20th February 2017 ARC response to DWP call for evidence on bulk transfers of defined contribution pensions without member consent
ARC Pensions Law is a leading firm of dedicated pension lawyers specialising in workplace pension schemes. Our client base consists of DB, DC and hybrid schemes and their sponsors. In view of our particular client focus, we are restricting our response to the call for evidence to the issues faced by occupational pension schemes and on which we have had sufficient exposure as lawyers to enable us to comment.
Regulation 12 of the Occupational Pension Schemes (Preservation of Benefit) Regulations 1991 was written with DB schemes in mind. We agree that it is not fit for purpose for the DC environment. We consider therefore that it is overdue for change. In its current form Regulation 12 is unduly restrictive when applied to DC – DC bulk transfers and can often result in timely and sometimes costly additional measures being taken to facilitate a without consent transfer which for all other purposes is in members’ interests.
Below we set out our responses to the questions that are within our area of expertise and experience as pensions lawyers.
Q1. In your view, how common are occupational DC-DC bulk transfers without consent and can you give examples of circumstances in which they occur?
There has been an increasing number of these types of transfer and we expect them to become more prevalent as employers seek to consolidate their occupational arrangements (e.g. by transferring DC sections of schemes or whole DC schemes into master trusts or other standalone DC vehicles in order to manage their pension exposure) and the likely consolidation of the DC master trust market itself, soon to be encouraged further by the Pensions Schemes Bill.
Q3. Do you think there is sufficient clarity regarding what is meant by “broadly no less favourable”, and how consistently do you think it is being applied?
The “broadly no less favourable” test lacks clarity in its application to DC-DC transfers and in our view lacks the necessary flexibility to enable the relevant characteristics of DC benefits to be taken into account when determining the impact of the transfer on members’ accrued benefits.
“Broadly no less favourable” makes more sense in a DB context where, in practice, it is the overall value of the members’ benefit rights (i.e. “transfer credits”) pre and post transfer that are being compared. Although, as evidenced by the Pollock v Read case, Regulation 12 is still lacking even in a DB context because of the inability to take into account the security of members’ benefits. (In Pollock v Read the Judge reluctantly decided that the transfer could not proceed because the greater security provided in the receiving scheme was irrelevant to the actuary’s considerations because non-financial factors could not be taken into account for the purposes of a Regulation 12 certificate, despite the fact that greater benefit security was a key factor that could have meant the transfer was in members’ interests.)
However, a value comparison makes far less sense in a DC context. A member’s “transfer credits” in a DC context are measured simply in terms of the monetary value of their DC pot of assets immediately before and immediately after the proposed transfer. A substantial proportion of proposed DC-DC bulk transfers involve members meeting the transition costs and/or facing higher charges in the receiving scheme. This is usually because only some of these costs are met from reserve accounts (i.e. unallocated funds) or by employers in the transferring scheme and/or because higher member-borne charges are levied in the receiving vehicle to pay for member services that make the transfer beneficial for members in the first place (e.g. higher quality communications or investment options). More often than not there is a consensus that members would be best served by a transfer into the receiving scheme but the requirement for an actuarial certificate causes problems because of a face value reduction in the monetary value of members’ “transfer credits” immediately post- transfer.
This has resulted in different and inconsistent approaches being adopted by individual actuaries in these circumstances. For example, some will sign the certificate if the transferring scheme is winding up and member pots would be used to pay wind-up expenses in any event. Some, however, will not sign the certificate unless the monetary value of members’ pots immediately post-transfer is no less than immediately before the transfer. In practice, this often requires the employer to meet some or all of the transition costs or contribute to the receiving scheme in order to reduce member-borne charges in the short term. The other ‘work around’ we have seen is the receiving scheme, particularly where a commercial master trust, voluntarily reducing or waiving charges for the transferring members for a period post-transfer. Alternatively, and particularly if there is no sponsor to provide the additional funding, the lack of actuarial certificate halts the transfer until a suitable receiving vehicle with lower costs can be found.
