Compass - Summer 2020
Compass provides commentary and analysis of recent legislative and regulatory developments affecting pensions and employee benefits.
Welcome to the Summer 2020 edition of Compass
Compass provides commentary and analysis of recent legislative and regulatory developments affecting pensions and employee benefits.
The Covid-19 pandemic has created chaos across the world, causing huge detriment to businesses with the pension industry being no exception.
The coronavirus outbreak has hit the stock markets hard and is likely to continue for some time. In this period of uncertainty and volatility the Regulator has responded with some very welcomed guidance to support trustees, employers and their advisors to focus on key activities with the most important one being that member’s benefits continue to be paid.
This edition of Compass therefore begins with an overview of the latest guidance issued by the Regulator and the easements introduced to help employers and trustees to sustain their pension schemes.
GMP reconciliation and inequalities remain hot topics in the news of pensions. Our second article looks at the second part to the Lloyds Banking Group court case, the focus being on historic transfer of benefits. We still await the anticipated judgement to confirm which scheme is responsible for equalise benefits.
Later in Compass we set out the recently issued guidance from the Regulator on the interim regime for regulating DB superfunds.
Ultimately, trustees who are considering to secure members' benefits outside of the scheme need to decide whether it is better to take cash from their sponsoring employer and transfer to a superfund or rely on their sponsor’s covenant to support them on the journey to buy-out with an insurer. Given the impact of Covid-19 on some sponsoring employers, schemes may favour the superfunds option.
Elsewhere in Compass, we cover:
- The current landscape of pension scams and how they have evolved since the introduction of pension freedoms
- The FCA’s ban on contingent charging for DB transfers
- How the Corporate Insolvency and Government Bill will provide businesses with extra flexibility and breathing space so they can continue trading during this difficult time
- The Regulator’s latest annual funding statement
- A round up of other news.
Covid-19 impacts the pensions industry
COVID-19 impacts the pensions industry
COVID-19 has caused a wide range of issues for everyone in the pensions industry from scheme members to trustees, employers and their advisers.
The period has been marked by a downturn in the financial markets followed by uncertainty and volatility. This directly impacts the pension savings of DC members and has implications for the employer covenant and funding of DB pension schemes.
In response, the Regulator issued wide ranging guidance to help the pensions industry in which it identified several key areas where activities should be focused:
Benefits need to be paid
The risk of scams needs to be minimised
Employers need to keep contributing
Savers need support to make good decisions
Some breaches of the law may occur, but the Regulator is willing to maintain a proportionate and fair approach to any action they may take.
The guidance covers topics including the Government’s Coronavirus Job Retention Scheme (JRS) and scheme funding issues. Here we provide a summary of the publications as they apply to different stakeholders in the industry.
For further detail we would strongly recommend visiting the Regulator’s website for the full guidance as there have been updates and amendments made throughout the period.
The Regulator has aimed two pieces of guidance toward employers in relating to automatic enrolment (AE) duties DC pension contributions, and funding of Defined Benefit (DB) schemes.
The Regulator reminds employers that AE duties continue to apply as normal, irrespective of whether employees are still working or have been furloughed.
The JRS covers minimum employer pension contributions in addition to paying 80% of an employee’s salary (subject to a cap) but employers may need to pay a proportion of the pension contribution for furloughed employees if they contribute more than the statutory minimum.
Contribution rates can be reduced to the statutory minimum, but a consultation is almost always needed, and these requirements remain unchanged.
There is an expectation that employers with DB schemes will be open with their trustees and that information required to assess the impact on the employer covenant will be provided.
Trustees of pension schemes have a difficult task to act in the best interests of their members, while ensuring the long-term sustainability of the scheme. The Regulator has provided several resources to guide trustees through communicating with scheme members, maintaining scheme administration and coping with any funding issues that arise.
Similar to the guidance issued for employers, trustees of DB schemes are asked to communicate with the employer and identify any risks to scheme funding and the employer covenant. In the guidance updated on 16 June the Regulator notes that whilst Deficit Repair Contribution (DRC) “suspensions or reductions may continue to remain appropriate...in view of the improved visibility of employers’ financial situations, we do not expect trustees to unquestioningly extend their original suspension arrangements on a three-month rolling basis based on limited information and for this to become the new normal”.
As a result, trustees will need to undertake the relevant due diligence before agreeing to a new suspension or reduction. As ever, legal and investment advice should always be sought when making decisions on scheme funding.
Trustees are also being advised to review their cashflow requirements to ensure that the scheme continues to function with as little disruption to core services as possible.
On DC scheme management and investment, the Regulator asks trustees to consider how members may react and to review and manage specific risks that may have arisen within their investment portfolios. Where the employer proposes a reduction in contribution rates the bests interests of the members must be considered first.
