Trustees’ fiduciary duties – is it always about the money?

That pension fund trustees do not have to “maximise returns” in the short-term at the expense of risks over the longer term is one of the messages clarified by the Law Commission in a report following up on the work of the Kay Review into UK Equity Markets and Long-Term Decision Making (see Pensions Bulletin 2013/32).  In particular the report addresses one of the concerns noted by Professor Kay that “some pension fund trustees equated their fiduciary responsibilities with a narrow interpretation of the interests of their beneficiaries which focused on maximising financial returns over a short timescale and prevented the consideration of longer term factors which might impact on company performance, including questions of sustainability or environmental and social impact”.

The report considers how fiduciary duties currently apply to those working in financial markets, and looks to clarify how far those who invest on behalf of others may take account of factors such as social and environmental impact and ethical standards.

The Commission concludes that whilst the pursuit of a financial return should be the predominant concern of pension trustees, the law does permit trustees to make investment decisions that are based on non-financial factors, providing that they have good reason to think that scheme members share the concern and there is no risk of significant financial detriment to the fund.

The report also examines the extent to which contract-based pension providers are under a duty to act in the best interests of members.  The report recommends the creation of a statutory duty on the independent governance committees (that contract-based pension providers will be required to establish from April 2015) to act with reasonable care and skill in members’ interests.

In addition, the report makes numerous references to recent research suggesting that charges are the most significant factor influencing the member’s level of pension in a defined contribution (DC) scheme.  It goes on to make some suggestions in relation to the operation of the charge cap that the Government is introducing in April 2015 for default funds in schemes used for auto-enrolment.  For example, the Commission considers that there is a possibility that inappropriate incentives to trade may be created as the cap will not apply to transaction costs.  It therefore recommends that, as part of its review of the charge cap in 2017, the Government should specifically consider whether the design of the cap has incentivised trading over long-term investment.

The Commission has also produced a summary of the report and a short guidance document which is suitable for distribution to pension trustees.

Comment

This review of the legal concept of “fiduciary duty” is welcome and the clarifications and conclusions should help address uncertainties and misunderstandings around the issue.  The short guidance document could indeed be a useful tool for trustees when setting their scheme’s investment strategy.

Narrower definition of money purchase benefits to go live on 24 July 2014?

So it seems.  The Department for Work and Pensions has this week laid a Commencement Order before Parliament the effect of which is that the narrower definition of money purchase benefits set out in the Pensions Act 2011 is just about to be switched on.

The Pensions Act 2011 (Commencement No. 5) Order 2011 (SI 2014/1638) provides for Section 29 of the Pensions Act 2011 to come into force on 24 July 2014.  This narrowing of the definition of money purchase benefits will have significant consequences for those schemes that provide benefits that are just about to cease to be regarded as money purchase, such as pensions secured within a scheme from money purchase funds.

Comment

Amusingly, the explanatory note says that a full impact assessment has not been prepared “as no impact on the private, public or voluntary sectors is foreseen”.  We beg to differ.

Interim patch published to give flexibilities for those retiring with DC funds ahead of April 2015

The Government has laid amendments to the Finance Bill (now with the Lords for consideration) to deliver the temporary easements announced in April (see Pensions Bulletin 2014/18) to help individuals who had recently drawn a tax-free retirement lump sum from a scheme – or want to do so now ahead of April 2015 – but want to access the new flexibilities announced at the Budget (most of which will not be available until after April 2015) for the balance of their money purchase funds in the scheme.

Normally any tax-free lump sum paid from pension savings (the so-called pension commencement lump sum or PCLS) must be taken in connection with a “pension” no more than six months before the pension and must be paid from the same scheme.  Where these conditions are not met the intended PCLS is an unauthorised payment and subject to penal tax charges.  “Pension” here means a scheme pension, a lifetime annuity bought from an insurer, or a designation of a fund for drawdown – which might after April 2015 be the main route for full cash out.

