Pensions Bulletin 2018/36
13 September 2018
European Court forces PPF to re-design
The Court of Justice of the European Union has ruled that Pension Protection Fund compensation is not sufficient to protect the benefits of scheme members. In particular, application of the compensation cap and the lack of increases in payment to pensions accrued before April 1997 can lead to the value of PPF compensation dropping below half of the member’s original scheme pension, which the Court deems unacceptable.
See our News Alert for details of how this affects pension schemes that are winding up or reducing transfer values, and what the PPF will now have to do to meet the protection requirements.
The PPF has been quick to accept the verdict and says it is working with the DWP to implement the judgment as quickly as possible. Speed certainly is of the essence, as schemes that are winding up or reducing transfer values need to know the level of the PPF compensation as it has a privileged position in the winding up priority order. But this is not likely to be an easy process. Should the PPF have to monitor year on year the level of the member’s original scheme pension with the original scheme’s pension increases attached it will be a huge administrative task, even before considering the costs of augmenting benefits.
And who is going to pick up the tab for schemes that bought out “PPF+” style benefits with an insurer that might now look inadequate, when the scheme has wound up and the sponsor is insolvent? There only looks to be the PPF left!
Hampshire foils the PPF’s fixed transfer-in plan
The Hampshire case highlighted in the News Alert above has thwarted the Pension Protection Fund’s plan to have transferred-in fixed pensions amalgamated with other pension scheme benefits when being tested against the PPF compensation cap.
Following the case of Beaton vs the PPF, the PPF launched a quick consultation in July (see Pensions Bulletin 2018/27) to try to head off what it felt was an unintended treatment of transferred-in fixed pensions against the compensation cap. The consultation response issued this week with accompanying regulations still ensures the PPF has the legal basis to:
- Pay survivor benefits to widows, widowers and eligible dependent children
- Revalue PPF compensation which is not yet in payment
- Apply inflationary increases to compensation payments; and
- Include a relevant fixed pension in the application of the 90% level of compensation (subject to the cap) for those already receiving their pension, and who were below normal pension age (NPA) at the assessment date
But, at least until the PPF and DWP have fully digested the Hampshire judgment, transferred-in fixed pensions will now need to be tested against a separate PPF compensation cap – and regulations to that effect now make this clear.
That part of the Pension Protection Fund (Pensionable Service) and Occupational Pension Schemes (Investment and Disclosure) (Amendment and Modification) Regulations 2018 (SI 2018/988) relating to this issue comes into force on 2 October 2018.
The first, and nowhere near last, effect of the Hampshire case has proved a minor irritation to the PPF.
Responsible investment – new requirements from October 2019
On 11 September the DWP announced that it is legislating to clarify and strengthen trustees’ investment duties, with particular reference to “environmental, social and governance considerations” (including but not limited to climate change) and also the stewardship of the companies they invest in. This follows on from June’s consultation on draft regulations (see Pensions Bulletin 2018/25).
June’s proposals, which affect both DB and DC schemes, are to go ahead with the following changes:
- The new requirement for the statement of investment principles (SIP), which occupational pension schemes must prepare and maintain to cover trustees’ policies regarding financially material (which are defined as including ESG) considerations, must now do so over “an appropriate time horizon”
- The requirement to prepare a “statement of members’ views” about the SIP content has been dropped. Instead SIPs must state “the extent (if at all) to which non-financial matters [see below] are taken into account in the selection, retention and realisation of investments” – ie any policy about taking non-financial matters into account is optional
- A definition of “non-financial matters” has now been settled upon as “the views of members and beneficiaries including (but not limited to) their ethical views and their views in relation to social and environmental impact and present and future quality of life of the members and beneficiaries of the trust scheme”
- The requirement to state a policy on the stewardship of investments in the SIP is extended to the default investment strategy of most schemes providing money purchase benefits with more than 100 members
- The impact assessment has been adjusted to reflect a more realistic evaluation of the costs of compliance
The (unaltered) timing is that the new SIP requirements apply from 1 October 2019 and the requirements for production and publication of implementation statements apply from 1 October 2020. Guidance from the Pensions Regulator is promised by the end of November.
The DWP also indicates that further legislation/regulation in this space may be required depending on how the “SRD II” (see Pensions Bulletin 2017/02) and IORP II Directives are implemented (see Pensions Bulletin 2018/32).