The Regulator acknowledges that while the disruption is likely to affect non-critical services, it is important to keep delivering on key processes such as payments, retirements, and bereavements.
As part of these critical services, effective communication with members is vital to help them make good decisions, and to keep them informed of any disruption to normal services. Highlighting of the increased risks of pension scams is also one of the key features of this guidance.
Guidance for scheme members has been issued by the Regulator in conjunction with the Money and Pensions Service (MaPS) and the Financial Conduct Authority. They are urging savers not to make rash decisions and give a warning that scammers will look to take advantage of this situation. The clear and consistent message from all of the regulators, and the message trustees are also asked to give members, is don’t panic and if in doubt seek financial advice.
The Regulator is looking for trustees to make members aware of the benefits they could be losing if they decide to cease their contributions and/or leave the pension scheme. The guidance also states that schemes may wish to contact members who have left the scheme and remind them of their rights to either opt-in or re-join the pension scheme.
In addition, the Regulator has expressed a desire for DC schemes to communicate with members to help them better understand how current economic conditions are affecting their pension pot and the need to think carefully before making any decisions. It is recommended that this message is conveyed in benefit statements where they are to be issued over the next few months.
There has been some recognition that “the impact of COVID-19 means schemes need additional time to issue these to members” and therefore the Regulator will be taking a pragmatic approach where they are issued late.
Administrators and scheme providers
Guidance has been targeted towards administrators and scheme providers specifically to clarify what the Regulator expects from them during this time. The breach reporting duties were relaxed until 30 June and it has since been confirmed that reporting should resume from 1 July.
Before 1 July, breaches of the law that are rectified in less than three months and have no negative impact for members did not need to be reported but a record of any decisions should have been kept. The Regulator has confirmed that it will maintain a pragmatic approach to enforcement where breaches are COVID-19 related now that full reporting has resumed.
However, the automatic reporting of late contribution payments will continue to apply after 150 days instead of the usual period of 90 days. This extension will be reviewed again at the end of September 2020.
These measures are to ease the burden on already stressed schemes and allow for the fact that there will inevitably have been a reduction in service whilst working restrictions are in place.
Between April and the end of June trustees of DB schemes were allowed to delay issuing transfer values by up to three months. This blanket easement has now to come to an end, but the Regulator acknowledges that problems may still exist for trustees of DB schemes especially where:
- the calculation of cash equivalent transfer values (CETVs) takes more time as trustees revisit the basis upon which they are calculated; or
- there is an increased demand for CETVs at the same time as facing shortages of administrative staff
The guidance notes that if COVID-19 presents issues for producing CETVs, trustees may consider taking advantage of the existing flexibility in the legislation which provides for an extension of up to three months to issue quotations where the delay is deemed to be for reasons outside their control. Trustees should get advice before taking a decision to delay.
The Regulator’s extensive guidance provides some helpful advice to all parties in the industry, along with some easements to help employers and trustees maintain the sustainability of their pension schemes.
The key objective should be to protect pension benefits, and while the Regulator acknowledges the extremely challenging circumstances will affect everyone, the continued support of the regulators is vital to the safeguarding of scheme members.
GMP: Reconciliation, Rectification and Equalisation
GMP: Reconciliation, Rectification and Equalisation
GMP reconciliation and the need to equalise for the effects of GMP inequalities both remain hot topics in the pensions industry with many questions remaining unanswered.
GMP equalisation: the current picture
The second part of the Lloyds Banking Group court case began on 4 May 2020, focusing on members that have transferred their benefits. The Court is to consider who is responsible for paying the equalised benefits: the scheme from which the pension originated or the receiving scheme.
The argument put to the High Court by Lloyds is that the trustee does not need to address historic transfers. This is based on the Coloroll judgment of the 1990s which ruled that the obligation for equalised benefits lies with the receiving scheme. However, the Department for Work and Pensions (DWP) disagree. The DWP argues that if the transferring scheme has miscalculated the transfer value, they have a statutory obligation to correct the transfer calculation.
If the court agrees with the DWP, trustees will be required to assess whether former members that transferred out are eligible for additional benefits. In many cases the cost of such an exercise is expected to outweigh any benefit increase to the member. The judgement of the case will be eagerly anticipated by many.
HMRC GMP checker
In its Countdown Bulletin 53, HMRC has confirmed that it plans to issue the final data cuts to those schemes that used the Scheme Reconciliation Service or have been reconciled as part of the Scheme Cessation process, by the end of July 2020.
HMRC has admitted that the GMP data that will be provided is a lift from their system at a point in time after which updates may still have been carried out. In contrast, the online GMP checker provides a real time GMP value calculated at the point of request using current information, and so there may be discrepancies between the two data sets. The online checker provides accurate information and the figures are specific to the date input for the GMP calculation.
