DWP consultation on Contribution Notices

Our viewpoint

On 18 March, the DWP launched a consultation on some key draft regulations arising from the Pension Schemes Act 2021 (PSA21).  The consultation closes on 29 April.  This is the next step in a package of measures that will come fully into force from Q4 this year. 

There remains a lot of uncertainty about The Pensions Regulator’s (TPR) new powers, but we are beginning to see the wider picture.  And, as anticipated, the new regulatory regime does indeed look tougher for corporates, more favourable for trustees, and more resource heavy for TPR. 

The consultation covers draft regulations on information gathering and interviews, but the key new regulations are those relating to Contribution Notices (CNs).  As a reminder, in certain prescribed circumstances, under current law TPR can impose a CN on a company or director, that requires them to pay a large one-off contribution into a pension scheme. Currently there are two tests or triggers for a CN and the PSA21 introduces two additional new tests that, if satisfied, will enable TPR to consider imposing a CN in a broader range of circumstances.  This consultation focusses on one of these two new tests, the “employer resources test”.

DWP seem to be proposing a very simplistic approach for the employer resources test, that will run something like this:

  • Look up the most recently published normalised Profit Before Tax
  • Assess what the same number would have been (theoretically) as if the event in question had already happened (this could be any corporate act or failure to act)
  • Compare the difference between the two numbers (ie the reduction in profit), to the Section 75 debt in the scheme (ie the buy-out deficit), and see if it is material (TPR is unlikely to provide guidance on what is “material” and will use its judgement)

Many companies which are sponsors of DB pension schemes will be likely to raise an eyebrow of concern at this simplistic approach being proposed by the DWP.

When coupled with our guess at what the detail of the second new test (the “insolvency test”) is going to look like (similarly simplistic, to be fleshed out in TPR guidance), this appears to be a big shift in regulatory power.  In particular, TPR currently has to prove (and generally fails in its attempts) that one of the existing tests has been breached, before it can consider next steps.  In contrast, going forwards, many corporate acts (dividends, more debt, business sales, internal restructuring of groups) are likely to very clearly trigger one or other of the two new tests, and it will then be in TPR’s hands to consider whether a CN is reasonable to impose, if they wish to.  We expect this to shift the balance of power and leverage in trustee / company discussions (towards the trustees).

Further, there would seem to be a timing challenge in relation to the new employer resources test.  If a sponsor wishes to test whether they may be at risk of a CN in relation to a particular act, they can estimate the impact on profit, and take a view.  However, this consultation implies that TPR will also consider the actual impact on profit that subsequently arises and is reported to be relevant (ie they will have the benefit of hindsight).  This means that a company will not be able to predict TPR’s response with confidence at the time of the event.

It is not straightforward to think through how this all may work as a package without more detail on the other new test (the insolvency test), and revised clearance guidance from TPR.  But it would certainly seem to point to the likelihood of many more companies applying for clearance from TPR for various business events, at least until we all get used to the new regime. Will TPR have the resource for this? 

And it is also worth remembering that some lawyers have said that, effectively, there is a risk of a six year look back on these CNs – and so current events may even be in scope.  It will be important for sponsors to get legal advice if they think there are new risks arising from planned corporate activity. 

As a result of these changes, in the future we would expect sponsors to engage with trustees more frequently, and at an earlier stage in their decision-making process, in relation to any corporate activity that could potentially have a significant impact on the support available for the pension scheme (eg material dividend payments or debt refinancing).  It is also likely to be sensible for trustees to agree new information sharing arrangements with the sponsor, and review their covenant monitoring processes, to ensure they are managing their own risks in this area, and so that they are confident of being aware of all activity that could potentially have an adverse impact on the scheme in good time, particularly when also considering the threat of criminal offences.

We would expect that sponsor and trustee boards will want training on these developments over the coming months.

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