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Technical update April 2017

ARTICLE — 6 Apr 2017

Nigel Oakley

Nigel Oakley

Head of Technical Services

Welcome to our Technical update, providing you with an overview of the most recent developments within pensions and what they might mean for Schemes.

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Hot topics

Brexit Update

On 29 March 2017, the UK gave notice of its intention to leave the EU under Article 50 of the Treaty of Lisbon, meaning that the UK should withdraw from the EU by 29 March 2019. There is no immediate impact on UK pension law or regulations but any possible longer-term impact should become clearer over the coming months and years.

In the short term, EU laws will retain their powers within the UK but, in due course, an exit from the EU is likely to give the UK government scope to begin amending existing legislation influenced by Europe. However, a significant amount of EU pension-related legislation is already written into UK law and other elements are expected to be written into the government’s Great Repeal Bill. In either case, there would need to be a justifiable cause and appetite to amend the legislation, as changes would cost time and money, so there may not be any immediate or significant reduction in legal requirements for UK pension schemes.

As well as those items of EU law already in force, the new EU Directive on the activities and supervision of Institutions for Occupational Retirement Provision (“IORP Directive”) came into EU law in January 2017 and, ordinarily, would need to be implemented into UK law within two years. It is not yet known how the requirements of the IORP Directive will be dealt with.

Over time, we may also expect to see some changes relating to pension case law, as UK courts may no longer need to consider the views of the European Court of Justice when interpreting legislation. The House of Commons Library has updated a briefing paper that looks at the implications of the decision for the UK to leave the EU for pensions.

How this could affect you:
The effects of the UK’s departure from the EU will be far reaching and will no doubt impact pension schemes such as the RPS but we will need to wait to see what the actual impact will be.
 

Green Paper - Security and Sustainability in Defined Benefit Pension Schemes

On 20 February 2017 the Department for Work and Pensions (DWP) published the anticipated Green Paper on the future of DB schemes called ‘Security and Sustainability in Defined Benefit Pension Schemes’.

The government believes there is no single or immediate crisis in DB pensions, nor that the overall regulatory regime is unsatisfactory. As such, it suggests that fundamental changes are not required. However, it also recognises that there is a case for some changes to help employers and trustees manage liabilities as well as balancing the need to protect members’ benefits.

The Green Paper does not provide any definite policy proposals. However it focuses on seeking views on possible changes in the following four broad areas:

Funding and investment – suggestions in this area include improved communications on funding to reduce the widely held perception that the system is unsustainable. Additional suggestions include: changing valuation cycles for high risk and low risk schemes; introducing risk based reporting and reporting requirements; improving trustee decision making skills; and mandating the use of professional trustees. Consideration is given to whether there is scope to encourage some schemes to make more optimal investment decisions, and mitigate barriers to the greater use of alternative asset classes.

Employer contributions and affordability – The government does not believe there is a general affordability issue but recognises some schemes and employers are clearly struggling. As a result, the government suggests there is little appetite to reduce burdens on employers across the board but there is a stronger case for more targeted measures being introduced including: enhancing the powers of the Pensions Regulator (TPR) so that more intensive support can be provided; allowing a struggling business to more easily separate from their pension scheme; and renegotiation of benefits, including conditional or reduced indexation.

Member protection – The government’s assessment is that the funding regime and member protections are “working broadly as intended” but it makes a case for giving TPR additional scheme funding powers, as well as for imposing a formal duty on parties to co-operate and engage with TPR. On the issue of corporate restructuring the government may also consider compulsory regulator clearance of corporate activity in “very narrowly limited” circumstances. This could include a power to impose a “significant fine” where corporate activity was shown to have been detrimental without appropriate mitigation. There is also a suggestion of requiring consultation with trustees before dividends are paid when a scheme is severely underfunded.

Consolidations of schemes – The arguments for and against small scheme consolidation are considered, with the suggested merits being reduced costs, improved investment options and governance. Different consolidation models are considered and whether it should be voluntary or compulsory, although the clear preference is for the former. The government states that it does not consider it appropriate to take forward any consolidation “superfund” through a government body. Concerns about employer debts in non-associated multi-employer schemes are to be taken forward shortly, in a separate consultation.

