Government Introduces Pensions White Paper

June 2003 the Government introduced a new White Paper ("Action on occupational pension schemes") publishing various proposals on occupational pension schemes. Some of the proposals are radical. They build on some of the ideas raised by the previous Green Paper ("Working and saving for retirement") issued in December last year. The three principal aims of the proposals are:-

• improving member protection;
  
  
• deregulating pension provision; and
  
  
• increasing choice for retirement planning.
  
  

The proposals will affect employers and trustees. It is not expected that the changes will come into force before April 2005.

Improving Member Protection

Full buy-out on winding-up

The Government intends to strengthen the protection for members whose solvent employer chooses to wind-up a defined benefit pension scheme. The legislation will be retrospective to wind-ups that start on or after 11 June 2003. The main effect is that solvent employers who choose to wind-up their occupational pension schemes will need to ensure that there are sufficient funds to meet the full buy-out costs of the rights of all the scheme members. Buy-out costs are the actual costs of buying annuities from insurance companies. This proposal will replace the present requirement, which is usually to pay the much lower statutory Minimum Funding Requirement (MFR) debt. The scheme trustees will (as at present) still, it seems, be able to compromise the debt. However, a compromise will need to be consistent with their fiduciary duties and their right to a greater amount of money from the employer than under the present regime.

Comment: It is generally accepted that buying-out accrued pension benefits with insurance companies is very expensive. It is likely that the vast majority of pension schemes are substantially underfunded on a buy-out type basis. This proposal is likely to lead to an even more rigorous investigation of any company's defined benefit pension arrangements. It could also become imperative for companies not to trigger the wind-up, e.g. by sale of a large part of the business or by reorganisation or proceedings such as arrangements with creditors.

Extension of Transfer of Undertakings (Protection of Employment) Regulations 1981

On an asset deal the generally accepted view is that all employees' contractual rights are protected except certain limited occupational pension plan benefits.

The Government proposes that on a business sale where the old employer has an occupational pension scheme the new employer must, as a minimum, now offer membership of a new pension arrangement and match employer contributions of up to 6%.

Comment: This option is less onerous than previous suggestions. In particular, there is no proposal to provide broadly equivalent future service benefits or to take account of contracting-out.

Pensions Protection Fund

A compensation scheme, the Pensions Protection Fund (PPF), will be established by statute. It will be broadly similar to the Pension Benefit Guaranty Corporation in the US. The PPF will pay a maximum of 100% of pensions in payment and 90% of the benefits of those still working if a pension scheme winds-up when the employer is insolvent. The maximum amount guaranteed, however, by the PPF will be capped. Funding for the PPF will be provided by a levy payable by all defined benefit schemes. Schemes which are in deficit will pay not only a flat rate levy, but also an additional premium.

Comment: This potential further cost for underfunded schemes is an additional reason for careful pension due diligence on acquisitions. It appears that the proposal will not apply to historic wind-ups.

Priority order and winding-up

The Government also proposes changes to the winding-up priority order. The intention is to ensure a fairer sharing of assets where a scheme winds-up in deficit. The Government intends to afford greatest protection to those members who have contributed to the scheme for the longest period of time.

Comment: This proposal offers a potentially fairer allocation. Recent experience has shown that pensioners have been generally well protected at the expense of active and deferred members. This proposal may be particularly unwelcome for those approaching retirement with little or no time left to save for retirement.

Better trained trustees

The Government also proposes to introduce legislation to provide that trustees are familiar with all relevant issues and have knowledge across the full range of their responsibilities. Guidance on how to meet this requirement will be detailed in a code of practice.

Comment: This is not a new proposal, but it might discourage lay members from taking on the onerous role of being a trustee.

Better protection for early leavers

The Government proposes to abolish the current two-year vesting period. In effect, employees who have been a member of a scheme for at least three months, but leave during a vesting period, will need to be given the choice between a return of contributions or a compulsory transfer value.

Comment: This proposal avoids having to administer a large number of members with short service.

Consultation with employees on changes in benefits

In order to comply with the proposed new EU Directive on consultation legislation, employers will be required to consult with their employees, employees' representatives or both before significant pension scheme changes are made.

Comment: No detail on the manner of the proposed consultation has been released yet. This will add to the present debate on the extent to which pension rights can be changed without employee consent or consultation.

New regulator

The Government intends to establish a new pensions legislator focusing on fraud, bad governance and poor administration. It will also encourage best practice through an increased guidance role and education.

Comment: It is likely that the new regulator will be much more pro-active.

Deregulation

MFR

MFR has been criticised by many commentators because it distorts investment decisions and imposes a "one size fits all" solution. MFR will be replaced with a scheme-specific funding requirement to permit schemes greater flexibility in matching investment strategy to membership profile.

Trustees, employers and the scheme actuary will be required to develop an appropriate funding strategy for each scheme. The main provisions of the scheme-specific funding requirement will be:-

• scheme trustees must draw up a statement of funding principles;
  
  
• trustees will be required to obtain a full actuarial valuation at least every three years;
  
  
• after the valuation, the trustees must put in place a schedule of contributions, setting out how much the employer and employees must pay;
  
  
• if the trustees cannot reach agreement on the required employer contribution, they will have, as a last resort, power to freeze or wind-up the scheme;
  
  
• the trustees will be required to send information to members each year, covering the funding position of their scheme; and
  
  
• the actuary's duty of care towards the scheme will be clarified.
  