Scheme administrators are being advised to check the GMP amounts provided against their records and where there are differences this should be verified using the online checker service. If the data cannot be agreed, then this can be queried with HMRC at a life event.
The discrepancy of data being provided by HMRC may add to what has already been a long process for schemes to reconcile GMPs. The potential differences in the final data cut may mean that trustees and administrators have to review the GMPs once more before accepting the final data. Schemes that have already reconciled members, and either have or have not yet applied rectification, may also wish to carry out a final analysis of their data.
Although further checks may be required once the data is received from HMRC, this should be the final item outstanding before they can proceed with completing rectification or other projects that may have been put on hold whilst the GMP issues were resolved.
DB superfund market given the green light by the Pensions Regulator
DB superfund market given the green light by the Pensions Regulator
The Pensions Regulator has issued guidance on the interim regime for regulating defined benefit (DB) superfunds, which is effective immediately.
Superfund consolidation allows for the severance of an employer’s liability of a DB scheme by transferring their schemes’ assets and liabilities into a consolidated superfund pension scheme that is separate from the ceding sponsoring employer whilst the original scheme winds up.
The ceding sponsoring employer may need to make a cash payment to the superfund to provide enough funding to transfer the scheme and to ensure that there is a sufficient capital buffer in place to provide security for members. The capital buffer will come from a combination of capital raised by the superfund, assets transferred by the ceding scheme and payments made by the ceding sponsoring employer.
Superfunds will need the Regulator’s authorisation to operate and must prove they can meet the interim regime before taking on legacy DB schemes. The DWP is developing a legislative authorisation framework which will soon be in place to safeguard the benefits of members moving into superfunds.
Superfunds will have to explain how they will meet the expectations outlined in the guidance before accepting any legacy DB schemes.The focus of regulatory scrutiny will be on:
- The superfund and the capital buffer meeting the requirements of the interim regime;
- The key individuals who exert financial control and/or influence the superfund’s strategies (e.g. those of the corporate entity, and the trustee board). Those that have control over the assets should be fit and proper, including being financially sound;
- The adequacy of the governance, systems and processes associated with the capital buffer and the superfund scheme.
Ceding scheme entry requirements
Prior to a scheme transferring across to a superfund the following requirements will have to be adhered to:
- The ceding sponsoring employer must apply for clearance in relation to the transfer from their scheme to the superfund;
- The ceding scheme does not have the ability to buy-out within the foreseeable future (mooted as being within five years);
Running a superfund
The superfund will need to have its processes clearly documented. This will include the management of conflicts, triggers of intervention or wind-up and key powers. The corporate entity running the superfund will need to ring-fence financial reserves with the Regulator expecting a proportion of these to be held in cash or near cash, to address any short-term liquidity issues in the event of failure.
The level and quality of assets in the capital buffer are fundamental to the success of a superfund. The key aim is to ensure a high degree of certainty that members’ benefits will be paid. To achieve this the superfunds must comply with the following:
- The capital requirements must be based on the superfund scheme’s technical provisions;
- The additional risk-based capital should allow for a 99% probability of the superfund being funded at or above the technical provisions in five years.
The superfund will need to document rules around extraction of profit; fees and expenses; investment arrangements and risk management. All of which will come under frequent regulatory scrutiny.
The Regulator has included many provisions relating to the expectation that not all superfunds will survive (e.g. they will fail to reach sufficient scale or funding may deteriorate) so there needs to be sufficient funds and liquidity in order to transfer to new arrangements.
Superfunds cannot accept new business if they are not funded to the minimum regulatory level.
Regulatory Intervention Triggers
There are two legally enforceable intervention triggers that will result in the Regulator taking action at key points in a superfund’s funding level. They are described below:
- The low risk funding trigger where total superfund scheme assets plus the risk-based capital buffer are equal to 100% of the minimum technical provisions level. At this point, in the absence of an additional capital injection, all funds in the capital buffer are required to flow into the superfund pension scheme and come under the control of the superfund trustees.
- The wind-up trigger which is set at 105% of the s179 funding level under the Pension Act 2004. If this is breached, the superfund scheme must begin winding up and members transferred out. This provides protection against a claim being made on the Pension Protection Fund.
During the initial period (which is expected to be a duration of 3 years) there should be no surplus extracted from the capital buffer or pension scheme unless scheme benefits are bought out in full with an insurer.
Any surplus value should not be used as capital to support new transfers into a superfund. All transfers into a superfund should be able to meet the capital adequacy test on a standalone basis.
The Regulator has set rules on the investment of funds (including the capital buffer); limits on the concentration of assets; portability in the event of the superfund winding up; liquidity; and restrictions on investments provided by the ceding employer. The Regulator appears to be concerned that not all superfunds will survive so highly complicated and idiosyncratic approaches are discouraged in the early years as they may prevent the efficient transfer of funds to new arrangements.
