Pensions Bulletin Monitoring employer support Regulator

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                   Pensions Bulletin 2010/50
              2 December 2010



              Monitoring employer support – Regulator
              finalises guidance
              The Pensions Regulator has published finalised guidance for trustees of all occupational
              pension schemes with a defined benefit (DB) element on the practice that it expects
              trustees to follow in assessing, strengthening (through contingent assets and other forms
              of security), monitoring, and taking action on employer covenant. It has also published a
              response to the consultation about this guidance (see Pensions Bulletin 2010/25).


              Following some doubt as to precisely what the Regulator meant by “covenant,” it has
              now been defined (in a newly added glossary) as the employer’s legal obligation and its
              ability to fund the scheme now and in the future. Missing from this is “willingness” (given
              that this can quickly evaporate just when it is needed most). But the Regulator notes
              that willingness may well be an important consideration for the trustees to take into
              account in their overall decision-making on scheme funding and recovery plans.


              A number of improvements have been made to the draft guidance. These include
              adjusting the language where it was felt to be too prescriptive (such as when it is
              advisable to appoint external covenant assessors) and providing greater clarity as to
              what is a proportionate approach to compliance. The importance of trustees maintaining
              a good working relationship with the employer is reflected by adjusting the guidance in a
              number of places.


              The Regulator hopes that trustees will adopt approaches to covenant assessment,
              strengthening and monitoring having regard to the guidance it has provided, but in a
              manner that is appropriate to the circumstances of the scheme and events which may
              affect it.




                  The finalised guidance is a balanced treatise of a subject that in recent years has (or
                  should have) moved centre-stage in trustees’ deliberations. Although a challenging
                  read, it should repay close study, even where trustees currently have few concerns
                  regarding the covenant.


                  The real strength of this guidance is that it puts paid to the idea that covenant is
                  something that is measured scientifically, only as part of the triennial valuation,
                  and then is quietly forgotten. To be fully effective, trustees need to have a good
Page 2 of 7      handle on covenant strength and the risks to corporate profitability on an ongoing
                 basis as well as be aware that its measurement and analysis is something of an art.


                 Although the Regulator is not dogmatic as to how trustees should go about
                 measuring and monitoring covenant, it would not be surprising if this latest
                 guidance results in increased use of externally sourced advice in what is a complex
                 area with no easy answers.



              Abolition of money purchase contracting
              out – DB to DC transfers still to be
              permitted
              The Department for Work and Pensions (DWP) has published its response to the
              consultation it held on consequential regulations in anticipation of the abolition of money
              purchase contracting out on 6 April 2012 (see Pensions Bulletin 2010/33).


              By far the most important point in the response is a statement that legislation will be
              amended so that transfers from defined benefit (DB) contracted-out schemes to non-
              contracted-out schemes will, subject to certain safeguards, be allowed after 2012. This
              follows concerns raised that the regulations as written would have effectively ended the
              option for many individuals to transfer their benefits out of a DB scheme to another
              scheme, such as a personal pension.


              Other points include:


                 A useful disclosure easement – Currently schemes must inform members within one
                 month of ceasing to contract out that their scheme is no longer contracted-out and
                 must inform members within four months of the effect of the scheme ceasing to be
                 contracted-out. Schemes will be exempt from these requirements as long as they
                 have already informed affected members and provided the required information
                 within the year preceding the 6 April 2012 abolition date. This should enable
                 schemes to communicate these messages at the same time as other regular
                 communications are made.
                 Confirmation that certificates issued in respect of the money purchase sections of
                 Contracted-Out Mixed Benefit (COMB) schemes will be treated as cancelled for the
                 purpose of those sections only.
                 That, following an informal consultation carried out in 2009, the DWP does not intend
                 to make any changes to the reference scheme test.


              The finalised regulations will be laid before Parliament early in the New Year.
Page 3 of 7
              NEST announces charging plans
              NEST Corporation has announced that a 0.3% annual management charge will be levied
              on member funds under management in the National Employment Savings Trust (NEST)
              and that the charge on contributions will be 1.8%.


