Pensions Act 2004 (Part 2): Measures to enhance member security central to reforms
This second feature on the Pensions Act 2004 completes our examination of the Act's provisions. Part 1 of our analysis of the Act dealt with provisions that employers and trustees will need to implement. Here we concentrate on changes made that generally do not require implementation by employers and trustees.
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The Government had no option but to improve the security of members' benefits in the wake of high-profile cases where employees lost their jobs and most of their pensions at the same time. The Pension Protection Fund, the Financial Assistance Scheme and the new Pensions Regulator are intended to go some way towards restoring members' confidence in pensions.
The most important provisions are intended to enhance member security, by introducing the Pension Protection Fund (PPF), the financial assistance scheme (FAS) and the new Pensions Regulator. The Act also includes measures to aid pension planning, to implement the IORP Directive, to make deferring a state pension more attractive and to adjust the jurisdiction of the Pensions Ombudsman.
We will return to some of the most important initiatives in the Act, in future, as the detail is revealed in Regulations.
Member protection
Much rests on the success or failure of the PPF and the government's FAS. Both have been established by the Act to increase member confidence in workplace pension provision. Broadly speaking, the PPF will operate somewhat like an insurance scheme for defined-benefit (DB) scheme members with the aim of providing protection against loss of benefits, where the employer becomes insolvent. The FAS was originally set up as a retrospective measure, to compensate some of the members who have already lost out because their scheme was underfunded when wound up and their employer was unable to make up the deficit. It has now been announced that this will cover those who suffer such a fate right up until April 2005, when the PPF is due to be established.
Pension Protection Fund
Despite concern from some quarters of the pensions industry, the government will not provide financial backing for the PPF. Compensation will be funded by taking on the assets of pension schemes with insolvent employers, and through a levy on DB schemes and on the DB elements of hybrid schemes. Should a large number of claims fall on the PPF, the danger is that it could suffer a large deficit (as in the US, where a similar arrangement, the Pension Benefit Guaranty Corporation , has a massive shortfall).
The PPF will be run by a board chaired, in the first place, by Lawrence Churchill. The chief executive (Myra Kinghorn) will also be a member of the board, along with at least five other members. This non-departmental public body will also take over the functions of the existing Pensions Compensation Board. Its main responsibilities will be to pay pension and fraud compensation, manage the calculation and application of three levies (to fund pension compensation, administration, and fraud compensation), and set and oversee the investment strategy of the PPF fund. The PPF board can invest the funds held by it, provided that at least two fund managers are appointed. It is also given powers to borrow.
Applying for assistance
For a DB scheme to benefit from the PPF, an insolvency event must have occurred after the establishment of the PPF (likely to be 5 April 2005). One of the following must also apply:
the employer has become insolvent and the insolvency practitioner has issued a "scheme failure notice" stating that a scheme rescue is not possible (the exact nature of a scheme rescue to be set out in Regulations). The assets of the scheme must also be insufficient to secure the liabilities covered by the PPF (to be ascertained by an actuarial valuation arranged by the PPF board, as at a date immediately prior to the employer's insolvency); or
the trustees, or the Pensions Regulator, have applied to the board for the PPF to assume responsibility for the scheme because it appears that the employer is unlikely to continue as a going concern. The assets of the scheme must be insufficient to secure the liabilities covered by the PPF and the board must be satisfied that a scheme rescue is not possible.
Certain schemes are automatically excluded from the PPF. This includes money-purchase schemes and schemes that have commenced wind-up before the date that the PPF is to be introduced. Controversially, pensions minister Malcolm Wicks recently announced that potential eligibility will now be extended to those employers that have already had a "qualifying insolvency event" prior to April 2005 (See Final changes made to Pensions Bill ). This could lead to a large number of applications being made to the PPF immediately after it is set up, with as yet unknown consequences.
The board will be able to reject applications from those that appear to be seeking to take unfair advantage of the PPF. For instance, the board can refuse to take on a scheme that was outside the scope of the PPF during a specified period (to be clarified in Regulations). Likewise, it can refuse responsibility for schemes that were formerly ineligible - and which therefore did not pay the levy - but whose members are subsequently transferred to a different scheme when insolvency seemed likely.
Assessment process
The assessment period must last at least 12 months. During this time, severe restrictions are put on the scheme. For instance, no new members may be admitted, no further contributions may be paid towards the scheme, no further benefits can accrue and the winding-up of the scheme cannot begin unless the board decides this is the best action to take.
If the board is satisfied that all requirements have been met, the PPF assumes responsibility for the scheme, its assets and liabilities are transferred to the PPF, and pension payments are made to members from the fund. Trustees are discharged from their scheme obligations and the scheme is treated as being wound up.
PPF compensation
Benefits paid out under the PPF arrangements will be:
no more than 50% of the member's PPF entitlement for dependants on the death of a member in future.