As expected, the Regulator wants the investments held to be appropriate (and realisable or transferable for full value) to enable 100% of members’ benefits to be protected to a high degree of certainty.
The interim regime for superfunds is stronger and more rigorous than the funding requirements for occupational DB schemes generally. However, as expected, it provides lower security to members and policyholders than the Solvency II regime followed by insurers.
Ultimately, trustees will need to decide whether it is better to take cash from their sponsoring employer and transfer to a superfund or rely on their sponsor’s covenant to support them on the longer journey to buy-out with an insurer.
Given increased uncertainty over sponsor covenants currently, we expect some schemes will start exploring the superfund option now. Significant questions remain including whether, within this new regulatory regime, superfunds can deliver their product at a price that is significantly lower than the price of a bulk purchase annuity which, to many, is the preferable destination.
Initial thoughts, a transfer to a superfund may be up to 25% cheaper than a buy-out with an insurer; the saving versus the buy-out premium reduces significantly as a scheme matures.
With appropriate advice on the prospects for the financial strength of the sponsoring employer and the financial strength of the superfunds, we expect that some trustees and employers will transfer their schemes to superfunds, with the first schemes being imperative to wind-up, schemes with 75% to 95% funding on a buy-out basis but will not reach 100% within the next 5 years or schemes with a simple benefit structure.
The current landscape of pension scams
The current landscape of pension scams
Pension scams remain a significant threat to savers with new channels of contact and types of scam evolving.
Transfers during the Coronavirus
The Coronavirus pandemic could make members more vulnerable to scams.
The Regulator, Financial Conduct Authority (FCA) and the Money and Pensions Service (MaPS) say fears over the impact of the pandemic on markets and personal finances may make savers more vulnerable to scams or making a decision that could damage their long-term interests.
The Regulator has asked trustees to urge their scheme members looking to transfer to exercise caution and to visit the ScamSmart website to learn how to protect themselves from pensions scams.
To reinforce this message, the Regulator, the FCA and MaPS have jointly issued a letter addressed to members of defined benefit pension schemes who are considering transferring out. The letter contains important information on the points that the reader should consider before making a decision, where to go for impartial guidance and asks them to take extra care at this uncertain time. Guidance from the Regulator states that a copy of the letter must be issued to all members who have defined benefits and request a transfer quotation.
How scams have evolved since the introduction of pension freedoms
The Pensions Policy Institute (PPI) has published Briefing Note 121 which explores how scams have evolved since the introduction of pension freedoms in 2015.
Initially the main concern was over pension liberation which saw savers transferring their benefits to a scheme promising them access to cash often before the tax rules allow (i.e. usually age 55). For many savers this resulted in unexpected tax charges from HMRC but in addition many lost all, or nearly all, of their money as the savings were effectively siphoned off by scammers. The PPI report finds that this trend shifted following the introduction of pension flexibilities to a much stronger focus on investment scams.
These types of scam can involve inappropriately high risk investments, investment opportunities that don’t exist, a real investment opportunity but one where rather than investing in it the scammer takes the individual’s money themselves, or a product where there may be high charges or hidden costs associated with the investments.
DB transfers have also increased since the introduction of pension flexibilities as members see the potential to access large lump sums following the transfer to a DC arrangement such as a personal pension. This flexibility, coupled with perceived high transfer values, potentially puts more savers at risk from scammers despite the requirement for independent financial advice in many cases.
In the briefing note the PPI argues that the data surrounding pension scams does not offer a comprehensive view of the true scale of the issue. This is particularly down to the belief that only a minority of pension scams are actually reported, and for those that are, the data is not collected in a comparable way across the industry.
Although regulatory action has been taken to try and combat scams new approaches have developed. Since the cold calling ban was introduced in 2019 scammers have sought new ways of targeting victims, with increasing numbers being targeted online. The FCA reported that 54% of those who had checked the FCA warning list in 2018 had been contacted by potential scammers via online sources, up from 45% in 2017.
Evidence from across the industry has found that many savers are not aware of the warning signs of a scam. In 2016, Citizens Advice carried out an experiment in which participants were shown mock pension adverts. 88% of participants selected a pension access offer containing pension scam warnings signs. Regulators and the industry are working together to highlight the steps that savers should take to protect themselves against scams.
Scam Man & Robbin' is a new retro online game that aims to educate consumers about pension scams.
The launch of Scam Man & Robbin’ follows a Hackathon, hosted by PensionBee in November 2019, which challenged teams to create an online concept that raises awareness of pension scams in both an engaging and educational way. In the game, the player takes on the role of ‘Scam Man’, a vigilante whose main objective is to protect people’s pensions from scams.
The game challenges some common misconceptions which may initially seem positive about a pension scheme but may in fact be the hallmarks of a scam.
