21 December 2017
The PPF finalises the 2018/19 levy
On 19 December the Pension Protection Fund issued its final levy rules for 2018/19 – the first year of the new “triennium” of levy seasons running from 2018/19 to 2020/21. There are very few changes from the draft rules issued for consultation in September (see our News Alert). So, as in September, the levy scaling factor is reducing from 0.65 to 0.48, the scheme-based levy multiplier is staying at £21 per £1 million of liabilities and the risk-based levy cap is reducing from 0.75% to 0.5% of smoothed liabilities. The PPF estimates it will collect £550 million in levies for 2018/19.
The PPF has gone ahead with its proposals to:
- Change several Experian insolvency risk scorecards and incorporate credit ratings, an industry-specific model for banks, buildings societies and insurers and a special category employer status within the insolvency risk calculation. Notably, a new “what-if” tool that calculates the S&P industry-specific model score should be available for use on the Experian portal from January 2018. Insolvency scores will be averaged over the period from 31 October 2017 to 31 March 2018
- Increase the insolvency rates associated with the strongest employers (those in levy bands 1, 2 and 3)
- Change the stress factors applying to assets and liabilities in the PPF levy valuation roll forward
- Require trustees with parental guarantees that will save £100,000 or more of PPF levy to commission a guarantor strength report before certifying/re-certifying the guarantee and make improvements to the calculation for schemes with multiple guarantors or where the guarantor participates in the scheme
- Simplify the deficit-reduction contribution (DRC) certification system (it may now also be possible to exclude investment advice expenses from the expenses calculation) and provide an alternative for small schemes
- Simplify certain transfers under the block transfer regime
The PPF has also responded to its consultation on contingent assets (see Pensions Bulletin 2017/44). Headlines include:
- The new contingent asset standard agreements will be available in January 2018
- Existing contingent assets with some form of fixed cap will have to re-execute in time for the 2019/20 levy season, but contingent assets without a fixed cap will not need to be re-executed
- The new fixed cap will be a cap on the amount guaranteed on employer insolvency – if a cap is required on the amounts payable before insolvency this will have to be added separately (and must be at least equal to the lesser of the cap on insolvency or one year’s contributions to the scheme)
In supporting documentation, the PPF has published its conclusions on the consultation in the form of a policy statement; the final determination that sets out the 2018/19 levy calculation, together with a number of appendices; and guidance materials on asset-backed contributions, the bespoke investment stress calculation, block transfers, deficit-reduction contributions, insolvency risk and exclusion of mortgages.
Deadlines for the 2018/19 levy season
The deadlines for providing information to the PPF are as follows:
- Midnight at the end of 31 March 2018 (changed from 29 March 2018) for the compulsory submission of scheme returns (including any voluntary section 179 valuations), and certification/re-certification of asset-backed contributions, mortgages (to Experian) and contingent assets (which includes for the first time this year, where a parental guarantee is expected to save £100,000 or more of levy, a guarantor strength report). Hard copy documents (such as contingent asset documentation) need to be received by the PPF by 5pm on 29 March 2018
- 5pm on 30 April 2018 for certification of deficit-reduction contributions
- 5pm on 29 June 2018 for certification of full block transfers that have taken place before 1 April 2018
Now that the PPF levy materials are in final form pension schemes and their employers can consider their levy-saving measures with a degree of certainty.
The further simplification to the DRC certification is welcome, as is the removal of the requirement for contingent assets without any form of fixed cap to re-execute their agreements before 2019/20. Trustees must, however, remember to obtain a guarantor strength report if their parental guarantee is expected to save £100,000 or more of levy, and will need to re-execute contingent assets with any form of fixed cap over the next 15 months.
Auto-enrolment review published – but is the momentum actually being maintained?
On 18 December the Government published its long-awaited review of the auto-enrolment system (see Pensions Bulletin 2016/50). Titled “Maintaining the Momentum” it is clear that the Government is struggling to balance the costs of auto-enrolment with the challenges of a stagnant economy.
This is clearly seen within the Government’s less than ambitious timescale for making its proposed changes “in the mid-2020s”. So this suggests a wait of at least six years, and possible nearly a decade, before they are implemented. This will be several years after the end of the current Parliament, and well into the next.