The consultation is seeking the views of all stakeholders involved with DB schemes and, although the Green Paper focuses on aspects relating to the security and sustainability of DB rights already accrued to date, we understand that DWP will also welcome any suggestions relating to improving the security and sustainability of future DB accrual.

Consultation on the Green Paper closes on 14 May 2017 and we will be working with the Trustee on a response.

How this could affect you:
Some of the potential changes suggested in the Green Paper could impact on the future operation of the RPS and the Trustee’s other schemes. However, we will need to wait for more details to emerge before determining how much of an impact any proposals may have.
 

PPF consultation on third PPF levy triennium

On 23 March 2017, the Pension Protection Fund (PPF) published their consultation on the third PPF levy triennium, outlining the proposed changes to the current PPF levy framework for the next three-year period starting 2018/19. 

The PPF has noted that the insolvency risk model with Experian has worked well but that they intend to update certain aspects of the model to help improve accuracy and, ultimately, to better reflect the risks that the PPF is facing. 

The main proposals are: 

  • Credit ratings – the PPF’s analysis confirms that the ratings given by specialist credit rating agencies are more predicative of insolvency risk than the Experian model. Therefore, credit ratings will be used to derive the PPF levy score for those companies that are publicly rated. 
  • Rebuilding some of the Experian’s scorecards – only three group scorecards would be retained from the current position. The other five scorecards will use different variables from the existing scorecards and will no longer feature mortgage age or trend variables.
  • Dispensing with the monthly averaging of Experian scores – there are proposals to use just the insolvency score as at 31 March or the average over a shorter period, rather than the 12 month average of scores used in the current calculation. For 2018/19, given the formulae will not be finalised until the autumn, there will be at most six months of averaging from the end of October 2017 to the end of March 2018.
  • Simplifying the certification of deficit reduction contributions (DRCs) – by removing the allowance of investment expenses, or simply certifying the contributions paid under the recovery plan.
  • Changes in certification of contingent assets – the PPF is proposing to introduce a requirement for large group company guarantees (£100 million or more) to have a guarantor strength report prepared by a professional advisor.
  • Government/Crown backed entities - the PPF is proposing to give itself the power to place entities established by statute or wholly or directly owned by the Crown, central government or a statutory authority in levy band 1. It feels the current Experian model does not fully reflect the security of these employers.

This consultation will be followed by a second consultation in autumn 2017, setting out the PPF’s conclusions, with definite proposals in the areas explored in this consultation, alongside a draft set of rules for 2018/19. This second consultation will also set out the PPF’s view on how much they will need to raise from the levy overall. 

How this could affect you:
According to the consultation, two thirds of schemes are likely to see a levy reduction, with one fifth (particularly some schemes with very large employers) seeing an increase. The intention is for the Trustee and RPMI to provide a joint response and put forward the case for some railway employers, such as train operating companies, to be placed in levy band 1.
 

Other developments 

Pension Schemes Bill

A new Pension Schemes Bill is currently making progress through Parliament, with its focus being on protecting savers in master trust arrangements in order to maintain confidence in pension savings. The introduction of automatic enrolment into workplace pension schemes has resulted in an expansion of the master trust market, and the Pensions Regulator (TPR) had voiced concerns about the quality and viability of some master trusts.

Once enacted, the Bill will introduce a new supervisory regime for master trusts. This will include a requirement for them to be authorised by TPR before they open to members and an ongoing supervision framework, including the submission of annual accounts to TPR by both the scheme and any scheme funder.

The Bill will also amend existing legislation to support the government's intention to cap early exit charges and ban member-borne commission charges in certain occupational pension schemes.

The Bill did not include, as was expected, clauses to create a single financial guidance body responsible for delivering debt advice, money and pensions guidance to the public, as currently provided by The Pensions Advisory Service (TPAS), Pension Wise and the Money Advice Service (MAS). However, this is still expected to go ahead and the government has been consulting on plans for a single body model.

