The Pension Schemes Act: what to expect
At the time of writing, the Pension Schemes Bill had not yet received Royal Assent. It has since been enacted.
The Pension Schemes Bill is due to come into force in early 2021. The Bill made its way through the House of Lords, then House of Commons in 2020 with all parliamentary support. The new Act will establish a new form of pension scheme, aim to improve protections for pension savings (not least by the introduction of £1m fines and potential imprisonment for 7 years for wrongdoing) as well as help people plan for their retirement, as summarised below. The changes in the law are also designed to equip the Pensions Regulator with the tools needed to address the new compliance and enforcement challenges relating to workplace pension schemes that have arisen over time since its creation in April 2005.
Collective Money Purchase Schemes (CMP)
The Bill will introduce a new framework for the establishment and administration of CMP schemes. These schemes will offer an alternative to Defined Benefit (DB) and Defined Contribution (DC) schemes where the risks and costs are thought to be disproportionately borne by either the sponsoring employer (DB schemes) or the individual member (DC schemes).
A CMP scheme is where both the employer and employee contribute to a collective fund from which the employee will then take an income at retirement. Unlike in a traditional DC scheme, a CMP scheme allows investments to remain more liquid and in assets with a higher risk as the member approaches retirement. This is because the cash required to pay a member’s annuity is generated from the pension fund rather than the member’s notional pot.
On retirement a CMP scheme would aim to offer members a target pensions level which is based on their annual salary and years of employment. Unlike in a DB scheme, however, the target pension is not a guarantee and will be based on the member’s share of the collective fund as calculated in line with investment performance and other variable factors. It is likely, therefore, that a member’s income will fluctuate whilst in retirement.
The introduction of CMP schemes has been largely welcomed by the pensions industry as it offers a greater degree of flexibility than DB or DC schemes. CMP schemes could be an attractive proposition for sponsoring employers and, particularly, members in their individual capacities as the member owns a proportionate share of the collective assets, rather than an individual share, placing the risk on the membership as a collective. There are, however, reservations particularly given that the level of pension to be provided is merely a “target” based on investment performance, akin to traditional DC schemes.
Extension of Pensions Regulator’s statutory powers and new criminal offences
The Bill sets out legislation to strengthen the existing statutory investigation and enforcement powers of the Pensions Regulator, expand the circumstances in which it can challenge corporate activity (whether ‘business as usual’ like an internal group restructuring, or in a distressed situation), and significantly increase the penalties and sanctions it can impose if it doesn’t like what it finds.
The draft legislation strengthens the “moral hazard” powers of the Pensions Regulator powers (ie the ability to ‘pierce the corporate veil’ and require an associated group company, and in extreme cases individual directors, wherever located, to pay money into a UK defined benefits pension scheme). There will also be new criminal offences punishable by imprisonment for up to 7 years (and/or an unlimited fine) for conduct that puts at risk the likelihood of benefits being received under a defined benefits scheme. Any person can be a target, so company directors, HR managers, professional advisers, banks, investors, commercial counterparties and all other third parties are potentially in scope.
There will be two new notifiable events, which are statutory obligations to engage with the Pensions Regulator as an early warning of certain transactions. The Regulator will need to be notified of the sale of a material part of the business of any company participating in a defined benefits scheme, (where that company has funding responsibility for at least 20% of the scheme liabilities). It must also be notified where security is granted with priority over the pension scheme trustees, as a creditor. These types of notifications are aimed to give the Regulator an early warning system to flag opportunities for it to intervene and investigate if it does not like how the defined benefits pension scheme is being treated as a stakeholder (usually the major unsecured creditor).
The Bill also provides that where a group intends to sell a controlling interest in a scheme employer or either of the two new notifiable events occurs, the ‘corporate decision maker’ must issue a declaration of intent to the scheme trustees as early as possible, copied to the Pensions Regulator. This will turn current good practice into a legal requirement and require very early, and meaningful engagement with the trustees of any defined benefits scheme (even if its employer is not directly involved in the deal).
The Regulator can impose fines of up to £1m for failure to notify.
The Bill also gives the Pensions Regulator additional powers of investigation, in particular to require a meeting (with the risk of being fined if you do not attend), and also extended powers to inspect premises (other than private homes) at any reasonable time where documents relevant to the administration of an employer are being held. Once inside the building, the inspector can demand that documents are provided, take copies of or the originals of those documents and interview any person present. Refusing to co-operate with an inspection (such as refusing, without reasonable excuse, to let the inspector in or to provide the paperwork requested) is, as now, a criminal offence.
The Bill will establish a new framework for the Pensions Dashboard, including enacting powers to compel pension schemes to provide pension information to their members. The Pensions Dashboard is an online service that enables members (who are under state pension age and not yet drawn their pension) to view their pension information in one single place.
The data will be presented on different bases for different schemes. For example, DC estimates of retirement pots could be based on Statutory Money Purchase Illustration assumptions, or in line with FCA projections. DB estimates could be based on pension built up to date or assuming continued service up to retirement. In short, schemes will be free to choose how to present their data. In December, the Pensions Dashboards Programme published its dashboard data standards document (https://www.pensionsdashboardsprogramme.org.uk/2020/12/15/data-standards-guide/) setting out the type of information which pension schemes and pension providers will have to supply to the Pensions Dashboard. In practice this will include information on pension accrued to date and expected retirement income, and details of where the pension was built up (ie details of previous employment). The Pensions Dashboard will also contain links to scheme websites which may include helpful information on costs and charges, for example.