The amendments are intended to allow individuals to take a tax-free lump sum now and wait until the new regime is in place to decide how they want to access their money purchase pension savings; to be able to transfer the rest of their pension savings to another pension provider before doing so; or to receive the rest of the pension savings now as a lump sum in some limited circumstances.  In detail:

• Where what was intended to be a PCLS is paid before 6 April 2015 “in respect of a money purchase arrangement”, it will be a PCLS if the “pension” associated with the PCLS commences by 5 October 2015.  In addition, that pension can be paid (following transfer of its purchase sums) from a different scheme from the scheme that paid the PCLS; and if the transfer option is used in this way, any right to a protected pension age or protected lump sum is preserved as part of the transfer
• Where an intended PCLS paid before 6 April 2015 in respect of a money purchase arrangement is repaid before 6 October 2015, the intended PCLS is treated for all tax purposes as if it had never been paid.  This is in contrast to an annuity put in place – it cannot be unwound unless cancelled in a cooling-off period
• Where a member received an intended PCLS before 27 March 2014, but instead of the scheme providing the expected pension it provides a further lump sum on or after 6 July 2014 overall within trivial commutation or small pots rules then the intended PCLS will continue to be an authorised payment and tax free

The easements even cover intended PCLSs paid before 19 September 2013 (ie paid more than six months before the Budget announcement) provided a lifetime annuity was purchased to provide the associated pension but was cancelled (within a cooling-off period) on or after 19 March 2014.

Once an intended PCLS is paid under one of these flexibilities, there cannot be a further PCLS from the associated pension funds in the scheme.

Comment

The legislation applies if an intended PCLS is paid “in connection with” money purchase arrangements – “arrangement” in the tax law sense.  We read this to mean broadly that it applies where the pension associated with the intended PCLS is from a money purchase arrangement (including cash balance) within a scheme.  So this legislation is relevant not just for pure DC schemes but may have some relevance for an individual with DB and DC benefits in one scheme, though with more complex application.

A scheme wanting to implement any of the temporary patches may need to change its rules to do so (particularly the patch relating to trivial or small pot rules).  It would then need to keep a careful eye on any cases to ensure the member commits to pension format by 5 October 2015.  And it would need to comply with modified information requirements.  It may be easier in most cases to suggest that members wanting flexibility delay drawing benefits (including possibly unwinding PCLS already paid) until the new regime is in force.

Members choosing to delay committing to a pension format will need to think through any ramifications (for example, will it be material to them that the test of how much Lifetime Allowance is used up will move to the date when the pension is finally put in place?  Will they miss out on any special annuity terms?).

Cheaper and quicker public sector outsourcing passport system announced

Changes to the passport certificate system have been announced that have immediate effect.

These certificates are used for assessing whether an outsourcing contractor’s pension scheme satisfies the Government’s “broad comparability” requirements when staff transfer from public sector employment under its old Fair Deal policy.

The new system will be more streamlined and, generally, significantly less expensive for contractors to use than the current system.

For further details of this development see LCP’s News Alert.

Will the Government require retrospective non-discrimination in survivor benefits?

This is the question for which a number of lobbyists are now awaiting the answer.

Section 16 of the Marriage (Same Sex Couples) Act 2013 required the Government to conduct a review of survivor benefits in occupational pension schemes and to report its findings before 1 July 2014.  The review must have examined the differences in survivor benefits and the costs and other effects of requiring any differences to be equalised.

That review has now been published in the form of a report that sets out findings, but without any recommendations.  The Act places a duty on the Government to reduce or eliminate the differences, having considered the report, if it thinks that the law needs to be changed.  So far, the Government has just announced the publication of the report.

The genesis for this report was a concern by some that there should be no difference between same sex survivor benefits and opposite sex survivor benefits for all past service, but significantly the Act also provided for an examination of the differences between opposite sex survivor benefits provided to widows and widowers, even though such remain permissible under European law in respect of pre-17 May 1990 service.

The report concludes by saying that the costs, potential impact on pension schemes and wider consequences of making retrospective changes to scheme rules are complex issues and that the Government will have to consider these very carefully before making a decision on whether the law should be changed.

Comment

We will have to wait and see but it seems unlikely that the Government will be minded to force additional benefit costs onto schemes on a retrospective basis.  The reason?  Whilst the cost for private sector schemes is estimated to be £0.4 billion (which may be concentrated in a relatively small group of schemes), the bill for public service pension schemes comes in at £2.9 billion.  But if the Government decides to act only in relation to same sex survivors, the bill is much less – £0.1 billion in each of the public and the private sectors.