Of course, the receiving scheme will likely have the power under its rules to change member charges going forward. So the ‘work arounds’ requiring the sponsor or receiving scheme to meet costs in the short term is, in reality, an artificial construct necessary only because of the wording of Regulation 12.
It is also worth noting that DC schemes, unlike DB, will not as a matter of course have an appointed Scheme actuary. In nearly all cases the transferring Trustees will be appointing an actuary solely for the purpose of providing a Regulation 12 certificate, in which case that certificate should be a help not a hindrance given the additional time and cost associated with appointing an actuary for this purpose.
Q4. Do you think that the actuarial certificate or an alternative check of scheme quality still has a role in occupational DC-DC transfers? If so, who ought to carry out such an assessment? What factors should be considered as part of that assessment and which should be excluded? Do you have any thoughts on how the relative strengths and importance of those factors should be weighed up? If not, how would members continue to be protected?
When deciding whether to make the bulk transfer out the transferring Trustees’ legal fiduciary duties will require them to look at all relevant factors when deciding whether the transfer is in members’ interests. It is these duties that offer the primary source of protection for members, not the actuarial certificate. Even in a DB context, the certificate is not the key to member protection. For example, the certificate could be provided if the pre and post transfer benefits were on their terms identical, but Trustees may not be able to proceed with the transfer if the transfer would materially reduce the security of members’ benefits (i.e. the funding levels and employer covenant in the receiving scheme was far weaker than in the transferring scheme).
Trustees’ legal duties require them to consider all relevant factors, including non- financial factors. Trustees balance these factors to reach a decision whether the transfer is in members’ interests. In DC-DC bulk transfers, in our experience, Trustees will look at whether members bear transition costs and conduct a comparison of the transferring and receiving schemes with respect to (and without limitation) member borne administration and investment charges, the range of investment options, the anticipated investment performance, the perceived quality of scheme communication methods, the quality of scheme administration functions and governance and in some cases what the alternative option to transfer is (e.g. annuitisation or winding up lump sums if available taking into account member pot sizes). This consideration of all relevant factors provides member protection in the broadest sense. Consequently, and in disagreement with the suggestion otherwise in the consultation, we believe that Trustees’ fiduciary duties do provide sufficient member protection.
We therefore suggest that the statutory requirement for an actuarial certificate is removed for DC-DC bulk transfers. The Trustees’ fiduciary duties already, in our opinion, require Trustees to undertake an assessment that, amongst other things, addresses the mischief the “broadly no less favourable” test is aimed at but in a manner more helpful in a DC context. If a statutory replacement for the certificate is insisted upon we think it should go no further than requiring Trustees to take such appropriate advice as they think necessary.
We would expect Trustees to continue to seek input from investment consultants, legal advisers and in some cases actuaries to assess the various ‘relevant factors’. The extent and nature of the advice will depend on the circumstances of the transfer, the features of the transferring and receiving schemes and the skills and experience on the Trustee board. So rather than including prescriptive statutory requirements, we think it would be more appropriate for The Pensions Regulator to issue some short formal guidance as to what steps Trustees should consider, including seeking professional advice where appropriate, when deciding whether to make the transfer. However, to be clear, we would not recommend that the Regulator be required to approve the transfer, as we doubt whether they have the resources to do so in a timely manner and we see no reason why the Regulator would be better placed than the Trustees to decide what is in the best interests of scheme members. Such guidance would also help Trustees who do not regularly take professional advice by pointing out the kind of factors they should be thinking about.
Given the breadth of features of different DC schemes, it will not be possible or appropriate for any guidance (or, if there is any, any replacement regulation) to be specific about the decision making process and the factors to be taken into account that would form an acceptable basis for a without-consent DC transfer to be assessed. It must be written as a broad guide, involving suggested consideration of a number of specified issues, but leaving the application of the test to the Trustees in line with their equitable duties in the circumstances. As noted above we would expect them to take advice as a matter of course, including legal advice and some expert assessment of the financial factors pre and post transfer. We do not see that there should be a need for statute to require actuarial advice but instead Trustees should be free to choose if and when such advice is required, for example, if in the circumstances the Trustees felt an understanding of the projected retirement benefit would be a determining factor.
