7 October 2021
- “Good headway” made on small pots solution
- MPs call on Government to show global leadership on pensions and climate change
- FCA finalises rules for value for money in workplace pension schemes and pathway investments
- Public sector pension schemes cost control mechanism gets reined in
- The “headline” cost of tax relief to the Exchequer increases once more …
- … and yet more individuals hit Lifetime and Annual Allowance charges
- Pensions Regulator blogs in support of long-term investment by DC schemes
- GMP equalisation – anti-franking guidance issued
The Small Pots Co-ordination Group has launched its first report into solving the small DC pots problem. Due to the success of auto-enrolment the number of deferred pension pots is likely to increase significantly, with a figure of 27 million such pots in Master Trust schemes alone predicted by 2035. This creates challenges both for members in keeping track of their old pension pots and not suffering erosion of them due to charges and for providers in administering them efficiently. In March 2021, the PLSA and ABI jointly convened the Group which comprises experts from a range of pension providers, industry bodies and stakeholders (see Pensions Bulletin 2021/14). Its formation was a recommendation of the Small Pension Pots Working Group report, published in December 2020.
The Co-ordination Group notes that resolving the problem is complex and so it is prioritising actions on the feasibility of a “member exchange” pilot, learning from the experiences of the Pensions Dashboards Programme (data matching and data standards) as well as forthcoming research, that looks to identify the number of small pots held by scheme members across the industry. Member exchange is a solution where, as a result of regular exercises, any identified small deferred pot belonging to the individual is transferred to a currently active pot of that individual.
The Group has found that eventual solutions must address the existing stock of small pots but also stem the flow of new ones. They must work for trust and contract-based pensions, navigating the legal and regulatory differences between the two structures. Solutions must also combine “push”, which allow pension providers to consolidate pots, and “pull” solutions, which will allow pension savers to find and consolidate pots more easily on their own.
Adding to the complexity is an ambition to ensure that whatever solutions are proposed, they work in conjunction with other ongoing interventions in the industry and are as simple and low cost as possible to derive the maximum future benefit for pension savers.
The next phase of the Group’s work will focus on administrative issues such as how to identify and match savers with pots, and issues with data quality through the lens of the current prioritised models (pot follows member, default consolidators and member exchange). The Group has also noted that some regulatory changes might be needed in the future.
The Group’s roadmap shows that it is hoping that a mass-scale consolidation model will be implemented during 2025/26. We think whether this happens will depend on many factors, of which a key one is whether new legislation is needed, as we suspect will be the case. The pensions minister appears to be pushing for solutions that do not require legislation, which is understandable given how long the legislative process takes. However, without legislative “protection” for trustees and managers, some of the blocks to implementing a solution may be very difficult to work around.
The results of Parliament’s Work and Pensions Committee’s inquiry into the risks for pension schemes posed by climate change and the role they can play in meeting emission reduction targets have been published as preparations for the COP26 UN Conference this November gather pace.
The main findings and recommendations of the inquiry launched in April (see Pensions Bulletin 2021/19) are grouped under three headings – reporting standards, scheme governance, and investment and stewardship. Amongst those with a UK focus are the following:
- Schemes are encouraged to consider setting net zero targets and the Pensions Regulator should provide guidance to assist with this, including clarifying the position regarding trustees’ fiduciary duty. The Regulator should also continuously monitor and update guidelines to explain how trustees should consider the effects of climate change on scheme members
- The Government should consult on whether there is a case for the default investment option, within DC schemes used for auto-enrolment, to align to UK Government climate goals
- The Government should set out a UK climate roadmap – including sector-specific pathways to meet the Paris Agreement goals – to provide greater certainty for pension schemes and other investors, particularly in long-term investments such as infrastructure
- As larger pension schemes are usually better placed to meet the costs of making green investments, the Pensions Regulator should report annually on the progress made in consolidating schemes. The DWP should also publish information about levels of direct investment in green infrastructure and other illiquid assets by pension schemes in its annual report
- The DWP should set out what specific steps it is taking to ensure that its policies do not incentivise divestment over good stewardship, while making clear that schemes could nevertheless consider divestment when there is no other option
The MPs also call on the Government to try to secure international commitments to work towards the global harmonisation of climate-related reporting standards; and, being the first economy to mandate disclosure of climate-related financial risks and opportunities for its pension sector (as set out in the Pension Schemes Act 2021), to play an active role in encouraging and facilitating other economies to do the same.
