declared that the Personal Allowance and 40% income tax thresholds for 2015/16 will each be £100 higher than previously announced (see Pensions Bulletin 2014/12), so £10,600 and £42,385 respectively
  • Next week the Government will publish the “market leading rates” on the new pension savings bonds announced in Budget 2014 which will be available to people aged 65 or over from January (see Pensions Bulletin 2014/12)

Comment

With so much change already underway in pensions, many people will be grateful that pensions were not the focus of yet more upheaval in the Autumn Statement.

We look forward to seeing the detailed wording of the legislation for the extra change to the death tax – but we assume this wording will take some time to come through given that there are so many other matters to deal with. The wording will enable us to check whether we now have consistency of tax treatment – and in particular no income tax applying following death before age 75 – however money purchase funds are delivered at death.

We understand from sources that, similarly to the provisions already made for dependant’s/nominee drawdown in the Taxation of Pensions Bill, the intention is that this tax free status will apply only where the first payment to the beneficiary is made after 5 April 2015, ie it will not apply for beneficiaries who have already started to receive such income.

We note the remaining stark contrast with defined benefit death pensions which will attract income tax however young the member dies.

DWP proposes further changes to auto-enrolment legislation

Draft regulations whose stated purpose is to simplify the automatic enrolment process and reduce burdens on employers have been issued for consultation by the Department for Work and Pensions (DWP).

The draft Occupational and Personal Pension Schemes (Automatic Enrolment) (Amendment) Regulations 2015 introduce an alternative quality requirement for defined benefit schemes, simplify the information requirements on employers and create exceptions to the employer duties in certain circumstances. This has been made possible by amendments to the auto-enrolment legislation delivered by the Pensions Act 2014 (see “auto-enrolment changes” in our guide to the Pensions Act 2014).

The alternative quality requirement for defined benefit schemes

The Pensions Act 2014 enabled an alternative and simpler approach to the test scheme standard to be delivered, which may be of particular use to those schemes that currently are a simple “pass” by virtue of being contracted out. Under this a defined benefit scheme qualifies if the cost of providing the benefits accruing for or in respect of the “relevant members” over a “relevant period” would require contributions to be made of a total amount equal to at least a “prescribed percentage” of the members’ total “relevant earnings” over that period.

The DWP now proposes to fill in the detail by setting contributions equal to 10% of qualifying earnings or 9% if the scheme does not provide dependant pension benefits. Furthermore, the following three variations (with similar 1% reductions if dependant pension benefits are not provided) will be permitted:

  • 11% of pensionable earnings, so long as pensionable earnings are at least equal to basic pay
  • 10% of pensionable earnings, so long as pensionable earnings are at least equal to basic pay and the pensionable earnings of all the relevant members is at least 85% of their combined earnings; and
  • 9% of earnings, where all earnings are pensionable

This test was one of three legislated for by the Pensions Act 2014. But the DWP now intends not to proceed with the other two. In particular, that intended for schemes that class as defined benefit but whose structure more closely resembles that of a defined contribution scheme is now to be delivered via rewriting the Hybrid Schemes Quality Requirement Rules in the light of the “shared risk schemes” being legislated for by the Pensions Schemes Bill.

Simplification of the information requirements

The auto-enrolment requirements include a potentially complex web of disclosure requirements. In the light of a desire to reduce the administrative burden on employers and to improve automatic enrolment processes, particularly having regard to the small and micro employers that will be staging from 2015 onwards, changes are proposed with the following intention:

  • To reduce the employer’s obligation to make an assessment of all categories of employees
  • To facilitate one individualised communication, which suits all circumstances; and
  • To reduce the information requirements to a basic minimum that would be appropriate for all types of employee

The DWP believes that the minimum requirements can be dealt with in two or three pieces of information at three relevant moments in time.

Employers will be able to continue with the existing information requirements if they wish to, for example if this is embedded in their systems and change would cause additional costs.

Exceptions to the employer duties

The Pensions Act 2014 allows the DWP to prescribe exceptions to the employer duty so that in certain situations an employer is not required to take action to achieve pension scheme membership. It provides that the exceptions may in particular turn an employer duty into a power. It also allows the DWP to modify any of the enrolment or joining processes and turn the duties back on if the circumstances that triggered the exception come to an end.