How this could affect you:
The Bill is expected to have limited impact on the Shared Cost arrangement of the RPS. However, due to the structure of the Industry Wide Defined Contribution (IWDC) arrangement, it may be considered a master trust in which case it would be directly impacted by any new supervisory regime for master trusts, unless regulations allow for exemptions in this area for schemes such as the RPS. Consequently, the Trustee and RPMI are monitoring developments in this area.
 

Spring Budget 2017

This year's Spring Budget was held on 8 March 2017 and included little about pensions. The main pensions-related announcement was that the government will introduce a 25% charge in some circumstances if a member transfers their pension to a qualifying recognised overseas pensions scheme (QROPS).

The overseas transfer charge targets those who may have tried to reduce the tax they would pay on their pension benefits by transferring overseas and came into effect for transfer requests from 9 March 2017.

The Budget documents also confirmed some measures previously announced, including: 

  • The Money Purchase Annual Allowance (MPAA) reduction from £10,000 to £4,000 with effect from April 2017. The MPAA was introduced in April 2015 as a reduced level of annual allowance for future money purchase contributions when an individual has already accessed their pension benefits using aspects of the new pension flexibilities such as flexible drawdown and full encashment.
  • That the Lifetime ISA will be launched on 6 April 2017.  This follows finalised regulations being laid before Parliament a couple of weeks before the Spring Budget.

The Spring Budget was the last Budget being held in the spring, with there being an additional Budget this autumn.

How this could affect you:
Now that it is coming into force, the change to the MPAA is being communicated both to alert those members impacted by the MPAA about its reduction; and inform members not impacted by the MPAA that the reduction does not apply to them.
 

Government consultation on GMP equalisation 

The government has launched consultations on:

1. a proposed new methodology to equalise guaranteed minimum pensions (GMPs); and

2. a GMP conversion methodology.

Both were developed by an industry working group set up to consider the issues, and followed an earlier proposed methodology in 2012, which was widely dismissed as being too complex and costly.

The updated proposed method uses a GMP conversion approach which involves valuing the benefits accrued between 17 May 1990 and 5 April 1997 and comparing them with the corresponding value if the member was the opposite sex. Equalisation is achieved by taking the higher of the two values.

This higher of two values, plus the value of any other benefit to be converted (typically GMP in respect of any pre-17 May 1990 period during which a GMP accrued), can then be converted into a revised non-GMP pension benefit.

Compared to the 2012 ’dual record‘ proposal, the conversion process would be a one-off calculation, and would appear to be simpler and therefore less costly to implement.

In addition, the advantage of this method is that once it’s done, not only will the inequalities issue have been resolved, there will be an opportunity to remove the complexity and restrictions generated by GMPs and the associated anti-franking requirements. However, the proposed method would be calculation intensive, and there are likely to be many data issues, especially for pensioners.

There would also be a need to complete GMP reconciliation work before the conversion process.

The consultation also includes various amendments, mainly to tidy up the legislation governing formerly contracted-out rights and help improve scheme administration, provide clarity and review past contracting-out regulations. 

The government provided a response to the consultation on 13 March 2017 in which it stated it continues to believe that the proposed method meets the equalisation obligation derived from EU law, but made it clear that the proposed methodology was not the only method by which schemes can equalise benefits for the effect of GMPs. The government emphasised that it is for the trustees of a scheme to decide what, if any, action is needed for their scheme to provide equal pension.

The DWP intends to give further consideration to the methodology with the industry working group (set up to consider this issue) based on the responses received and decide what further changes might be necessary along with what further changes might be required to legislation to enable schemes to convert benefits more easily.

How this could affect you:
Whilst the proposed method, if adopted, would not be compulsory, it would seem likely that the majority of schemes, including the RPS, would look to adopt this method or something similar. Due to the scale and complexity involved in GMP equalisation it is anticipated this would be a significant project for the RPS and other schemes.  
 