Regulations combining this and the PPF fixed pension issue (see the item above) were laid before Parliament on 11 September.
There are many factors pushing trustees to take ESG factors into account in setting investment policies but there are still no explicit statutory requirements on the horizon. Nevertheless, quite a lot of work will be needed to get schemes compliant over the next year.
The consultation response is a helpfully prepared document. There is also a useful diagram on page 11 showing how the requirements will apply to different types of schemes – with some applicable to both DB and DC schemes and others applicable to DC schemes only.
Public Service Pension Schemes: Treasury statement points at surprising mix of higher contributions plus benefit improvements from April 2019
On 6 September 2018, the Chief Secretary to the Treasury, Elizabeth Truss, provided an update to Parliament on the latest quadrennial actuarial valuations of the public service pension schemes. It indicated that:
- Future service member benefits in several unfunded public service schemes will need to be improved significantly from 1 April 2019. The affected schemes are those with a cost-cap mechanism and are as yet unnamed but are likely to include the pension schemes for NHS employees, civil servants and teachers
- The valuations are also going to show significant increases in contributions from April 2019 for employers in the NHS, Civil Service and Teachers schemes due primarily to a reduction in the “SCAPE” discount rate
- In the absence of further legislation, both the improvements to members’ benefits to be earned in future and the increase in contributions will need to be funded entirely by employers since employee contribution rates were protected for a period of 25 years from April 2015
- The Government is proposing to change the cost-cap mechanism to stop this happening again, and has written to the TUC to explain what and why
- The Local Government Pension Scheme (LGPS) is subject to an additional review process with the LGPS Advisory Board before the outcome is known. Any changes are likely to be felt a year later when the 2019 funding valuations take effect
Further detail on the background and the Government announcement can be found in our News Alert.
This is on the face of it a perverse outcome, but at the same time a natural consequence of the cost-capping mechanism agreed between the Government and the Unions as part of the review of public service schemes that took place in 2014 (under which the impact of changes to the discount rate are stripped out when the cost-capping calculations are made).
Employers who participate in unfunded public sector pension schemes (eg those for the NHS, civil service and teachers) should now expect significant increases in pension costs from 1 April 2019, and factor these into budgets from 2019/20 onwards. Further substantial increases can be expected from April 2023. Those employers who regularly take on public service contracts with employees who TUPE transfer across but remain in these schemes need to consider possible increases in costs when pricing new contracts.
Employers who participate in the Local Government Pension Scheme (LGPS) can only wait and see for now, but they should be aware of the potential for significant changes in costs following the 31 March 2019 actuarial valuations – which come into effect in April 2020.
DB schemes – the Regulator focuses on the smaller ones
According to research published by the Pensions Regulator on 10 September, smaller DB schemes tend to display poorer governance standards with trustees placing less emphasis on assessing the fitness and propriety of new trustee board members. They also perform worse than larger schemes on meeting the principles of the DB funding code, particularly around taking and managing risk.
Therefore, the Regulator intends to step up its proactive involvement with smaller schemes to assess their performance in key risk areas, including governance, covenant, investment and funding. Clearer, directive feedback to the trustees of all small schemes is promised with “further action” threatened against schemes which do not act on the feedback.
Quite what the Regulator has in mind for the smaller DB schemes is not made clear. However, we understand that the Regulator is writing to a number of small schemes before they start their valuation, raising issues pertinent to the scheme and asking for a valuation questionnaire to be completed and submitted by the end of the valuation process. This questionnaire focuses on covenant, investment and funding risk.
DC retirement income – showing the strain?
The latest Data Bulletin from the Financial Conduct Authority, authored by outgoing Director of Market Intelligence, Jo Hill, illustrates some worrying trends in the contract-based DC retirement income market, set against a backdrop of a decline in full cash withdrawals and an increase in the use of drawdown and partial withdrawal products.