The main proposals are:
- Reducing the lower age limit: currently one of the conditions for eligibility for automatic enrolment is that the worker must be at least 22 years old. The Government is proposing to reduce this to 18 arguing that “it will normalise workplace pension saving for more young people as they start work for the first time. This will help embed good savings habits earlier and allow more time to build up a meaningful workplace pension over an individual’s lifetime, while they balance work and other responsibilities”. This change would also bring consistency with the National Minimum Wage age threshold and thus simplify administration processes for employers. (There is no change to the upper age limit for automatic enrolment, which will remain aligned with State Pension Age)
- Calculate auto-enrolment contributions based on earnings up to the upper limit: currently under the “standard” DC auto-enrolment requirements contributions need only be paid on earnings between the lower and upper earnings limits for NIC purposes (£5,876 and £45,000 in 2017/18). The Government intends to remove this lower limit so that contributions are calculated on all earnings up to the upper limit. The report demonstrates that this will dramatically improve the amount of pension contributions being paid by and on behalf of the lowest earners. For example, a person being paid the National Minimum Wage (£13,564 annually) will see their pension contributions increase by 76%, albeit their take home pay will decrease by 2%. This also means that earners below the upper limit will, for the first time under auto-enrolment, actually accrue pension contributions equal to the headline percentage contribution rate. (The earnings trigger of £10,000 for automatic enrolment is being kept – see article below)
- Effectively remove the category of “entitled worker”: currently a person earning less than the lower earnings limit is not entitled to an employer contribution even if they opt-in to a workplace pension in their job. By making the change set out in the above bullet point this will effectively remove the category of “entitled worker” and mean that all employees joining an auto-enrolment scheme will benefit from an employer contribution
Three major issues are effectively kicked down the road with no explicit action being taken to directly address them:
- Increasing minimum contribution rates: the Government has not announced any further contribution rates beyond those already scheduled for DC schemes in April 2018 and April 2019, stating instead that it will monitor the impact of those increases “to inform discussions with stakeholders about future contribution rates and also to better understand how costs from changes to automatic enrolment are shared between individuals, employers and taxpayers”
- Multiple jobholders: the current auto-enrolment structure does not always work well for multiple jobholders on low earnings. For example, somebody who earns more than £10,000 in total across all their jobs, but does not earn that amount in a single job is not eligible for auto-enrolment. The Government has concluded that it has “not been able to identify a straightforward, proportionate administrative or automatic route for combining earnings or assigning which of several employers should then become liable for paying contributions”. However, it believes that the changes it is proposing will at least go some way in mitigating these issues
- Self-employed and auto-enrolment: it is generally recognised that, although variable, many self-employed workers do not have significant pension savings. However, the report has concluded that the self-employed workforce is too diverse to impose a single blanket pension saving solution across it. There is a statement that the Government will look to use more “nudges” and test targeted interventions to “help more self-employed people recognise the value of pension saving and achieve a shift, over time, in saving behaviour”
For those who are seeking respite from Christmas movies and charades with the in-laws over the festive season we can recommend finding a quiet corner and settling down to read the 192 page analytical report which was published alongside the main report. This provides in-depth background and some justification for the Government’s main proposals. Enjoy!
The Government has chosen to largely duck the issue of inadequate retirement savings being made into its flagship pension policy when it could have given the necessary signalling at this review. And the timescale for the changes it does propose is shockingly slow. One wonders whether these will even make it onto the statute book, given the highly fluid state that UK politics is in.
Having said this, we have some sympathy with the bind the Government finds itself in. Auto-enrolment has, on the surface, been a great success with more than 9 million employees brought into a workplace pension. The problem is that the minimum contribution rates are far too low, but the Government is scared to say this and start the process of increasing them to an adequate level (for example the ACA suggests 16%) for fear of triggering mass opt-outs from pension schemes. It would also be a brave politician who imposes additional costs on businesses in the current economic conditions.
From a social policy aspect, we do welcome the removal of the lower earnings limit for calculating pension contributions, as this will have a real impact on the lowest paid members of society. But, again, we are also aware that this change will add potentially large costs to an employer’s business costs.
Auto-enrolment – little change to the alternative quality tests
In the final chapter of the main review, the Government has now reported on the results of reviews on aspects of auto-enrolment that the Pensions Act 2008 requires it to carry out in 2017. The net result is little change.
First up is whether the alternative quality requirements for DB schemes remain appropriate – a subject on which the DWP launched a call for evidence in July (see Pensions Bulletin 2017/31). The broad conclusion is that they are, but the DWP will be looking further at the possibility of adjusting legislation so that the cost of accruals test can be used where active members have voluntarily opted to accrue on a benefit scale that would otherwise fail the test.