Background information

State Pension age review

Following changes made to the State Pension age in recent years, a system of regular reviews of the State Pension age was introduced by the Pensions Act 2014. The report from the first of these reviews, under the leadership of John Cridland CBE, a former Director General of the CBI, was published on 23 March 2017. His main recommendations were:

  • State Pension age should rise to age 68 over a two year period, starting in 2037 and ending in 2039, seven years earlier than the currently legislated 2044-46 step up. 
  • The triple lock should be withdrawn in the next Parliament.
  • That State Pension age should not increase more than one year in any 10 year period, assuming that there are no exceptional changes to the data. 
  • Early access and regional or individual variations in SPA should be rejected on the grounds of complexity, but some new flexibility is recommended in the form of options for partial deferred retirement.

The government has confirmed it will publish its first statutory review of State Pension age by 7 May 2017.

How this could affect you:
This review provides useful information on issues surrounding State Pension provision and an idea of what the government are likely to consider. However, we will need to wait for the formal statutory review of the State Pension before we know what changes the government propose. In any case, changes to the State Pension age will not directly impact the RPS or the Trustee’s other schemes. 

IORP II Directive finalised

The IORP Directive was approved by the European Parliament and Council in December 2016 and came into force on 13 January 2017. EU Member States now have until 13 January 2019 to implement the requirements of the IORP Directive into their national laws. Given the timing expected for the UK’s exit from the EU, the new IORP Directive may still need to be implemented for UK pension schemes, depending on the terms of the UK’s withdrawal from the EU.

The IORP Directive mainly focuses on the governance of schemes and communications with members. From a UK perspective, the main aspects of the new IORP Directive are requirements for:

  • Schemes to have ‘fit and proper management’, with this requirement applying collectively to trustees.
  • Professional qualifications for those who carry out actuarial or internal audit functions, with others with ‘key functions’ to have qualifications, knowledge and experience which is adequate to properly carry out their key functions.
  • There to be a risk management function which identifies, measures, monitors and manages risks.
  • Schemes to produce their own risk assessment, with this carried out at least every three years, or following any significant change to the risk profile of the scheme.
  • All members, including preserved members, are to be given an annual ‘pension benefit statement’.
  • Schemes to publish a remuneration policy for all those involved in effectively running the scheme. The policy is to cover all those who perform key functions for the scheme and other staff whose professional activities have substantial implications for a scheme’s risk profile.
  • DC schemes to appoint a depositary (with responsibilities including safekeeping of assets and oversight), although this requirement is at the discretion of each member state so might not require implementation in the UK.

It is expected that the government will consult on its plans for implementing the IORP Directive within UK law in the summer. Therefore, a more detailed analysis of its potential impact will be considered once these details are available.

How this could affect you:
What impact this has on schemes such as the RPS will largely depend upon whether the government decides to implement the requirements into UK law or not. Until more is known we will continue to monitor the situation.

TPR publishes DB investment guidance

The Pensions Regulator published new DB investment guidance on 30 March 2017.

This guidance is for trustees of occupational pension schemes providing defined benefits (DB) and aims to provide trustees with practical information, examples of approaches that could be taken and factors to consider when investing scheme assets to fund defined benefits.

Some of the key points from the guidance are:

  • Governance: TPR expects trustees to have suitably documented investment governance arrangements so effective decisions can be taken in a timely manner. In addition, trustees should monitor their own effectiveness and take action where weaknesses are identified.
  • Investment strategy: TPR maintains that a good investment strategy will involve effective governance, delegation and monitoring, form part of an integrated risk management process, have stable scheme objectives and long-term plans, have total risk consistent with risk appetite, involve risk-taking that is understood and balanced, and allow for the scheme’s future cash flow and liquidity requirements.
  • Timeliness: The guidance emphasises the importance of monitoring scheme’s investments and funding level regularly based on the scheme’s circumstances. Following these reviews, trustees need to actively consider whether to take action in response.

How this could affect you:
A review of the guidance will be undertaken to identify if any actions are required as a consequence.

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