              This level of the annual management charge is in line with what the previous
              Government announced in March (see Pensions Bulletin 2010/11) but the charge on
              contributions is slightly lower than the anticipated 2%.


              NEST Corporation has also published a briefing note explaining how it believes the
              combination of the two charge rates announced will meet its objective of delivering a low
              charge to prospective scheme members.




                 The overall charge is indeed low compared to what private pension providers are
                 likely to require to serve NEST’s target market – especially those on modest
                 earnings in small companies. But there remain difficulties. There has yet to be any
                 explanation of precisely what these charges cover and the firm linkage of the
                 contribution charge to NEST’s set-up costs may yet prove to be disincentivising,
                 especially as it is likely to be many years before the ambition of a pure annual
                 management charge expense structure is achieved.



              Annual Allowance – HMRC clarifying
              guidance
              HM Revenue & Customs (HMRC) has published a short note clarifying some points
              raised by the draft legislation and guidance on the Annual Allowance published on
              14 October 2010 (see LCP’s News Alert).


              The note includes a helpful illustration of how the notional “carry-forward” from 2008/09
              to 2010/11 works – which is not immediately intuitive – as well as explanation of some
              other technical points.


              Its most urgently awaited item is a clarification on whether an arrangement’s “Pension
              Input Period” (PIP) can be changed under current legislation. The note explains that in a
              member’s arrangement that has not yet had a PIP “nominated”, it is currently possible to
              change the PIP from the default that would otherwise apply, including the possibility of
              realigning with the tax year; but the process involves making the change retrospectively
              to A-day or the date of joining the arrangement if later; and this facility will cease when
              the Finance Bill 2011 is enacted (July or August 2011). Where a nomination has already
Page 4 of 7   been made for a member’s arrangement, changing the PIP for a tax year (and hence
              now to align with 5 April) is not possible.


              The note gives an example of the unintuitive default that would apply if a PIP is left
              unnominated, and why this might lead to confusion – but the example should be read
              with care as (without explicitly saying so) it focuses on a member already in a DB
              arrangement at A-day. For other members the default could be very different (but still
              unintuitive!).




                  While the PIP clarification is important, there are various other aspects to the PIP
                  rules that need modification (involving changes to the proposed legislation) if they
                  are to work well with an Annual Allowance of £50,000. The industry continues to
                  lobby and we hope for further changes in this area.



              Annual Allowance – HMT consults on
              options to meet charges
              HM Treasury (HMT) has published a discussion document to gather feedback and views
              on methods to enable individuals to meet large Annual Allowance (AA) charges out of
              their pension benefits, rather than current income. Colloquially known as “scheme pays”,
              this involves the member choosing that a scheme pays the charge and correspondingly
              reduces the benefits due from the scheme. The document suggests that either or both
              of the following methods will be available:


                  paying a year’s AA charge in real time, while pension benefits are still accruing; or
                  deferring the AA charge (rolled up with interest for late payment, and collated with
                  any other AA charge payable), until the individual’s pension benefits begin to be paid
                  (or are transferred out).


              The former would involve the scheme establishing the benefit deduction upfront; the
              latter – suggested in the hope that it might lessen administration for schemes – might
              mean the scheme can leave the form of the deduction to be established when benefits
              are drawn in the light of the member’s/scheme’s circumstances (however HMT does ask
              whether respondents agree that it is “insufficient” that members do not have an
              explanation of the “corresponding effect on pension benefits to the member” at the point
              of opting for ”scheme pays”). HMT identifies that the latter would involve delayed tax
              yield and administration for the Government so would need to be convinced of its
              usefulness. The Government’s view is that schemes should have flexibility over how the
              value of an offset to pay for the AA charge is determined, provided the terms are not
              actuarially disadvantageous to the individual.
Page 5 of 7   The Government asks for comments on its outline of the processes and timelines for
              both versions of “scheme pays”. It asks many questions as to how the overall
              mechanism would work, including:


                 Should members always have to use current income to meet the first part of a year’s
                 charge, with “scheme pays” only needing to be made available for the excess (the
                 Government suggests a threshold in the range of £2,000 to £6,000)?
                 Should access to “scheme pays” be restricted only to members of defined benefit
                 schemes? How should defined contribution/ money purchase arrangements fit in?
                 Are there exceptional circumstances in which certain schemes should be exempt
                 from offering members “scheme pays” (the Government otherwise states that it will
                 be mandatory for defined benefit schemes to do so)?
                 How should “scheme pays” be handled where the individual is a member of more
                 than one scheme?
                 Given that identifying a charge and the “scheme pays benefit reduction” takes some
                 time, how can “scheme pays” be operated in relation to charges for the year of, and
                 the year before, starting to draw benefit, in time to actually settle the benefit – or
                 should it not be available?