Second is an assessment as to whether the alternative quality requirements for DC schemes are such that at least 90% of all jobholders would have the same, or better outcomes (ie level of contributions) under these tests as they would under the default test (of 8% of qualifying earnings). The review finds that just over 99% of jobholders are likely to have the same or better outcomes.
Finally, it is reported that early indications from the consultation on the regulations associated with seafarers and offshore workers (see Pensions Bulletin 2017/31) are such that these regulations should be maintained. However, further work is going to be undertaken before the DWP responds formally, as it is required to do, by July 2018.
None of this is a surprise in a review that seems focussed on making as little change as possible, but when every pound up to the UEL becomes pensionable, as the Government intends, it does seem that the alternative quality requirements for DC schemes will need to be rethought.
Auto-enrolment parameters for 2018/19 settled
The time of year has come around again when the Government sets the earnings trigger and qualifying earnings band for auto-enrolment purposes in the following tax year.
The review has now been published in which the Government concludes that for 2018/19 the earnings trigger will remain at £10,000 pa and the lower and upper limits for qualifying earnings will remain linked to the national insurance lower and upper earnings limits and so rise to £6,032pa and £46,350 respectively.
We expect regulations to this effect to be laid early next year.
Unsurprisingly, the Government has chosen to stick to what has become the status quo for now, whilst reserving the right to make adjustments to these parameters over the coming years. But it would seem that until the lower limit for qualifying earnings falls to zero at some time in the mid-2020s, tramlines will form the basis of future reviews.
Social investment – changes to the SIP are on their way
The Government has published its initial response to the Law Commission’s June report on pension funds and social investment (see Pensions Bulletin 2017/27) in which it sets out its first view of the Commission’s recommendations and areas in which it is considering taking action. The response includes plans to clarify legislation around consideration of broader long-term financial risks in investment decisions and pension schemes’ ability to consider members’ non-financial or ethical concerns. The ministers introducing the response say that together these will make it easier for trustees to invest members’ savings in assets that can “do good”, as well as delivering market returns.
Turning to the specifics, the Government is supportive of the Law Commission’s recommended changes to the Statement of Investment Principles for trust-based schemes and aims to consult during 2018 on the changes that would need to be made to the Occupational Pension Schemes (Investment) Regulations 2005. Under this, trustees would in future be required to state their policies in relation to:
- Evaluating risks to an investment in the long term, including risks relating to sustainability arising from corporate governance or from environmental or social impact
- Considering and responding to members’ ethical and other concerns; and
- Stewardship (if any) including the exercise of formal rights (such as voting) and more informal methods of engagement
The Law Commission made similar recommendations for contract-based schemes, which the Financial Conduct Authority is considering how to progress alongside its existing work in relation to such schemes.
In relation to other options for reform suggested by the Law Commission:
- The Pensions Regulator is of the view that its existing DC code and guides sufficiently address the request to provide further guidance to trustees on how to manage illiquid assets in the context of the requirement to process transactions promptly, but will keep the issue under review as part of its ongoing guidance review; and
- The Government will consider whether pension schemes should be required to ask their members periodically for their views on social investment and non-financial factors, but acknowledges the practical difficulties in doing so
The Government intends to provide a full response to the Law Commission’s report in summer 2018.
In relation to the SIP, although we must wait for the consultation and its outcome, it does now seem that we are set on a path in which it will be expanded to cover the matters outlined above. This could be a game changer for investment policy as illustrated by the examples set out in the Annex to the response. However, there is nothing to stop trustees of occupational pension schemes pre-empting this likely development by choosing to cover these issues in their SIP now.
PLSA annual survey published
The Pensions and Lifetime Savings Association has published its 43rd annual survey of its members, providing an insight into the pension provision of some of the UK’s largest employers and pension schemes.
The survey shows that the costs for operating DB schemes have increased by 12% since 2016 – not as eye watering as the 37% increase seen between 2015 and 2016, but significant nonetheless. The increase this year is largely driven by increases in the cost of levies, governance, trustee training, administration, record keeping and communications.
DC schemes reported that although investment choice remains high – with schemes reporting a median number of 14 funds available – 88% of their main DC active members remain in their default funds. Just over a third (34%) of DC respondents described their investment strategy for the growth phase of their main scheme’s default fund as passive tracker. This was followed by multi-asset fund (26%), diversified growth fund (25%) and bespoke solution (21%).
