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Pensions Bulletin 2021/27

Our viewpoint

Government proposes amendments to the public sector pension schemes cost control mechanism

On 24 June the Government proposed three amendments to the cost control mechanism used in various public sector pension schemes.

Introduced as part of the reform to the public service pension schemes, the mechanism was designed to protect the taxpayer by limiting the cost of such pensions, whilst at the same time maintaining the value of benefits for public service employees if pension provision gets cheaper.  It has been paused since January 2019 (see Pensions Bulletin 2019/05) whilst a decision was made on how public service pension schemes would implement the results of the Sargeant and McCloud discrimination cases (see Pensions Bulletin 2021/06).

In a recent report the Government Actuary noted the “somewhat perverse outcome” the cost control mechanism would have given after the 2016 valuations.  Employer contribution rates increased by up to 9% of pensionable salaries across the different schemes before the impact of the mechanism.  But in every case the mechanism indicated the “member value” of benefits had dropped by more than the 2% buffer (or corridor), and as a result benefits would have needed to improve with a commensurate further increase in employer contributions!

The main reason for this outcome is that the cost control mechanism only takes into account “member costs” – that is, broadly, costs which are deemed to affect the value of the scheme to members.  The increase in employer contributions is mainly driven by the falls in discount rates, and these are excluded from the mechanism, leading to the unintuitive outcome described above.

The Government Actuary proposed a number of possible changes to the mechanism which could address this issue.  The Government response proposes to implement three of them:

  • Removing any allowance for legacy public sector schemes in the cost control mechanism, so that it only considers past and future service in the reformed schemes
  • Widening the 2% corridor mentioned above to 3%
  • Introducing a validation step at the end of the process – ie an economic check so that a breach of the mechanism would only be implemented if it would still have occurred had the long-term economic assumptions been considered. Had this check been in place, there would not have been the same “perverse outcome” after the 2016 valuations

For the unfunded public service schemes, the discount rate used is known as the SCAPE discount rate.  The methodology for determining this rate is also subject to a consultation published on 24 June, and the Government notes that the two consultations are linked, given the potential for the SCAPE discount rate to impact the cost control mechanism.  Once the methodology has been set there will be a subsequent consultation around the level of the SCAPE discount rate in due course.  There are two main options:

  • Keep the methodology based on expected long-term GDP growth, potentially allowing for refinements such as term-dependent rates and/or actual GDP experience; or
  • Change back to a measure based on the Social Time Preference Rate (or “STPR”, a discount rate used in government to appraise projects), with options to allow for long-term uncertainty or reduce the value to remove allowance for catastrophe risk

The Government also proposes that future reviews of the SCAPE discount rate be aligned with the valuation cycle, to reduce the likelihood of “out-of-cycle” reviews being required.

Both consultations close on 19 August 2021.

Comment

It did seem bizarre that the cost control mechanism was proposing improvements in benefits for public sector members at the same time that their employers were already seeing significant increases in their contributions.  The Government has now proposed three measures to help address the issue.  In particular, the economic check should ensure that where a benefit improvement would be in order to maintain value for members, this should not be increasing the existing cost of the reformed schemes to the taxpayer.

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DWP finalises employer resources contribution notice test

The regulations that fill in some detail in relation to the new “employer resources test” have now been finalised following consultation in March (see Pensions Bulletin 2021/13).  They will now have to be approved by both Houses of Parliament before becoming law.

The regulations are not changed in substance from the draft on which DWP consulted – in particular, the employer resources test will continue to run using the proposed normalised profit before tax metric – ie profits adjusted for non-recurring or exceptional items.  However, it is now made clear that the Pensions Regulator must have regard to relevant financial reporting standards when determining whether an item is to be treated as non-recurring or exceptional and the value of such an item.

It has also been clarified that, so long as the Regulator takes into account all relevant information in its possession when completing its employer resources calculations, such a determination needs no further verification step.  As a result it appears that companies will not get an opportunity to challenge the calculation at this stage or provide further information that might impact the calculation.

In addition, charities and not trading for profit organisations are now dealt with explicitly via a normalised net income metric.

The DWP has also published its response to the consultation.  This includes some interesting points including the following:

  • Rejection, on a number of grounds, of an alternative EBITDA (Earnings Before Interest Tax Depreciation and Amortisation) measure put forward by many respondents
  • Where the employer resources test is met, the separate statutory test for reasonableness obliges the Regulator to take account of all relevant factors before imposing a Contribution Notice – and this may include a broader assessment of the employer’s strength than that provided by the test. This is a helpful reference to the Contribution Notice regime as a whole, providing some comfort that the Regulator will be taking a holistic view
  • A clear statement that the new Contribution Notice trigger will not be applied retrospectively, with the Commencement Order to come making clear that it will apply to acts and failures to act from 1 October 2021
  • Recognition that the Regulator may see an uptick in clearance applications, but should have the flexibility to divert resources as necessary to cope
  • The possibility that the Regulator may in the future produce a single document relating to its experience of considering and using its Contribution Notice powers, setting out its view and expectations

The Pensions Regulator (Employer Resources Test Regulations 2021 are intended to come into force on 1 October 2021.