Q5. Sometimes occupational DC pensions have valuable guarantees, either borne by the scheme or another body. How do you think the process should differ for these types of scheme?
We recognise that the proposed change (above) will result in separate regimes for DB and DC transfers. In most cases it will be clear which type of benefit is involved. However, there are schemes where that might not be so clear-cut. Where the benefit is of one type, but with a guarantee or underpin of the other type (e.g. a DC benefit with a DB underpin or a guaranteed rate of return), Trustees will need legal advice to determine the nature of the benefit at the relevant time. Trustees with these types of benefit most likely have already started to take legal advice on determining the nature of the benefit, as it is a point pervasive to the administration of those benefits. The assessment of the benefit and the legal position that applies will depend on whether the Trustees’ (having taken legal advice) determine the benefit to be DB or DC and consequently which legal requirements apply. The value of an underpin or guarantee would be a relevant factor for the Trustees to take into account when determining whether to make the transfer and the proposed flexibility above would permit this (including taking actuarial advice to determine the value of any underpin or guarantee).
Q6. Do you have any experience of how the scheme relationship condition works in practice? Do you think it serves a useful purpose or does it act as an obstacle in some circumstances? What is the frequency and impact of these obstacles?
We agree that the difficulties identified in the consultation paper with this requirement do indeed exist. There are ways to overcome these obstacles in practice but they add unnecessary time and cost to the process, which is particularly unsatisfactory given that the process can have cost sensitivities if financial factors are also causing issues with the actuarial certificate as discussed above. We doubt that there was ever any intention to erect these barriers in these situations and so do not anticipate any objections in principle to removing them.
It is not uncommon in legacy or long-standing DC schemes, or commercial master trusts, to have ‘orphaned’ members (e.g. deferred members whose employer no longer participates in the scheme or no longer exists). It is worth noting that this might become more common over time. For example, employers of a DC scheme often adhere to the DC receiving scheme (and particularly master trusts) to facilitate the bulk transfer without consent of members into that vehicle. The employers then dis-adhere from the receiving scheme. If that receiving scheme wants to subsequently bulk transfer without consent those members into another scheme (e.g. to another master trust due to market forces encouraging consolidation) they will find themselves with ‘orphaned’ members.
Q7. What is the impact of the current provisions around bulk transfers for ‘orphaned DC schemes’, where there are no surviving employers in relation to the scheme? Do you think that we need special provision for such schemes, for example, to allow pension providers to carry out a transfer where certain conditions are met? How do you think this should work in practice?
As regards orphaned schemes, we consider that in most cases there will be Trustees in place, who would be able to make a transfer if the scheme relationship condition was removed and there was overriding legislation that permitted the Trustees to exercise the powers of the employer under the scheme rules (e.g. in case rule amendments were needed and employer consent was required to the amendments). It should also be recognised that where there is no employer standing behind the scheme the costs of transfer would be met from members’ pots. Where the employer is also the Trustees and the employer winds-up or goes insolvent then there will be no trustee in place.
In the event that there is no Trustee in place in respect of an occupational scheme, The Pensions Regulator already holds powers to appoint a Trustee. This would appear to be a situation in which those powers could be exercised, although we appreciate that this may be a difficult decision for the Regulator, for example where it is restricted in practice to appointing a professional trustee and the only assets available for payment of that Trustee are scheme funds and member pot sizes are small. One option may be to ask the provider to step in as Trustee if they were willing (both in practice and to effectively indemnify itself), perhaps as way to manage their own administrative costs of having legacy schemes on their books.
If, in these circumstances, pension providers were permitted to make thought would need to be given to specifying the conditions to be met given that the provider owes no legal fiduciary duty to members unless it were the Trustee. The factors could be similar to those that the Trustee board would need to take into account but we would expect the provider to take professional advice, including legal and financial, although there again may a question of how this advice is paid for.
The Department for Work & Pensions’ call for evidence on bulk transfers of defined contribution pensions without member consent can be viewed here.
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.