In March, Action Fraud announced that coronavirus-related fraud reports had increased by 400%. To help highlight the new risks that face pension savers of all ages, a coronavirus-specific scam has been included within Scam Man & Robbin’.
Other scams featured in the game include cold calls, early pension release and pressure to make an immediate decision.
Contingent charging for transfer advice
The FCA has announced that it will implement a ban on contingent charging for defined benefit (DB) transfers.
In July 2019 the FCA announced a consultation on their proposals to ban contingent changing; where financial advisers only get paid if a pension transfer proceeds. Following the consultation process the ban has been agreed and will come force with effect from 1 October 2020. The FCA have issued a policy statement (PS20/06) which summaries the feedback they received to the consultation and sets out the final rules and guidance on the new measures.
Responses to the 2019 consultation (CP19/25) highlighted that whilst some argue contingent charging enables everyone to gain access to free pension advice, others are concerned that advisers may recommend a transfer in order to receive payment rather than it being in the consumers best interest.
The FCA views the proportion of consumers who have been advised to transfer out of DB schemes too high when compared to the advantages these types of scheme offer, and their reviews show too many instances where the transfers were not in the consumers’ best interests.
The ban is intended to address ongoing conflicts and reduce the numbers of those who proceed with unsuitable transfers. The new rules will require advisers to consider an available workplace pension as a receiving scheme and if an alternative is recommended, to demonstrate why the alternative would be more suitable.
Abridged advice also will be introduced which will enable consumers access to initial advice at an affordable cost. The abridged advice can only result in a recommendation not to transfer or a statement that it is unclear whether a consumer would benefit from a transfer without giving full advice.
Once the new rules are implemented, firms will need to set a total charge for their activities.
There will be exceptions applied in prescribed circumstances, such as ill-health or for those experiencing severe financial difficulty. Those who have agreed to contingent charges and started work before that date may charge contingently, provided that a personal recommendation is given before 1 January 2021.
There is little doubt that financial hardship, especially in these difficult times, will make pension savers prone to making decisions in the short term that may, or may not, go against professional financial advice.
Identifying and publishing trends help those running a pension scheme to shape their due diligence processes when reviewing the proposed receiving scheme following a transfer request. However, this is an imprecise science as clearly it is not usually possible to know what will then follow.
There is clearly no easy fix and therefore the measures being gradually introduced such as the cold calling ban and now the ban on contingent charging should be seen as continued steps in the right direction. At the same time, the regulators and other industry groups are rightly continuing to urge trustees to engage with members by alerting them to the danger of pension scams.
However, despite these positive moves there still remains large pressures on the transferring scheme to manage the conflict between carrying out the required due diligence on the proposed receiving scheme and processing the transfer request in a timely fashion.
It is important for pension providers to have effective procedures in place to not only protect scheme members but to give themselves confidence that if challenged on why a transfer went ahead that they have done all they can.
Please speak to your usual Capita contact if you would like further information on Capita’s processes.
Corporate Insolvency and Governance Bill
Corporate Insolvency and Governance Bill
Following the submission of this article, pressure from the pensions industry has led to significant amendments by the Government to the Bill which may ease some of the concerns raised in this article.
This Bill was introduced into Parliament in late May and passed its House of Commons’ stages on 3 June. At the time of writing it is before the House of Lords and is likely to be passed by the time this edition of Compass is published.
The purpose of the Bill is to provide businesses with extra flexibility and breathing space so that they can continue trading during this difficult time.
The aim is for UK companies and other similar entities avoid unnecessary insolvency during this period of economic uncertainty.
The Bill’s principal features are:
- The introduction of greater flexibility into the insolvency regime including a potential moratorium on debt for at least 20 business days (which in some circumstances can be extended by another 20 business days), allowing companies more time to explore rescue options whilst supplies are protected;
- The temporary suspension of parts of insolvency law to support directors to continue trading through the emergency without the threat of personal liability and to protect companies from aggressive creditor action; and
- Providing companies and other bodies with temporary easements on company filing requirements and requirements relating to meetings including annual general meetings.
Many of these features will be welcome to many firms and some will be totally uncontroversial.
However, there is concern within the pensions industry that the greater flexibility being proposed for the insolvency regime could be prejudicial to the funding of defined benefit (DB) pension schemes and place greater strain on the finances of the Pension Protection Fund.
Essentially the proposals have been described as giving a dramatic enhancement in the position of 'lender' creditors to an insolvent company compared to the position of its other 'non-lender' unsecured creditors. This enhancement would not just apply to bank lenders, but potentially to any lender to the distressed company, including shareholders and other group companies. The result is that, on a restructuring or insolvency, other unsecured creditors, including any DB pension schemes, could suffer materially worse recoveries.