The DWP now intends to proceed as follows:

  • Jobholders leaving employment – the duty to enrol is turned into a power to enrol if someone is in a notice period, or where a notice is given at any time up to six weeks after the duty has arisen. The effect is that the employer can choose whether or not to enrol the employee. They can also choose to stop the auto-enrolment process where notice is given after the duty has arisen but before the arrangements are complete. If notice is withdrawn, the duty will effectively be turned back on
  • Cancelling membership prior to automatic enrolment – the enrolment duties are turned into powers thereby giving the employer the choice as to whether to enrol the employee who has cancelled membership. They apply to all those who have left a qualifying scheme regardless of the reason for joining, so long as they left within 12 months prior to the automatic enrolment, or re-enrolment, date. The employer duty to enrol will still apply, however, at the next re-enrolment date
  • Individuals who have registered for certain Lifetime Allowance protections – the duty to enrol or re-enrol is turned into a power where the employer has reasonable grounds to believe that a jobholder registered for (and still validly holds) any of Enhanced, Primary, Fixed (2012), Fixed (2014) or Individual (2014) Protection. There will be no information requirements for these employees so (in theory at least) that they can be kept completely outside the enrolment process
  • Individuals who have been paid a winding up lump sum (WULS) – under tax law payment of a WULS is subject to a condition that there can be no contributions to any registered pension scheme by the employer in respect of that member in the following 12 months. This is potentially at odds with the employer duties under the auto-enrolment legislation. The DWP is now proposing, in such a situation (but not where the individual has continuity of employment), to turn the enrolment duty into a power. The employer’s duties in relation to the employee’s right to opt in or join are also lifted for 12 months. The re-enrolment duty is undisturbed

The DWP has considered whether to extend the exceptions to employees who flexibly draw down their money purchase pension rights, but is minded not to proceed with this.

Consultation closes on 9 January 2015. A response is to be published in January with a view to making the regulations in February; to come into force in April 2015.

Comment

Subject to the inevitable caveat about devil in the detail, all these reforms appear to be sensible. Hindsight is a wonderful thing, but it would have been good if these had been in place before the start of auto-enrolment!

High Court rules that trustee can assign a section 75 debt

In a significant development of the law regarding employer debts, the High Court has ruled that the trustee of a defined benefit scheme can assign to a third party the balance of the section 75 debt that had been admitted by the administrator of the employer following the latter’s insolvency.

The decision was handed down on 16 October, but has only just come to light given the market sensitivity of the transaction which has now occurred.

The case concerns the same pension scheme of Kaupthing, Singer & Friedlander (KSF), as was in the High Court in 2013 regarding the admissibility of the same section 75 debt (see Pensions Bulletin 2013/33).

The finally agreed debt was £73.94m, of which £60.26m had been received by way of dividend payments from the administrator. The issue was that the trustee wished to wind up the scheme (outside the Pension Protection Fund), but could not do so as there remained the possibility of further distributions by way of dividends from the KSF estate which might not come through for another three to four years. But if the trustee could sell the balance of the section 75 debt now it would save scheme running costs over a number of years, exchange uncertainty for certainty, and also likely get a better recovery from the buyers than from KSF because of the sales terms that were available. It seemed the right way to go. But was it permissible?

Had it not been for the moral hazard provisions of the Pensions Act 2004, the judge would have found it relatively straightforward to confirm that assignment was possible, just like any other debt. But these 2004 provisions necessitated close legal argument before the judge was able to rule in favour of the trustee. This was because aspects of the moral hazard provisions, in particular, those relating to contribution notices, were inconsistent with assignability.

Having surmounted this hurdle all seemed clear, except that the judge had a last minute worry – allowing the debt to be assignable created the possibility of double recovery by the scheme and unnecessary loss to other creditors. In the end the judge concluded that although the relationship between the moral hazard provisions and the section 75 debt system was complex, as it was “unreal” to find that the former was intended by Parliament to alter the latter, the section 75 debt can be assigned by the trustee.

Comment

The significance of this case is that to date it has been assumed that the section 75 debt is almost personal to the trustees of a defined benefit scheme – for them alone to present to the employer/insolvency practitioner and negotiate an appropriate recovery. But given that assignability has now been given the green light this is a matter that trustees, particularly in wind up, may need to consider seriously, especially if they can secure attractive terms by a debt collector. It may even lead to a new market being created by the latter.

Move to accounting basis for insurer pension risk calculations?

The Bank of England Prudential Regulation Authority (PRA) has published a consultation paper introducing a package of measures to facilitate the implementation of the Solvency II regulation of insurance companies. This is also of interest to insurers as sponsors of defined benefit schemes and the trustees of these schemes as it includes a draft supervisory statement on the subject of pension obligation risk.