              The document implies that where an individual uses “scheme pays”, the fact that the
              benefits are reduced would be reflected in two other key tax calculations, the maximum
              tax-free cash sum allowed by tax laws and the Lifetime Allowance charge. The reduced
              overall package would mean a reduced allowed lump sum and (should it arise) reduced
              Lifetime Allowance charge. This does mean that, despite statements elsewhere in the
              document to the contrary, members using “scheme pays” are in a different tax position to
              those paying the AA charge direct from their own resources.


              Responses to the discussion document should be sent to HMT by 7 January 2011.




                 This document shows how difficult it will be to implement “scheme pays” to strike a
                 balance between meeting the needs of affected individuals without overburdening
                 schemes with excessive administration. Organisations wishing to respond may
                 wish to focus on where and when exemptions from the mechanism would be
                 appropriate. The Government – while hoping that the numbers impacted by large
                 AA charges will be very few because of behavioural changes (reduced pension
                 saving so the tax does not arise) – seeks evidence of the numbers and types of
                 members who would be eligible for the facility. It may of course be that the schemes
                 most using “scheme pays” will be public sector ones, where there has to date been a
                 practice of not offering a cash alternative to the standard pensions provisions.
Page 6 of 7
              Corporate Governance Code – NAPF
              guidance
              The National Association of Pension Funds (NAPF) has updated its Corporate
              Governance Policy and Voting Guidelines to take account of the changes to the UK
              Corporate Governance Code made earlier this year by the Financial Reporting Council
              (see Pensions Bulletin 2010/23).


              The main purpose of the policy and guidelines is to assist investors in their interpretation
              of the Code when assessing a company’s compliance with it.



              Stewardship Code for Institutional
              Investors – NAPF guidance
              The National Association of Pension Funds (NAPF) has published guidance for pension
              funds and investors signing up to the UK Stewardship Code for institutional investors
              published by the Financial Reporting Council (see Pensions Bulletin 2010/29).


              In it the NAPF encourages all pension funds to disclose:


                 whether they support the Code’s Principles and if not, to explain why;
                 whether reference is made to the Code in their Statement of Investment Principles
                 and Investment Management Agreements;
                 the review process and its frequency (eg annual consultant assessment, manager
                 report and/or meeting); and
                 the managers used by the scheme and whether they apply the Code.



              IOPS Principles of Private Pension
              Provision
              The International Organisation of Pension Supervisors (IOPS) has published a set of
              updated principles for national supervisors of private pension arrangements to follow,
              following on from the recent issue of guidance on managing and supervising pension
              system risks in November (see Pensions Bulletin 2010/46).
Page 7 of 7
              Reforming the Institutional Framework for
              Financial Regulation – Progress report
              HM Treasury has published a summary of responses to its consultation on reforms to the
              institutional framework for financial regulation (see Pensions Bulletin 2010/32). It
              confirms some Government decisions, namely that:


                  the UK Listing Authority will remain within a new consumer protection and markets
                  authority’s (CPMA); and
                  the Financial Services Authority’s criminal enforcement powers in relation to market
                  conduct will also be retained within the CPMA at this time.


              The Government intends to present more detailed policy and legislative proposals for
              further consultation early in 2011. Legislation to implement those proposals will be
              introduced in mid-2011 and its passage through Parliament is expected to take around a
              year, such that the new regulatory framework is anticipated to be in place by the end of
              2012.




              This Pensions Bulletin should not be relied upon for detailed advice or taken as an authoritative
              statement of the law. For further help, please contact David Everett at our London office or the
              partner who normally advises you.




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