DWP adjusts the legislative ground rules to enable the Olympic scheme to enter the PPF

The Department for Work and Pensions (DWP) has laid regulations before Parliament that temporarily widen the scope of the Pension Protection Fund (PPF) to include certain employers which would otherwise be unable to undergo a qualifying insolvency event in order for the schemes that they sponsor to be considered for PPF entry.

The Pension Protection Fund (Entry Rules) (Amendment) Regulations 2014 (SI 2014/1664) come into force on 21 July 2014 and cease to have effect three years later.

Comment

Although these regulations purport to be of general application, the conditions that they set out in order for PPF entry to be possible are in fact designed solely to assist the entry of the Olympic Airlines Scheme (see Pensions Bulletin 2013/25).  As such they fail to adequately address the regulatory gap exposed by this case – namely that schemes sponsored directly by overseas employers may not be able to utilise the PPF safety net despite paying PPF levies.

Right to request flexible working now extended to all

The Department for Business, Innovation & Skills has marked the extension of the right to request flexible working arrangements to all employees by the Children and Families Act 2014 (see Pensions Bulletin 2014/11), which came into effect from 30 June 2014.  All employees who have been employed for at least 26 weeks now have the right to request to work flexibly.  Up until now, the right has only been available for parents with children under the age of 17 (or 18 if the child is disabled) and certain carers.

Acas (the Advisory, Conciliation and Arbitration Service) has produced a new Code of Practice and Guide designed to help employers understand the extension to the right, and how to consider any requests in a reasonable manner and process them.

Comment

The extension of the right to request flexible working arrangements to most employees in the workforce will in many cases be just a restructuring of existing working hours so should not, in itself, impact directly on pension arrangements.  The potential for the new flexibility in working might, however, boost staff recruitment and retention which could in turn impact on pension take up.  It might also provide older workers with more flexible routes into retirement which would pose some administrative and communication issues where fewer hours are perhaps worked in the run up to retirement.

Financial resilience of the recently retired

The Pensions Policy Institute (PPI) has published a report examining how resilient the finances of the “recently retired” are to economic, health and lifestyle shocks and making suggestions on how the “pensions industry” might work to improve this resilience.

The report considers the “recently retired” to be those within 10 years of State Pension Age (SPA) and under the age of 75 and considers four hypothetical individuals – who reached SPA in April 2012 – to examine how the income for each one would be affected by the following events:

• A period of unexpectedly high inflation – the model showed that those more reliant on private pension income, and in particular DC pension income, would be more likely to see a significant fall in their actual income against their income requirement than those reliant on the state pension
• The onset of a medium severity disability - ie difficulties with memory, comprehension and ability – this is likely to trigger a significant increase in income requirements
• Assuming that two of the individuals are in a couple, either partner dying unexpectedly five years into retirement – whilst couples are generally more financially resilient than individuals, the death of a partner early in retirement will usually result in falling income against income requirements, with the magnitude of the fall being heavily influenced by the relative shape and size of each partner’s benefits

The paper goes on to make some suggestions to improve the financial resilience of the recently retired.  These include:

• Highlighting to individuals coming up to retirement the potential improvement working an extra year or two beyond SPA would make to their retirement income
• Sending clear warnings to those who already have single-life annuities to ensure that they understand the implications and have a “Plan B” where appropriate
• Developing guidance and tools that can indicate when products such as fixed-term and flexible annuities or income drawdown might be suitable; and
• Generating financial planning tools that can model the impact of such lifestyle shocks over the course of retirement

The report was prepared for Age UK’s Financial Services Commission in February and therefore does not consider the likely impact of the 2014 Budget announcement of the removal of restrictions on accessing defined contribution (DC) savings.

Comment

This is a thought provoking report on how well the finances of the roughly 6 million people that the PPI classify as recently retired would withstand the “shocks” modelled.  It is interesting to consider the potential issues that it has put forward, all of which are centred on improving information and education.

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.