Pension obligation risk is the measure of the regulatory capital that a regulated financial firm is required to hold to meet its defined benefit pension obligations, if it has them, throughout a period of stress and beyond. As well as in the PRA handbook the PRA’s current requirements and expectations are set out in supervisory statements that were issued last year (see Pensions Bulletin 2013/18).

This latest consultation announces changes to the ground rules for calculating pension obligation risk for insurance companies (but not other regulated financial firms such as banks, building societies and investment managers). In particular, it appears to signal a move away from scheme funding to IAS 19 as the means by which to recognise and to measure both pension liabilities on insurer balance sheets under Solvency II and pension obligation risk.

The draft statement is divided into two parts.

Expectations in relation to schemes sponsored by intra-group service companies

Firms that are part of a wider group who do not participate directly in the pension scheme will be required to have regard to IAS 19 when deciding whether or not a pension scheme should be recognised on its balance sheet. This depends on whether there is a contractual agreement or stated policy in place under which the firm will contribute to the scheme.

Firms should also consider the extent to which a pension scheme sponsored by an intra-group service company poses a risk to their safety and soundness, whether or not obligations in connection with a pension scheme are recognised on their balance sheet. Examples are given.

Expectations in relation to internal models

The PRA states the following in relation to internal models:

  • Credit spread risk – when an internal model projects the value of the pension scheme liabilities following a hypothetical shock to credit spreads, it should consider which bonds will remain high quality following this shock, and what their yield would be in these circumstances (bearing in mind the requirement of IAS 19 to use a discount rate based on high quality bonds)
  • Restrictions on the recognition of pension scheme surplus – internal models need to reflect requirements in the relevant International Financial Reporting Standards concerning the circumstances under which a pension scheme surplus may be recognised as an asset of the sponsor
  • Diversification allowance – although it is permissible for an internal model to allow for a “diversification benefit” between the pension risks and the firm’s other risks, given the likely correlations between the firm’s and the scheme’s assets as well as the demographic risks of the scheme and the underwriting risks of the firm, any such benefit needs to be robustly justified

Consultation closes on 30 January 2015 and the finalised rules and supervisory statements are promised for the first quarter of 2015 (the PRA being required to transpose the Solvency II Directive by 31 March 2015 with it applying to all affected firms from 1 January 2016).

Comment

The emphasis on IAS 19 is interesting as the current PRA guidance refers clearly to the scheme funding basis as the relevant starting point. IAS 19 could potentially result in lower capital charges compared to the current requirements, although there may be links back to the funding figures if the insurer has IAS 19 asset limit complications under the IFRIC 14 requirements.

At this stage it is not entirely clear how the transition between the 2013 and 2015 statements will work and as such it may need to be explored on an individual basis between insurers and the PRA.

We also wonder whether there might be some divergence in the treatment of pension risk between insurers and banks emerging – that seems likely unless the PRA releases a further statement on pension risk for banks, moving them to IAS 19 also.

FCA finalises guidance guarantee standards and levy structure

The Financial Conduct Authority (FCA) has published its “near final” suite of principles-based standards for those responsible for delivering the guidance guarantee announced by the Chancellor in the 2014 Budget.

Policy Statement PS14/17 includes the rules that contract-based scheme providers will need to follow in the light of the guidance guarantee to signpost their customers to the guidance. The rules are published in “near final” form in order to provide firms that operate personal and stakeholder pensions with the opportunity to make the necessary changes so that they should comply with the “final” rules once they are made and come into force. Overall, the FCA has strengthened the standards consulted on in July (see Pensions Bulletin 2014/30) with the intention of ensuring consumer confidence and the delivery of helpful guidance for consumers. The main changes to the standards concern how:

  • Complaints should be dealt with
  • The outcome of a guidance guarantee session should be recorded; and
  • Those delivering the guidance should work together to ensure that all those accessing the service get a consistent outcome

The FCA has outlined some detail on plans for monitoring and enforcing the standards, with further guidance and a thorough review of the rules in the pension and retirement area in 2015.

The FCA has also published its annual fees consultation paper, which for the first time this year outlines how the levy to fund the provision of the guidance will be collected.

The annual fees consultation paper includes a proposal that financial advisers will receive a 50% reduction on the originally proposed levy. Responses to and comments on the fees and levies proposals are invited by 2 February 2015.

Comment

With about four months to go until the promised guidance makes its bow, personal and stakeholder pension schemes are up against tight timescales to ensure their processes signpost this information adequately. But the Pensions Advisory Service and the Citizens Advice Bureau must have considerably more to do over the same period; time is certainly running out!