Given the Government’s recent focus on climate action by pension schemes, some may feel that attention should now be directed elsewhere. Nonetheless, the Committee makes several recommendations that would help trustees meet their new obligations – global harmonisation of climate reporting by investee companies, greater certainty on the UK economy’s net zero pathway, and clarification of trustees’ fiduciary duty in relation to net zero targets. We welcome these.
More concerning is the Committee’s suggestion that DC schemes might be mandated to align default strategies with net zero, which seems at odds with the current interpretation of fiduciary duty (even though the Committee says it does not believe this should be changed).
The Financial Conduct Authority has published its final rules about how Independent Governance Committees (IGCs) and Governance Advisory Arrangements (GAAs) in the workplace personal pension sector should compare the value of pension products and services and promote best value for scheme members. This follows its consultation last year (see Pensions Bulletin 2020/27) about defining value for money and the three key elements to take into account (costs and charges, investment performance and quality of service). These rules were also referred to in the FCA and Pensions Regulator’s recent joint discussion paper on this topic relating to all DC schemes (see Pensions Bulletin 2021/39).
The final rules are largely the same as those set out in the consultation draft, but following feedback, now allow IGCs some flexibility to decide how best to conduct the costs and charges comparison – ie whether it is carried out at an individual employer arrangement level or at a more aggregated level, or a combination of both. Additional reporting requirements will apply where the assessment has been carried out at an aggregate level.
The new rules also require that IGCs compare their provider’s offerings with similar offerings available on the market as part of the assessment.
As a result of these rules the FCA expects “that frameworks for assessing value for money will continue to develop and become more detailed as IGCs become increasingly competent at clearly explaining the specific targets or benchmarks used as part of their assessment, as well as other considerations given to the differing needs of members. This would be reflected in the quality of IGC reports, as comparisons between providers become more consistent and effective at driving improvements in product offerings”.
The FCA also states that, following feedback, it is not going to consult, for the time being, on any further changes to require that pension providers have a specific responsibility to ensure value for money for their pension products – this was raised for discussion in the consultation.
The new rules took effect from 4 October 2021 and provider firms and IGCs have until 30 September 2022 to publish their next report (extended from 31 July 2022). Future reports will also have a 30 September deadline.
IGCs and GAAs have had a value for money assessment obligation since they were established in 2015, but there have been concerns about how this should be undertaken, with different practices developing. Hopefully, by making the FCA’s expectations clearer, both will find it easier to carry out these assessments.
However, the cost and charges easement provided to allow comparisons to be aggregated by reference to employer criteria still require significant work where a pension provider has hundreds or thousands of employers. Analysis will be needed to combine employers into “sufficiently similar” cohorts and the IGC must explain its reasons for doing so.
And these rules are just a further step towards a more systematic and transparent framework. We can expect more in this area from 2022 after the FCA and Regulator’s joint consultation concludes.
The Government has announced that it will implement all three proposals it consulted on in June (see Pensions Bulletin 2021/27) to fine tune the cost control mechanism applicable to public sector DB pension schemes, first tested at the 2016 valuations and immediately proving not to work.
The new design aims to reduce intergenerational unfairness by removing any allowance for legacy public sector schemes in the mechanism, improve its stability by increasing the corridor outside of which future benefits or member contributions must be adjusted, and take into account the wider economic situation by introducing a validation layer whereby breaches of the mechanism only lead to a change in benefits where that is in line with the long-term economic outlook.
The Government expects to implement all three proposals in time for the 2020 valuations. As for the as-yet unfinalised 2016 valuations, the Government has committed to honouring the impact of any “floor breaches” on the old mechanism and expects to deliver any benefit improvements that are due via increases in benefit accrual and/or reductions in member contributions in respect of services from 1 April 2019.
The results of a related consultation on the Superannuation Contributions Adjusted for Past Experience – or SCAPE – discount rate has not yet been announced.
Statistics published by HMRC, for tax years 2018/19 and 2019/20, reveal that the estimated cost of tax relief on pension contributions is projected to rise over a two year period by £4.4bn to £41.3bn, from the most recent year previously published (2017/18 – now estimated to amount to £36.9bn). This continues an upwards trend seen over recent years. The increase is spread across both occupational and personal pension schemes.