There are concerns over the practical difficulties in operating the Pensions Dashboard. One of the issues trustees of pension schemes will face is how close a data match is in terms of ID verification before data is then sent on to the Pensions Dashboard. Scheme trustees will need to exercise vigilance and caution when identifying the true source of the information before sharing data on the dashboard to ensure that they are not revealing sensitive pension information to third parties. This is particularly important given the considerable implications of falling foul to GDPR legislation. There will, however, need to be a balance struck in ensuring that there aren’t large numbers of “false negatives”, which will go against the spirit of the legislation which was introduced to reunite people with their lost pension pots.
Schemes should also note that complying with these provisions will involve a large data migration exercise, which will result in significant cost and resource implications. Schemes (and their trustees, sponsors and respective advisers) must therefore begin to prepare for this exercise in advance and take the associated costs into consideration when carrying out any financial forecasts.
Funding of DB Schemes
The Bill will introduce new measures with the aim of revising the current scheme funding process. In short, the Bill will (1) introduce a new scheme funding code and (2) alter the existing scheme funding legislation.
(a) Introducing a new scheme funding code
DB schemes will be required to put in place a funding strategy (when setting the scheme funding objective) for ensuring the long-term provision of benefits. The strategy will need to specify which investments the trustees intend to hold, and the intended funding levels that these are intending to produce. Trustees will be required to report in the triennial valuation proving how they have used the long-term objective to inform the scheme’s technical provisions and recovery plan. Consultation by the Pensions Regulator on the code is ongoing, including “fast track” and “bespoke” approaches to funding strategy and valuations.
(b) Changing the scheme funding legislation
The Bill will also impose a new duty on trustees of DB Schemes to determine and keep under review a funding and investment strategy. The scheme trustees will need to report on its implementation to the Pensions Regulator, specifying the funding level which the trustees intend the scheme to have achieved and detail the investments the trustees intend the scheme to hold at a particular date.
Trustees will also be required to complete a new statement of strategy, including a written statement of the scheme’s funding and investment strategy. Trustees will need to work closely with the employer when completing this, particularly when looking at the main risks faced by the scheme in implementing the investment strategy and how the trustees intend to mitigate or manage these risks.
There is uncertainty as to whether there is a requirement for schemes to capitalise future expenses and PPF levies and include this liability within deficits, which could be very material addition to liabilities for lots of smaller schemes. If so this may, in turn, mean many smaller schemes accelerating their path to buyout and therefore creating a bigger market for faster consolidation with insurers and superfunds. Consultation is ongoing on the practical implications of these changes, with the outcome expected in 2021.
Anti-scam protection for scheme members on transferring out benefits
At present, members of DB schemes have a statutory right provided they are at least a year before normal retirement age, to elect to transfer their accrued benefits out of the scheme into a pension arrangement of their choice. This is called taking a cash equivalent transfer value if the benefits are in a defined benefits pension scheme. However, this transfer out option is open to bad practice and, in particular, scheme members being subject to pension scams, risking them losing their pensions savings entirely. At present a member must take financial advice if the value of the benefits being transferred is £30,000 or more. But the Bill adds a set of trigger conditions that, if not met, will give the scheme trustees the right to refuse to implement a member’s statutory transfer out request. This is designed to try to stop transfer being made to fraudulently established pension schemes.
The Government reports that in 2017, pension scam victims were reported to have lost an average of £91,000, with only a minority of pension scams believed to ever get reported. Pension scams are on the increase in the UK, despite awareness-raising campaigns, and scammers are exploiting fears about the financial impact of coronavirus to target pensions savings. The Bill is trying to close the loophole where scheme members are encouraged by unscrupulous advisers to transfer their valuable defined benefits into totally unsuitable (eg very high risk, or illiquid), or even illegal, investment products held within sham pension schemes.
Climate Change risk reporting requirements
The Bill will impose mandatory requirements on trustees and managers of large occupational pension schemes (ie those with assets of £1bn or more) with a view to ensuring effective governance in respect of climate change.
These requirements will include managing and reporting annually on the scheme’s exposure to climate-related risks and opportunities. This will require careful thought from schemes and their trustees who should consider implementing measures to ensure that such data is captured, consulted on and recorded appropriately. This is particularly important as the Bill will put in place a compliance framework regarding the new duties with additional powers conferred on the Pensions Regulator to issue compliance, third party and penalty notices (of a maximum of £5,000 for individuals, £50,000 for other cases).
It is increasingly clear that pension schemes need to act to manage climate risk and opportunities, which has been a hot topic in recent years. Acting promptly to manage climate risks and to take advantage of the low-carbon transition will put schemes in a stronger position for the future.
These detailed regulations and statutory guidance should be welcomed by scheme trustees to whom they apply as they will help them navigate this difficult area by providing real focus and support. These provisions are expected to drive improved market practices and point the way for those smaller schemes in the future.
Read Anne-Marie and Riccardo’s article in Compliance Monitor.
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.