Comment

The now settled regulations continue to give limited insight into how this new test is to operate, making the settling of the Regulator’s Code of Practice (see Pensions Bulletin 2021/23) and the promised refresh of its Clearance guidance all the more important.

Once the new regime is activated corporates will need to be able to assess the impact of their business activities against the new tests and conclude whether or not they are triggered (ie whether the reduction in employer resources and/or reduction in scheme insolvency recoveries are ‘material’).  In scenarios where one (or both) of the tests are triggered, the Regulator still has to conclude that it would be reasonable to impose a Contribution Notice, taking into account all relevant factors, which is expected to include the extent of any mitigation provided and a broader assessment of the employer’s strength.

Therefore, in order to build a defence against these potential regulatory actions, it will be important for the company and directors to put together a case on file as to why, in the context of the broader covenant support for the scheme, it is reasonable to proceed with the business activity.

For cases which are clearly ‘material’, or those which are considered at ‘high risk’ of potentially being considered ‘material’ by the Regulator, the corporate may consider applying for Clearance.  This is the only way in which they will get certainty, but it may come at a price.

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DWP lays information gathering regulations

On 28 June the regulations extending the Pensions Regulator’s powers in a number of areas, as a result of provisions set out in the Pension Schemes Act 2021 were laid before Parliament.

The regulations are not changed in substance from the draft on which DWP consulted in March (see Pensions Bulletin 2021/13) although there have been many changes at the drafting level.  As before they cover the following topics:

  • The contents of the notice that must be given by the Pensions Regulator when requesting attendance for an interview (virtually or in person) about a regulatory matter
  • Extension of the new inspection of premises powers so that they potentially apply to any employer in a multi-employer scheme
  • The fixed and escalating penalties applicable where individuals fail to comply with information gathering requests

The DWP has also published its response to the consultation.

The Pensions Regulator (Information Gathering Powers and Modification) Regulations 2021 (SI 2021/754) come into force on 1 October 2021.

Comment

The finalisation of these regulations has proceeded as expected.  The next step is for the Pensions Regulator to update its policy guidance in these areas.

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The Pensions Regulator’s ambitions for equality, diversity and inclusion

On 24 June the Pensions Regulator published a thought-provoking strategy document setting out how it plans to not only embed equality, diversity and inclusion throughout its own organisation, but also how it will try to drive change in these areas across the pensions industry.

The Regulator’s vision, as set out in the document, is to build a workplace pensions system that delivers the best possible outcomes for all workplace savers, particularly in light of the “explosion” of the number of people saving for their retirement due to auto-enrolment.  The Regulator is of the opinion that diversity and inclusion is important to good governance and decision-making, which in turn is key to achieving good outcomes for savers, as is identifying and understanding the factors that can lead to pension inequalities and how to drive improvements.

The Regulator has accordingly set out the following three strategic aims, which it hopes to achieve between now and 2025:

  • To be a fair, diverse and inclusive employer
  • To build a collective understanding of why pensions inequalities occur and, within its regulatory remit, work in partnership with others seeking to reduce them
  • To promote high standards of equality, diversity and inclusion among its regulated community

The report includes detailed information about the composition of the Regulator’s own workforce and plans to improve its own performance in this area, but of wider impact will be its intention to “contribute to the ongoing development of the evidence base for why pensions inequalities occur, to inform evidence-based policy making and help support industry, fellow regulators and central government to achieve the best outcomes for all workplace savers” and “work with and influence the governing bodies that manage workplace schemes, providing positive support and encouragement to help them become more diverse and inclusive in their decision-making”.

The Pensions Regulator is already working with the pensions industry – via its Industry Working Group – to, among other things, improve the diversity in the composition of pension scheme boards.  An action plan is expected later this year.

Comment

We welcome the Regulator’s acknowledgement that while auto-enrolment has increased the numbers of workplace pension savers, it has also resulted in a more diverse saver profile which will need to be understood in order to alleviate inherent inequalities.  We also welcome its promise to work with the governing bodies that manage workplace schemes to help them become more diverse and inclusive in their decision-making.

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Annual funding statement analysis shows improved position for deficit repair contributions

The expected valuation positions of “tranche 16” DB pension schemes (ie those with valuation dates between 22 September 2020 and 21 September 2021) is explored in analysis carried out by the Pensions Regulator to give context to the Annual Funding Statement 2021 (see Pensions Bulletin 2021/23).