Therefore, a number of representations are being made by industry bodies to Ministers, civil servants and parliamentarians. The Bill is expected to complete its House of Lords’ stages on Tuesday 23 June, with enactment likely once any amendments have been agreed between the two Houses of Parliament towards the end of that week.
"We and our members fully appreciate the need for emergency protective measures to help companies survive the unprecedented business disruptions from Covid-19. However, the new proposals will have unintended – but very serious – consequences for underfunded pension schemes where the employer becomes insolvent"
Nigel Peaple, Director of Policy and Research at the PLSA
The Pensions and Lifetime Savings Association has gone so far as to suggest the following adjustments to the Bill should be made before it is passed:
- Limiting the bank debts that gain super-priority to those that become due and payable on a non-accelerated basis during the moratorium.
- Narrowing the definition of financial arrangements that gain super-priority so that it only covers the bank debts and does not extend to all financial arrangements and lending.
- Amending legislation to provide for a PPF assessment period to be triggered where a company enters a moratorium.
This is a fast-developing matter and clients with a concern or interest in this matter should check with their usual Capita contact once the legislation is finally passed.
The Regulator issues its Annual Funding Statement
The Regulator issues its Annual Funding Statement
The Regulator has published its 2020 annual funding statement which outlines what the Regulator expects from trustees and employers with a focus on long-term funding targets.
The statement is aimed at all trustees and sponsoring employers of occupational defined benefit (DB) pension schemes but is particularly relevant to schemes with valuation dates between 22 September 2019 and 21 September 2020 or schemes undergoing significant changes that require review of their funding and risk strategies.
The statement sets out specific guidance on how to approach the valuation under current conditions but also provides an update on some topical and recent issues, such as COVID-19, and regulatory developments.
DB funding code consultation
The Regulator has published its first consultation which sets out a clear new framework for DB funding. It focuses on a long-term approach to the scheme’s funding and investment strategies to ensure savers get the benefits they expect.
A twin-track compliance approach to valuations has been proposed, either ‘Fast-track’ or ‘Bespoke’, with both allowing schemes to meet their legal obligations. The added flexibility of the bespoke approach will provide more flexibility to account for scheme and employer-specific circumstances but naturally brings with it the potential for increased regulatory scrutiny.
This first consultation is now planned to run until 2 September 2020. This will be followed by a second consultation due to be published next year which will focus on the business impact assessment. The new funding code is not expected to come into force until late 2021 at the earliest.
Therefore, all current valuations will be regulated in accordance with the existing regulations and guidance.
The Regulator recognises that most schemes will have been impacted by COVID-19 and it has recently published guidance which covers areas such as DB funding and investments. Trustees are being encouraged to take the time to read this.
The guidance is designed to support trustees who are faced with difficult decisions but should not override their obligations and duties under the scheme rules or legislation.
If the effective valuation dates are on or around 31 March 2020, some trustees may consider bringing forward the effective date to a date when conditions were considered more normal.
If they are considering this, trustees should think carefully as to why this option is in the best interest of their members and the impact it may have on member security.
Given the impact COVID-19 will have had on many employers, trustees should carry out additional due diligence in accordance with the available guidance. It is difficult to predict how long the current situation will continue for, or what total impact this will have on pension schemes, and therefore it will be important to monitor the situation and look out for further regulatory guidance in the coming months.
What the Regulator expects of Trustees
The Regulator expects the promised benefits to members to be the key objective for all schemes.
This requires trustees to think long-term by agreeing a strategy with the employer which recognises the balance between investment risk, contributions and covenant support.
Assessing the covenant is understanding the extent to which the employer can support the scheme. For many schemes, COVID-19 will have resulted in considerable uncertainty over the strength of their employer’s covenant and this may be heightened by the UK’s departure from the EU. Trustees are therefore being encouraged to consider obtaining independent specialist advice to support the covenant assessment.
Trustees are expected to continue to focus on the integrated management of three broad areas of risk; the strength of the covenant support; the investment risks; and the scheme’s funding plans.
The Regulator has currently suspended all their regulatory initiatives detailed in last year’s statement and it will continue to play its role in supporting trustees in responding to the impact of COVID-19.
The funding statement is essential reading for those involved in running a pension scheme as it sets out how the Regulator expects trustees and employers to deliver on what should be their key aim - paying the promised benefits to the membership. This requires a clear plan, with objectives set out for how this will be achieved. Naturally, emphasis is therefore placed on the approach to carrying out valuations and assessing the strength of the employer covenant. There is a recognition that COVID-19 will have had a significant impact on schemes, and the guidance and easements discussed within it should help trustees in this current environment.
The statement contains important guidance, as well as some cautionary warnings, for trustees to consider when assessing the scheme’s funding position, including the need for obtaining independent specialist advice where employers may have been significantly affected. The extra flexibility for schemes preparing and finalising valuation will no doubt be very much welcomed at this point in time, but the Regulator is also sending out a veiled warning to trustees to not take their eye off the ball.