Revised SORP for pension scheme accounts launched

The Pensions Research Accountants Group (PRAG), an independent research and discussion group, launched “Financial Reports of Pension Schemes – A Statement of Recommended Practice (2015)” (SORP) at its annual general meeting last week. This November 2014 version of the SORP provides guidance on the requirements of Financial Reporting Standard 102 (FRS 102) that relate to pension scheme accounts.

The SORP was circulated in draft form back in April (see Pensions Bulletin 2014/17), and the main proposals at that time appear to have been carried through to the final SORP. In particular, the new SORP provides guidance on the increased investment risk disclosures introduced by FRS 102 and outlines valuation methods for buy-ins/buyouts and special purpose vehicles (such as those used for asset-backed contribution vehicles). That said, certain adjustments have been made including:

  • The wording surrounding the valuation of annuities (including buy-ins and buyouts) appears to have been made more permissive; and
  • The suggestion that where a bulk buy-in has a “true-up” arrangement in progress (eg taking into account a data cleanse exercise) this is disclosed in the financial statements

The new SORP is effective for accounting periods beginning on or after 1 January 2015 (prior year comparative figures will also be needed). It replaces the current SORP which was published back in May 2007 (see Pensions Bulletin 2007/30).

Comment

The greater pragmatism included in the final guidance on the valuation of bulk annuities is welcome. The vast majority of people are only interested in an order of magnitude for those contracts, so spending time and effort getting figures on a specific basis would normally have been a waste.

Further changes made to IORP 2

A fourth “compromise directive” has been agreed by the European Council (see Pensions Bulletin 2014/40 for our reporting on the first). There are countless drafting changes between these versions, but the most significant appear to be the following:

  • Cross-border schemes – the requirement for the technical provisions to be fully funded “at all times” has reappeared (after previously disappearing) and no mention is now made of the recovery plan. Instead, the competent authorities of the home Member State are required to intervene
  • Fit and proper requirements – these now apply collectively to the persons comprising the governing body as a whole rather than on individual members of that body as previously
  • Risk evaluation for pensions – vast swathes of the previously proposed requirements have been removed. In particular, the requirement for quantitative risk profile information on material risks that the scheme is exposed to over its life time has been deleted
  • Depository – there is now a potential exemption from the requirement for defined contribution schemes to appoint a custodian where the scheme is 100% invested in regulated financial products

There may be more changes to the text at Council level before the directive goes to the European Parliament for consideration.

The text currently states that the directive will come into force on the twentieth day after its publication in the Official Journal (likely to be next year) and that Member States must transpose it into national law within 24 months of then. Previous versions stated that the directive would come into force directly in Member States on 1 January 2017.

Draft regulations fill in details of single tier state pension

Draft regulations have been laid before Parliament containing some of the detail of the single tier pension that will be available for those reaching State Pension Age after 5 April 2016.

The draft State Pension Regulations 2015 provide amongst other things that:

  • The minimum number of qualifying years necessary to become entitled to the single tier state pension at the reduced or transitional rate is ten; and
  • If the single tier state pension is deferred beyond State Pension Age, it will increase at 1/9% for each week of deferral (with no increase applying until the ninth week of deferral has been completed)

These are both as expected.

There are also provisions regarding:

  • The ability of a person to choose a lump sum or periodical payment in respect of their deceased spouse or civil partner’s deferred old state pension; and
  • Information and valuation requirements relating to the continuation of state pension sharing on divorce or dissolution of a civil partnership for those reaching State Pension Age after 5 April 2016 who are entitled to the single tier state pension at the transitional rate

Statutory revaluation and indexation confirmed

The Order has now been made setting the statutory minimum revaluation of deferred pensions other than GMPs for those reaching normal pension age in 2015. The same Order also sets, indirectly, the statutory minimum increases for pensions in payment in 2015.

The revaluation percentages within the Occupational Pensions (Revaluation) Order 2014 (SI 2014/3078) reflect the rise in the Consumer Prices Index (CPI) from September 2010 to September 2014 (see also the explanatory memorandum) and movements in the Retail Prices Index (RPI) prior to this.

The one year Order for revaluations subject to both the 5% cap and the 2.5% cap is 1.2%. These one year Orders also form the basis for so-called Limited Price Indexation (LPI) for pensions in payment and so the 5% LPI increase and the 2.5% LPI increase will also both be 1.2%.

This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you.