Overall, the Regulator’s modelling suggests that schemes undertaking valuations as at 31 December 2020 will show similar funding levels but on average worse deficits from those reported three years previously and the current recovery plan will not be on track to remove the deficit by the end date.  On the other hand, schemes undertaking valuations as at 31 March 2021 will have on average improved funding levels and deficits compared to those reported three years previously.  This is mainly due to financial market movements over the three months to 31 March 2021, and there will of course be much variation in how individual schemes have fared around these averages.

The Regulator’s modelling also suggests that if tranche 16 schemes all had 31 March 2021 valuation dates, in order to retain their recovery plan end dates (or for those schemes nearing the end of their recovery plan period to make a modest increase in the remaining recovery plan length to bring it to three years):

  • The median required increase in deficit repair contributions would be around 0% to 25% – this compares to around 50% to 75% in the same analysis last year
  • 34% of schemes would be able to retain their DRCs at the same level or less, while just 4% would need to increase DRCs to more than three times their current level – these percentages were “fewer than 15%” and 20% respectively last year

However, the Regulator notes that the analysis does not factor in how the Covid-19 crisis may have impacted the strength of the employers’ covenant, contribution affordability or mortality experience or assumptions.  The Regulator also reminds us that the position for individual schemes will vary greatly compared with the aggregate estimates, being dependent on scheme-specific inter-valuation experience, valuation dates, funding assumptions and investment strategies.

Comment

This brief analysis adds useful context to the matters discussed in the annual funding statement published in May.  Whilst some comfort can be taken from the improved outlook, as at 31 March 2021, for recovery plans and deficit recovery contributions compared to last year, this could turn out to be a misleading picture if trustees need to revisit their approach to technical provisions as a result of reappraising the employer covenant in the light of Covid-19 and Brexit (and in any case, as we have seen, the majority of these schemes will still be required to increase their DRCs).

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HMRC starts to withdraw Covid-19 easements

HMRC’s latest pension schemes newsletter published on 25 June contains the usual mix of subjects the first of which relates to the temporary changes to pension processes brought in, from March 2020, as a result of Covid-19 and the wholesale switch to remote working.  But instead of extending nearly all of the easements, due to end on 30 June, for a further three months as has been the custom, most end on this date.  Unhelpfully, HMRC does not go on to list which ones are ending, leaving it to the reader to trawl through six previous newsletters to work it out.

The easements that are ending include:

  • The cancellation of penalties for late reporting of transfers to QROPS
  • The special circumstances that can be called on when testing, against the lifetime allowance, certain sums and assets being crystallised for drawdown purposes
  • The ability to use other methods to value assets where it is not possible to use normal methods
  • The ability to agree payment holidays on loans due from connected parties and rents on commercial properties held in registered pension schemes, without independent valuations taking place

In relation to the cancellation of penalties and interest for late submissions of Accounting for Tax returns, it appears that this easement, which is also being withdrawn, applied only in respect of the quarters ending 31 March 2020, 30 June 2020 and 30 September 2020.

The other topics covered in the newsletter comprise:

  • Some further updates relating to the roll out of the Managing Pension Schemes service
  • The deletion of credentials for users who have not, for the past three years, signed into the old Pension Schemes Online, the new Managing Pension Schemes service, or any other tax service
  • A reminder about the rules governing rent or loan payment holidays and those for renegotiating leases, where a commercial property held within a SSAS or SIPP is being rented out to a connected party. HMRC has also noted that if they ask for details of a transaction between a pension scheme and a connected tenant, scheme administrators should be able to show they’ve taken steps to make sure they’ve acted in the best interests of scheme members

Comment

Whilst ending many of these easements appears to be the right thing to do, to give next to no notice, and fail to highlight which ones are ending and the reasons why, is the wrong way to go about it.

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Data protection – European Commission adopts adequacy decisions for the UK

On 28 June, in a welcome move, and just prior to the end of the six-month grace period following the end of the Brexit transition period of 31 December 2020, the European Commission adopted two adequacy decisions for the United Kingdom – one under the General Data Protection Regulation (GDPR) and the other for the Law Enforcement Directive.  Personal data can therefore continue to flow freely from the EU to the UK where it benefits from an essentially equivalent level of protection to that guaranteed under EU law.

The adequacy decisions also facilitate the correct implementation of the EU-UK Trade and Cooperation Agreement, which foresees the exchange of personal information, for example for cooperation on judicial matters.

Both adequacy decisions include a ‘sunset clause', which limits the duration of adequacy to four years, although they can be renewed if the UK continues to operate a data protection level deemed adequate by the Commission.

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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.