  

Comment: This change will grant trustees much greater influence on the funding strategy. Most scheme rules provide a reasonable amount of control to an employer when setting contribution rates as long as the contribution rate is sufficient to meet the MFR. Trustees now will have a nuclear deterrent. If they cannot reach agreement they could wind the scheme up, possibly requiring the employer to ensure that it is fully funded on a buy-out basis.

Lower LPI

The Government has determined to relax the current indexation requirements. The proposal is that in future schemes need only index pensions in payment by inflation, capped at 2.5% per year, as opposed to the present 5% cap.

Comment: This proposal should be welcomed by employers. Presumably the proposal only relates to changes to future service accrual.

Scheme amendments

Section 67 of the Pensions Act 1995 is to be relaxed, so schemes will be able to make rule amendments subject to the following:-

• the scheme rules contain a power to make changes;
  
  
• the change does not involve converting defined benefit rights into defined contribution rights;
  
  
• trustee consent is obtained;
  
  
• the total actuarial value of the member's accrued rights at the point of any change is maintained (seemingly on a group basis);
  
  
• pensions in payment are not reduced; and
  
  
• members are consulted before any change is made.
  
  

Comment: This looks like a welcome change to the historically very thorny issue of section 67. However, much will depend on the exact scope of the drafting and the form of consultation that is required. Actuarial input will still be needed for changes.

Simplifying legislation

The Government has stated that the level of prescription of legislation will in future be based on the proportionate risk to scheme members.

Member-nominated trustees

Schemes will be required to have at least one-third member-nominated trustees without any right for an opt out. The intention is that all members are able to nominate some of the trustees, giving the trustees the flexibility to meet the legislation in a manner appropriate to their circumstances.

Simplification of contracting-out

A number of proposals have been made:-

• relaxation on contracted-out rights forming part of the tax-free lump sum permitted under Inland Revenue rules;
  
  
• simplification of the administration of Guaranteed Minimum Pensions (GMP) and the anti-franking legislation which protects benefits in excess of the GMP from being eroded;
  
  
• a relaxation of restrictions preventing contracted-out rights being paid at the same time as other benefits;
  
  
• an increase in the level at which small pensions derived from contracting-out rights can be commuted;
  
  
• to remove the requirement to obtain member consent for the commutation of a pension into a lump sum when that entitlement consists solely of equivalent pension benefits.
  
  

Other simplifications

The Government also plans to:-

• streamline the internal dispute resolution procedure;
  
  
• rationalise rules on employee communication;
  
  
• clarify the Pensions Ombudsman's jurisdiction;
  
  
• simplify pensions on divorce legislation by abolishing safeguarded rights (broadly the ex-spouse's share of contracted-out rights); and
  
  
• simplify the tax treatment of multi-employer schemes.
  
  

Increased Retirement Planning

The Government intends to raise the profile of retirement planning and ensure that adequate information is provided to allow individuals to make an informed choice.

Pension forecast

Earlier in 2003, defined contribution members began to receive their first statutory money purchase illustration. This facility will be extended to all types of pension arrangements. Each scheme must issue annual benefit statements to their members showing the amount of pension they have built up as well as the likely amount they will receive on retirement.

Combined pension forecast

The Government started its five-year programme of issuing state pension forecasts in May 2003. The Government wishes to encourage employees and pension providers to provide combined pension forecasts. The present proposal is just an initiative. However, legislation will be enacted if employers fail to issue forecasts.

Retirement plan pilot scheme

The Government is to pursue a pilot scheme so that it can evaluate the effectiveness of providing employees with access to pension information and advice in the work place. If this proves successful, the Government may introduce legislation.

Greater choice for older workers

The Government proposes to give older employees more flexible retirement options. State pension age is to be maintained at 65. However, the Government proposes the following initiatives:-

• although state pension age will remain 65, there will be flexibility to take the state pension later with a correspondingly higher pension benefit;
  
  
• people should have the right to work longer, but this will be voluntary;
  
  
• age discrimination is to be outlawed (there will be further consultation on the implementation of age discrimination legislation later on in the year);
  
  
• tax legislation will be introduced to permit flexible retirement (i.e. to allow employees to carry on working for the same employer while drawing a pension); and
  
  
• the earliest stage at which a pension may be taken will be increased to 55 (from 50) by 2010.
  
  

Further Information

This commentary is a publication of Jones Day Gouldens. The contents are intended for general informational purposes only and are to raise your awareness of certain issues (as at August 2003) under the laws of England and Wales. This commentary is not comprehensive or a substitute for proper advice, which should always be taken for particular queries. It may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at its discretion. The mailing of this publication is not intended to create, and receipt of it does not constitute, a solicitor-client relationship.

If you require advice on this issue or other issues in relation to pensions matters, please contact:

John Papadakis, Partner
+44 (0)20 7842 6174

Martin Scott, Associate
+44 (0)20 7634 9276

Rosalind Connor, Associate
+44 (0)20 7842 6266

Graeme Standen, Associate
+44 (0)20 7842 6129