For DB schemes, the share of assets invested in equities continued to fall – to 23% from 28% in 2016 and before that 33% in 2015. The mean employer contribution rate to DB schemes rose to 28.0% from 24.2% in 2016, while at 5.6% the mean member contribution continued to be around 6.0%.
A copy of the survey can be purchased via the PLSA’s website.
EIOPA’s second stab at stressing European pension schemes
On 13 December 2017 the European Insurance and Occupational Pensions Authority (EIOPA) published its report on its 2017 Occupational Pensions Stress Test. This exercise builds on EIOPA’s first stress test in 2015 (see Pensions Bulletin 2016/03), when occupational pension schemes were evaluated for their resilience to an adverse market scenario, using both local funding measurements and a pan-European “common methodology”. The latter, amongst other things, discounts technical provisions at a risk-free rate and also takes into account factors such as sponsor support, pension protection funds and benefit reduction mechanisms.
For the 2017 test (with a reference date of 31 December 2016), schemes were tested against a set of 257 individual risk factors covering the investment exposures of pension schemes. The adverse scenario combines a fall in risk-free interest rates with an abrupt and large drop in the price of assets, in effect producing a “double-hit” scenario. On local funding measures of DB and hybrid schemes, whilst the unstressed aggregate funding level has improved from 95% in 2015 to 97% in 2017, the stressed aggregate funding level has worsened over the period from 97% to 79%, mainly because of a fall in investments. On the common methodology, the aggregate funding level shows a very small surplus under both unstressed and stressed scenarios, but only after taking account of mitigating factors such as sponsor support, pension protection schemes and benefit reductions.
As well as an updated version of the 2015 stress test, EIOPA also considered how the wider economy might be affected by pension schemes under an adverse market scenario. In the DB and hybrid world, because of the available mitigation tools, the occupational pension sector does not seem to exert direct financial instability effects to the same extent as banking or insurance. In the DC world, adverse market conditions will affect the aggregate retirement income only gradually, over several decades, with the extent to which this affects real short-term economic activity depending on the extent to which members base their current consumption/savings decisions on their retirement projection. However, there might be more significant changes to investment behaviour following an adverse market shock.
The report also notes the lack of participation among the UK and Irish pension schemes, attributing this as a direct result of inadequate supervisory powers. The IORP II Directive (see Pensions Bulletin 2017/01), which is due to become national laws by early 2019, will give national supervisors (the Pensions Regulator in the UK) more powers to require schemes “to supply at any time information about all business matters”.
Given the current political and economic climate it is easy to understand the Regulator’s difficulties in fulfilling EIOPA’s requests on what is essentially an information collection exercise. It is also understandable that EIOPA is frustrated by the UK’s lack of response, given over half of all European DB assets are from UK schemes. Whilst IORP II will need to be transposed into UK law before Brexit and so will continue to affect UK schemes after Brexit, how much weight UK schemes will have in future EIOPA investigations remains to be seen. Separately, the Regulator has hinted at an onerous IORP III due in 2022; UK companies having close ties with European occupational pension arrangements will most likely need to take note.
Professional trustee standards proposed
A group set up with backing from the Pensions Regulator is consulting on proposed standards for those trustees of occupational pension schemes that fall within the Regulator’s definition of a “professional trustee” (see Pensions Bulletin 2017/34).
A multi-layered approach is proposed by the Professional Trustee Standards Working Group. First there are proposed standards applicable to all professional trustees covering matters such as integrity, expertise and care and impartiality. There are then additional standards applicable to those professional trustees who act as chairs and separately, those who act as a sole trustee. An Appendix gives examples of trustee duties and conflicts of interest.
The idea is that the standards will operate on a “comply or explain” basis with professional trustees being encouraged to create a document to that end which is disclosed to an interested party on request and updated at least once a year.
The Working Group is also developing an accreditation framework which professional trustees will be expected to submit themselves to; details of which will be published in 2018.
Consultation closes on 2 March 2018 and the intention is that the standards will apply from April/May 2018.
The Regulator has had a concern for some while that not all professional trustees possess what is necessary to fulfil their roles. The development of this standard is the next step in improving quality in this area of the pensions market. But it is one thing to develop a standard whose contents are almost entirely uncontroversial and another to set up a sufficiently robust accreditation framework through which an external party will need to become satisfied that the ethical and technical requirements of the standard are being operated.
Income tax – Scotland takes a different path
One of the logical outcomes of the greater tax-raising powers devolved to the Scottish Parliament by means of the Scotland Act 2016 has now come to pass with the Scottish Government proposing that in 2018/19 different tax rates and tax bands will apply for non-savings and non-dividend income of Scottish taxpayers to those in the rest of the UK.