These worries include the following:
- Almost 60% of those accessing DC pots with valuable guaranteed incomes are not taking the guarantee – almost certainly preferring the flexibility of cash or drawdown
- 60% of new drawdown sales are for DC pots going into zero-income drawdown – which the bulletin suggests means that many individuals are using the pension freedoms to access the tax-free lump sum and are not going on to set up an invested drawdown policy to provide for retirement income, losing out on tax-sheltered investment growth over the longer term
- The annual withdrawal rate for those in drawdown has nudged up to nearly 6% of the fund value – which is significantly above the broadly 4% ceiling recommended by many advisers to ensure that funds are not depleted too rapidly
The Bulletin also contains a wealth of other statistics from the contract-based DC retirement income market.
Public policy on retirement income has yet to catch up with the freedoms unleashed by the previous Chancellor. Although a number of the charts and statistics make absolute sense – such as those with small pots choosing to encash them – this Bulletin gives some insight into the dangers of enabling what may well be sub-optimal choices being made.
Can a PPF-constructed guarantee pass muster against an overseas parental promise?
“Yes” is the answer, according to a summary judgment published last week. Whether the trustee will receive the guaranteed amount, or indeed any amount, might be a different matter.
When the Caribonum Pension Scheme’s employer, Pelikan Hardcopy Scotland Limited, went into administration in January 2018, the Scheme’s trustee made a claim of £4.3m against the Guarantor, Pelikan Hardcopy Production AG, a group company registered in Switzerland. This was brought in front of the High Court where the Guarantor raised two main defences:
- The guarantee is limited to the Guarantor’s freely disposable reserves (the “Construction Point”); and
- Because of some interaction between the trustee’s demands, the National Insurance Fund and the PPF, there is no proper basis on which to bring the claim and so any judgment against the Guarantor will be unenforceable (the “Abuse of Process Point”)
On both these defences Master Clark found against the Guarantor on grounds that there is no real prospect of successfully defending the claims. He found that the Guarantee did create a liability on the Guarantor, the enforceability of which was not under consideration. On this he concluded that “it would be open to [the employer’s ultimate parent company (Pelikan International Corporation Berhad)] not to ‘bail out’ the defendant, and to leave the judgment debt unsatisfied – the existence of the judgment does not ensure that the claimant will receive satisfaction of it”.
Much of the defence hinged on what the Swiss Guarantor might be able to pay, rather than what it is liable to pay. Given the Guarantor’s own accounts showing a negative figure of almost 9m Swiss francs, it is quite likely that the PPF levy reduction had been minimal in the past few years. The guarantee was set up in 2008 when the PPF relied completely on the liability and not enforceability to calculate levy reductions; it serves as a reminder that companies and guarantors should reconsider the value and effectiveness of any guarantees in place.
Pan-European personal pension schemes – the next stage is reached
The European Parliament’s economic affairs committee has voted in favour of rules introducing personal pension products with standard features across the EU. MEPs will now start negotiations with the European Council and the European Commission in order to find agreement on the proposed Regulation that will introduce the “pan-European Personal Pension Product” (PEPP).
The draft Regulation was published in June (see Pensions Bulletin 2018/26), but current timings are such that this Regulation is unlikely to become EU law until after Brexit. We remain of the view that this Regulation, once finalised, is unlikely to come into force in the UK and even if it did it would have minimal impact.
Master Trust Regulations finalised
Lengthy regulations, that set out much of the legislative detail of the DC master trust regime, have now been approved by Parliament.
The Occupational Pension Schemes (Master Trusts) Regulations 2018 (SI 2018/1030) mostly come into force on 1 October 2018.
Separately, the Pensions Regulator has published its latest facts and figures on the current master trust market. In this it says that it has identified 89 market participants of which 3 have wound up and 21 have triggered their exit from the market, leaving 65 schemes that are either expected to either apply for authorisation or trigger their exit from the market in the coming months.
The regulations mark yet another milestone in the creation of an authorisation and supervision regime for these increasingly important means for retirement saving, whilst these latest statistics from the Regulator provide solid evidence that the market is consolidating.
Class 2 NICs to remain
The Government has announced that it will not proceed with the abolition of Class 2 national insurance contributions due to the significant impact this would have had on the self-employed on the lowest profits who would have seen the voluntary payment they make to maintain access to the state pension rise substantially.
Class 2 NICs are a flat rate tax of £2.95 per week payable by the self-employed with profits of £6,205 or more a year, but those below this threshold can choose to make the payment (of just over £150 over the year) in order to ensure that they will get a full year’s accrual of the new State Pension.
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.