HMRC explains this increase as expected largely “as result of automatic enrolment, which has increased the number of individuals saving … and partly due to increases in employer contribution rates”. There has also been “substantial growth in employer contributions” to public sector DB schemes following increases to contribution rates to many such schemes from April 2019.
Net of tax revenue from pensions currently being paid, the 2019/20 cost is estimated as £22.1bn. The 2019/20 cost of employer national insurance relief is estimated at £19.7bn.
As ever, users of the cost statistics need to be wary: HMRC warns that they are “subject to large revisions and have a particularly wide margin of error”.
The fear is that this latest increase in the cost of tax relief could play into the Chancellor’s hands as he looks at various revenue raising measures in preparation for the 27 October Budget. But the growth – certainly from the auto-enrolment aspect – reflects greater retirement provision being made, spread over millions of workers and so is something to be welcomed (indeed the auto-enrolment growth was to be expected as a result of the phased rise in statutory minimum contributions). It also means that in years to come there will be greater tax revenue flowing into the Exchequer as more taxable pension income is received than would otherwise have been the case.
Other statistics published by HMRC at the same time as those in the article above show that the highly complex pension tax system is catching more and more people through annual and lifetime allowance charges.
42,350 individuals reported an annual allowance charge in 2019/20 self-assessment returns and 8,510 individuals were caught by the lifetime allowance (LTA) charge, as revealed in scheme returns made in relation to the same tax year. The latter brings the total number of reported LTA charge cases since A-day to over 43,000 despite the various protections alongside past reductions in the LTA.
The amount of money withdrawn from pensions flexibly since the 2015 pension freedoms also remains on an upwards trajectory (which must mean a growing number of individuals becoming subject to the money purchase annual allowance measure).
The number of individuals being hit by tax charges connected with the allowances is escalating – not a surprise given freezes or reductions in allowances over the years, but completely out of line with the original intention that these complex measures rarely impact.
This does of course represent only part of the tax relief savings for the Government from the measure. Many individuals will have cut back on making pension savings to avoid incurring an AA or LTA charge, or (in the defined benefits world) retired early.
As an aside, we note that HMRC’s recent Pension schemes newsletter 133 reports corrections to their “signposting” of changes made to the HMRC Pensions Tax Manual Guidance. It is good to see the signposts back in place including filling in retrospective gaps – these signposts are essential and much appreciated, to keep track of HMRC’s latest reading of the complex regime.
David Fairs, Executive Director of Regulatory Policy, Analysis and Advice at the Pensions Regulator has blogged in support of the report and recommendations of the Productive Finance Working Group (see Pensions Bulletin 2021/40), whilst at the same time setting out, in his view, some of the negative aspects of the growing DC market.
These include: too many subscale schemes, a focus on cost rather than saver outcomes, and a lack of innovation, particularly when it comes to investment. In relation to the Working Group’s recommendation that the Regulator provides some additional guidance for trustees on investing in illiquid assets, the Regulator is to engage with a range of industry stakeholders to scope out the form and extent of the guidance that might best meet the needs of trustees, with an intention of publishing the guidance in 2022. It will also work with the DWP and other parties, as appropriate, as the Working Group’s recommendations are taken forward.
This blog reveals once more the Regulator’s dissatisfaction with the current state of the DC market and is a sign that more is likely to come from Government and regulators with the overall aim of improving outcomes for DC savers.
The GMP Equalisation Working Group, a cross-industry grouping of GMP equalisation experts brought together by the Pensions Administration Standards Association, has ventured into the complex and uncertain world that is anti-franking, looking at it in the context of achieving GMP equalisation, where it can have a significant impact on any uplifts due.
Anti-franking is the means by which legislation seeks to ensure that, in most circumstances, the revaluation provided to GMPs in deferment can’t eat into a member’s other benefits. Unfortunately, for those who commenced service before 17 May 1990 it is not clear how to apply this protective legislation when seeking to deliver GMP equalisation for benefits that accrued between this date and 5 April 1997.
The guidance focuses on one potential technique – Ring fence (90-97) – providing examples using this technique, which it hopes will be useful to schemes and their administrators. It also describes two other techniques – DWP 2012 (Whole of Service Mixed Sex) and Apportionment (Whole of Service Pure Sex) – which are more complex and goes on to compare these with the Ring fence technique. The expectation is that most will use the ring fence technique due to its (relative) simplicity.
This guidance exposes the fiendish complexity of just one aspect of GMP equalisation and will clearly be of assistance to those called upon to undertake such work.
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.