The Scottish Government intends introducing a 19% starter rate of tax on earnings between £11,850 and £13,850, maintaining the basic rate of 20% on earnings between £13,850 and £24,000, adding an intermediate rate of 21% on earnings between £24,000 and £44,273, increasing the higher rate to 41% on income between £44,273 and £150,000 and increasing the top rate to 46% on incomes above £150,000.
In the rest of the UK income tax will be 20% on earnings between £11,850 and £46,350, 40% on earnings between £46,350 and £150,000 and 45% on earnings above £150,000.
The immediate concern for pension schemes will be how these new Scottish rates and bands apply to the tax relief that member contributions attract and the tax applied to benefits paid. Thankfully it should all work out with minimal disturbance.
Insofar as member contributions are concerned:
- For those operating the net pay arrangement (such as occupational pension schemes), the appropriate tax relief at the member’s marginal rate should come through automatically alongside the appropriate taxation of income, via the individual’s tax coding because contributions are deducted from gross pay
- For those operating relief at source (such as group personal pensions), tax relief is reclaimed at the “basic rate” of tax (Scottish or non-Scottish as appropriate) and thus will continue to be reclaimed by the provider at 20% leaving those subject to greater tax needing to claim for any additional relief
When it comes to retirement income, it goes without saying that Scottish taxpayers will pay income tax at Scottish rates, whether delivered through pension, annuity, drawdown or “UFPLS”. And in this vein a Scottish taxpayer who is:
- Subject to the annual allowance charge on excess pension savings will have this assessed by reference to how those savings sit in Scottish rates and bands
- Receiving a trivial commutation or winding up lump sum will ultimately have to pay income tax at his or her marginal Scottish tax rate on any payment derived from crystallised rights and on 75% of any payment derived from uncrystallised rights (although HMRC’s instructions for schemes continues to be to deduct basic rate in all cases and leave the member to claim back any balance)
- Receiving a trivial commutation lump sum death benefit will ultimately have to pay income tax at his or her marginal Scottish tax rate on that lump sum
A number of other taxes that apply when benefits are taken from pension schemes remain undisturbed as they are hard-coded. So, for example, the lifetime allowance charge remains at 25% on excess income benefit (and then income tax) or 55% on excess funds taken as a lump sum.
One big UK-wide issue is that many of those contributing to a scheme that operates relief at source fail to claim the additional relief to which they are entitled (beyond the basic rate automatically collected) if they are not required to complete a self-assessment tax return. This problem, currently restricted to 40% taxpayers, is about to extend to 21% taxpayers in Scotland. By contrast 19% taxpayers might be able to keep a miniscule extra tax advantage through their provider claiming tax relief at 20%.
It could have been so much more challenging for pension schemes had the Scottish Government chosen to alter the basic rate. But as proposed, the challenge will largely rest with payroll providers (on which pension schemes rely to pay out taxable benefits). It will also be most important for Scottish taxpayers to ensure that they are recorded as such by HMRC in order that not only do they pay the right amount of income tax on their earnings (and pension income), but they also receive the correct amount of relief on contributions they make personally to registered pension schemes. A particular challenge will be the tax year status of those who change residency part way through.
Scottish income tax – more news on relief at source
Following on from the Scottish Government’s income tax proposals, HMRC has issued its second pension tax newsletter focussed entirely on Scottish matters. In it, it explains how schemes operating relief at source and registered with the “secure data exchange service” will be sent a report of residency tax status of scheme members each January, starting in January 2018. The report is based on information supplied by the scheme on its last annual return of information, with HMRC adding a new field (S for Scottish tax status, U for unmatched and blank for rest of the UK).
It also explains how schemes will be able to use the residency status look up service (to examine single or multiple members) which will be launched shortly, that they must use the same tax rate for a member for the whole of a tax year and how they should submit their annual return of individual information to HMRC.
Consultation concludes on the service-related FAS cap
The DWP has published the Government’s response to its consultation on the service-related FAS cap (see Pensions Bulletin 2017/39) and unsurprisingly is going ahead with its proposals, with the regulations likely to be in force by 6 April 2018.
Minor changes have been made to the regulations (which have been laid before Parliament in draft form this week) in order to ensure that the policy intent is delivered.
Christmas and New Year break
This is the last edition of the Pensions Bulletin for 2017. It will return after the Christmas and New Year break. May we wish readers a merry Christmas and a prosperous New Year!
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.