Pensions and benefits news round-up
We cover a significant court case concerning ‘in specie’ contributions receiving tax relief, a landmark ruling involving the Local Government Pension Scheme, changes to the RPI methodology, the FOS award limit increase and the Regulator’s proposed new data gathering powers.
HMRC v. Sippchoice – ‘in specie’ contributions
The Upper Tribunal has upheld an appeal by HM Revenue & Customs in this significant case concerning ‘in specie’ contributions receiving tax relief.
The overwhelming majority of contributions to pension schemes are in the form of money paid into the scheme and receive the benefit of tax relief.
However, it was understood that a ‘contribution’ could be in the form of a direct handover of an asset to the scheme – in this case the transfer of the ownership of shares and that tax relief could be claimed for such a contribution.
Traditionally these contributions were structured so as to involve the member making a legally binding and irrevocable obligation to make the contribution (so that it becomes a debt to the scheme) and then the member would ‘settle the debt’ by transferring the relevant asset and topping up the scheme with money if the asset was not sufficient to satisfy the debt (in this case £0.03 extra was paid).
Tax relief would then be claimed on the amount of debt. The legitimacy of this basis was supported, in the eyes of some commentators, by the text of HMRC’s Pensions Tax Manual at PTM042100.
Statements in HMRC’s manuals are merely HMRC’s interpretation of the law in their internal guidance and they do not have the force of law.
Upper Tribunal in HMRC v Sippchoice
However, HMRC refused to grant Sippchoice the requested tax relief and, after the firm had won at the First Tier Tribunal stage, appealed to the Upper Tribunal.
The Upper Tribunal found that:
- The expression “contributions paid” in section 188(1) of the Finance Act 2004 is restricted to contributions of money (whether in cash or other forms).
- This requirement for a money payment cannot encompass settlement by transfer of non-monetary assets even if the transfer is made in satisfaction of an earlier obligation to contribute money. An agreement to accept something other than money as performance of an obligation to pay in money does not convert the transfer of shares (or other assets) into a payment in money.
- The fact that HMRC’s Pensions Tax Manual contains passages that support Sippchoice’s case carried little weight in this case.
- In any event and notwithstanding the completion of certain forms, the Tribunal found that the member had never legally promised, and was never legally obliged, to make a monetary payment of the notional debt involved in the in-specie contribution.
As a consequence of this judgment (and assuming that no further appeal overturns it) then in specie contributions by members will not attract any tax relief and should not have received relief in the past.
This is a significant case and provides HMRC with a useful precedent to withhold tax relief in relation to all in specie contributions as the language for tax relief of employer contributions is basically the same. Rather problematically it interprets the law going back to April 2006 and therefore has unpleasant implications for any member (and potentially any employer) who has made such payments since then. Given the value of tax relief this could mean that many face large retrospective tax bills.
This case is of such significance that certain industry bodies have been in contact with HMRC to ask to avoid a mass clawback of tax relief on contributions paid using a method that had been previously agreed and was is in line with published HMRC guidance.
If you are a member or an employer who has made any in specie contributions in the past, then you should consider obtaining legal advice. Unless and until the law is clarified to the contrary, it may be appropriate to avoid the use of in specie contributions if tax relief is desired. Providers of personal pension schemes that have advertised the acceptance of such contributions will need to carefully consider where this leaves them.
(We wish to make it clear this is completely different from a recognised transfer between schemes where the assets were historically funded by money contributions but have now been transferred. The issue arises in relation to tax relief on payments into pension schemes and not payments between schemes.)
Please speak to your usual Capita contact if you are concerned about this matter.
Supreme Court makes final ruling in landmark case involving the Local Government Pension Scheme
In November 2016 the Ministry for Housing, Communities & Local Government (MHCLG) issued statutory guidance entitled “Local Government Pension Scheme: Guidance on Preparing and Maintaining an investment strategy statement” to administering authorities.
The guidance allowed administering authorities to take social and ethical objections into account when making decisions about which investment(s) they would use. However, it expressly stated that administering authorities should not use pension policies “to pursue boycotts, divestment and sanctions against foreign nations and UK defence industries…other than where formal legal sanctions, embargoes and restrictions have been put in place by the Government”, and that Local Government Pension Scheme (LGPS) funds “should not pursue policies that are contrary to UK foreign policy or UK defence policy”.
This guidance was subject to a judicial review, brought by Palestine Solidarity Campaign Ltd, and in July 2017 the guidance was reissued with the relevant passages removed. In June 2018 the Secretary of State appealed the decision arguing that LGPS funds are “public money” and that administering authorities were part of the machinery of state and therefore the government has the power to direct how those funds should be used via guidance. The Court of Appeal disagreed with the High Court and the case progressed to the Supreme Court.
