The Pension Schemes Act 2021 introduces two new powers for the Pensions Regulator to issue contribution notices based on the “employer resources” test and the “employer insolvency” test. We have had consultation from the Regulator on how it will exercise these powers and consultation on what exactly the “employer resources” test means and how resources will be calculated.

These new powers will allow the Regulator to impose liability by reference to a snapshot of the effect on the employer, even where there is no obvious and immediate detrimental impact of corporate activity on a DB pension scheme – so more transactions are likely to involve “moral hazard” risk. It’s likely there will be an increase in clearance applications to manage that risk, at least in the medium term.

The new Contribution Notice tests will allow the Regulator to impose liability where:

• The employer’s resources are materially reduced by comparison with the pension scheme’s “section 75 deficit” (the employer resources test), or
• The potential recovery of the pension scheme on insolvency of the employer is materially reduced (the employer insolvency test).

The policy intention behind these new tests is to allow the Regulator to look at a snapshot of the impact of corporate activity on the employer, without having to create a link between that impact and any potential impact on the pension scheme. While the Regulator still has to act reasonably, it should in theory be easier for the Regulator to impose liability where the covenant of the employer available to support a DB pension scheme is reduced – and remember the Regulator can look back up to six years when considering this. There will be a statutory defence but there is no case law on how this might operate or what would need to be demonstrated in order to succeed.

Draft regulations and consultation on the meaning of “employer resources” suggest that these should be calculated as the normalised profits of the employer before tax. This would be based on profits revealed in the latest accounts before the act in question, stripping out exceptional or non-recurring items and comparing those profits to published accounts or other management information after the act in question. That could cover acquisitions which are intended to provide increased employer strength or profitability over time but don’t deliver that on day 1.

The employer insolvency test does not include any consideration of the likelihood of insolvency – so if the theoretical return to trustees on an insolvency is reduced, there is a risk of failing the test even if it is thought that insolvency is a remote event.

The Regulator’s proposed Code of Conduct covering the new tests includes various examples of activity it thinks would be covered by them. These include restructurings where assets or a profitable business stream is transferred out of an employer, highly leveraged acquisitions, payment of dividends or the introduction of additional debt to a scheme employer.

Many of these are situations where we would already be advising clients to consider the impact on the pension scheme – but there will now be circumstances where there is a risk of falling foul of the new tests where previously the parties might have been comfortable because the likely impact on the pension scheme, over time, was considered to be small.

Comment: The new ‘snapshot’ tests, and their focus on the effect of activity on the employer rather than the pension scheme, mean there will be an increased risk of the Regulator imposing liability in a wider set of circumstances.

Until we have greater clarity on how the Regulator is likely to view transactions and other activity in practice, it will be difficult to advise clients on the level of risk involved. One way to deal with that is by a clearance application. It is likely there will be an increased number of clearance applications – much like when the “moral hazard” powers were first introduced in the early 2000s. The Regulator is expecting this to happen and gearing up its resources to deal with more applications.

In practice, that will mean factoring in more time to deal with the Regulator and trustees of a DB scheme where there is an acquisition, disposal, restructuring, refinancing, dividend payment… as well as the potential to have to provide mitigation in the form of cash payments or other support to the trustees.