In April 2020 the Supreme Court ruled, by a slim majority, that legislation does not permit the Secretary of State to impose the government's view on foreign and defence policy, on administering authorities. The judgment also confirms that when acting in its role as an administering authority of an LGPS fund, a local authority should not be viewed as part of the machinery of the state, acting on behalf of the UK central government.
This judgment does not change the role or duties of administering authorities in relation to their investment or other powers and confirms that the administering authority remains responsible for investment decisions.
Additionally, administering authorities may take non-financial considerations into account where this would not involve a risk of significant financial detriment and where the administering authority has good reason to think that scheme members would share the concern.
RPI Methodology Reform – effect on DB schemes
The Pensions Policy Institute (PPI) has published a Briefing Note of its own setting out how the proposed changes to the calculation methodology behind the Retail Prices Index (RPI) could affect defined benefit (DB) schemes.
This reform, discussed on page 28 of the Spring 2020 edition of Compass, aims to alter RPI so that its future rates of change map exactly to CPIH (a variation of the existing Consumer Prices Index (CPI) that also includes housing costs).
Amongst the key finding of the PPI are the following observations:
- A 65-year-old male pensioner in 2020 could by the age of 86 (which is the average life expectancy for such a man) be receiving 17% less per year in DB pension if the change took place from 2025 as compared with the position if the change were not made. If the change were delayed until 2030 then the reduction in income compared with the current position would only be in the region of 12%.
- Similarly, a 65-year old female pensioner in 2020 could by the time of that woman’s average life expectancy of age 88, see yearly average DB income 19% lower if the change were to be made from 2025 compared with the current position and 14% lower if the change were only to be from 2030. Women experience a greater drop over time on average due to their longer life expectancy than men.
- DB schemes could see a per member reduction in liabilities in respect of both pensioner members and deferred members who have benefits increased or revalued in line with RPI. Average liabilities for a 65-year pensioner member in 2020 could be reduced by 8% if the change took place from 2025 and by 4% if the change took place from 2030. Average liabilities for a 55-year-old deferred member in 2020 could see a 17% reduction in liabilities if the index change took effect in 2025 but only a 12% reduction if the change took effect in 2030.
- Asset values could also be affected but it is difficult to know the extent to which these reforms are already priced into the market or not. However, 29% of private sector DB scheme assets were invested in index-linked bonds (around £470bn in 2020), so movements may still be significant. There is also an indirect effect on other assets (such as investments in infrastructure, property and regulated utilities) where the returns on those assets may be affected by changes in RPI (e.g. train fares, property rentals, etc.).
- The total value of the bond-related investment impact may be in the region of £80bn if the switch were to be made in 2025 but more like £60bn if the switch were made in 2030.
- The impact on scheme funding will vary significantly depending on the extent that scheme benefit promises follow RPI or CPI and whether those liabilities are hedged by holding index-linked bonds or not.
The consultation on the reforms to the RPI Methodology has had its deadline for response extended to 21 August 2020.
Financial Ombudsman Services annual award limit increase
The Financial Conduct Authority (FCA) has confirmed the annual increase to the Financial Ombudsman Services (FOS) award limits.
From the 1 April 2020 the FOS’s award limit increased to £355,000 (from £350,000). This applies to complaints referred to the service on or after 1 April 2020 about acts or omissions by firms on or after 1 April 2019.
The limit remains at £160,000 for complaints about acts or omissions that occurred before 1 April 2019.
The award limit is the maximum amount FOS can require a financial service to pay when a complaint is upheld. The limit is adjusted each year in line with inflation, as measured by the CPI.
The Regulator’s proposed new data gathering powers
In addition to its existing powers, the Regulator is to be given new data gathering powers under the Investigatory Powers Act 2016 (IPA 2016).
The new powers under IPA 2016 are designed to improve the Regulator’s ability to intervene to protect pension savers. The proposals will support its ongoing drive to be clearer, quicker and tougher in the way it regulates.
The new powers are expected to apply where the Regulator believes it is necessary to obtain data for the purpose of preventing or detecting serious crime or in any other case, for the purpose of preventing or detecting crime.
In non-urgent cases, authority will have to be obtained from the Investigatory Powers Commissioner but in urgent cases the Regulator can authorise its staff to obtain the data.
Any individual or business required to provide data must take all reasonably practicable steps to comply with a notice and the Regulator may apply to court for an injunction, specific performance or other order to require compliance.
The legislation is currently in draft and we wait for this to be enacted through Parliament in the coming months.
This document is for information purposes only and is based on our understanding of current law and taxation at the date shown above. Tax policy, practice and legislation may change in the future. For more information on how your particular circumstances may be affected, please contact us.
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