Married or unmarried partners will be eligible to receive the survivor's pension only if this provision applies in the original scheme's rules. To comply with sex equality rules, the pension would also be payable to same-sex or opposite-sex partners.
Where a scheme member has been granted an ill-health early retirement pension during the three-year period prior to the PPF assessment period, the board has the power to review the decision to grant them a pension. This clause was added following an amendment proposed by shadow pensions minister Nigel Waterson. It is designed to catch out scheme members with inside knowledge about the impending insolvency, who attempt to bend the rules in order to secure 100% of their benefits. Members who have taken early retirement for reasons other than ill-health are only entitled to receive 90% of their original benefits and so it is not considered relevant to include them in this provision.
Benefits in payment will be subject to an annual increase of 2.5% or the increase in the retail prices index (RPI), whichever is lower, but only in respect of pensionable service after 6 April 1997 (for the period prior to that there will be no annual increases). If the scheme provides for a lump sum, the PPF will pay out funds equal to 25% of the member's PPF entitlement. Deferred pension rights will be revalued in line with the RPI capped at 5% pa.
PPF levy
The annual charge that is to be imposed on DB schemes to pay for the PPF has triggered fierce resistance from many of those responsible for operating pension schemes. An issue that featured strongly in debates on the Bill was the degree to which the levy should be assessed through factors relating to the financial strength of the schemes. This "risk-based" element of the levy would enable those with healthier funding levels to pay less than those with large deficits. Understandably, those who feel they have managed their affairs better than others believe this is a fairer way to proceed.
Originally the Pensions Bill allowed for an "initial levy" to be payable dependent solely on "scheme-based" factors (such as the number of scheme members, their pensionable earnings and the amount of scheme liabilities). The Bill allowed for this approach to continue past the first year and was consequently severely criticised. The clause was overturned during the Lords Report stage and, as a result, the Act stipulates that this initial levy will cease after 12 months.
A further bone of contention was that the Bill gave the board power to drop the risk-based element of the levy in any given year. Further, the maximum required level of the risk-based element was to be 50%. Opposition parties managed to overturn these provisions and the PPF's levy must now include an 80% risk-based element each year. Lawrence Churchill has commented that the PPF will now give greater importance to the risk-based levy than its US counterpart, the Pension Benefit Guaranty Corporation, which he suggests is a sign that the UK has learned "valuable lessons from the experience of the US".
The risk-based levy takes into account the difference between scheme assets and the level of benefits that would be paid to its members under the PPF. The board is also able to consider other factors, such as the risk of the employer's insolvency and the risks associated with the scheme's investments, with exceptions allowed for smaller schemes. The total levy cannot increase by more than 25% from one year to the next and it cannot exceed a ceiling amount, to be set in the initial year by the Secretary of State. Annual increases to this levy ceiling cannot exceed earnings inflation.
Under the Act, should the PPF get into financial difficulties, the PPF board could, if necessary, reduce its outgoings by bringing revaluation and indexation on pensions in payment down to nil. It can also apply to the Secretary of State to reduce the 100% and 90% compensation levels.
Financial assistance scheme
When the Pensions Bill was originally drafted, the government had no plans to compensate members of DB schemes who had lost benefits because of employer insolvency prior to the introduction of the PPF. However, strong lobbying from within parliament and by beleaguered individuals who lost significant parts of their pensions led the government to rethink its policy (See Government pledges £400 million 'assistance' package ).
Underpinning the FAS is the government's pledge to provide funding for such victims to the tune of £400 million over 20 years. The legislation also makes it possible for the body administering the FAS to take over the assets of schemes that qualify for assistance (as the PPF will).
Although the government had originally hoped to use additional sums from "industry", lobbying during the Bill's Report Stage in the Lords led to the abandonment of this idea. A clause in the Act makes it clear that no levy or charge can be made on any party to fund the FAS. Although this is good news for employers, it is difficult to see how £400 million will be sufficient to provide for the estimated 65,000 individuals - and more - who will be looking to the scheme for help. An Early Day Motion, currently with over 140 signatures, has been tabled by Labour MP Sandra Osborne, asking the government to acknowledge that further resources will be required.
Some details available
The legislation itself lays out scant detail about how the compensation will be allocated and distributed. According to an announcement made by Pensions Minister Malcolm Wicks (See Pensions agenda 2005 ), DB schemes must have begun winding up after 1 January 1997 and before the establishment of the PPF to qualify. Members will not be excluded because trustees complete winding-up or buy out members' annuities. In deciding which members will receive assistance, the government is expected to restrict this to those who are due to receive at least £10 a week.
The minister has also indicated that assistance levels will be set with "reference to the number of years an individual is from their retirement". This is based on the understanding that those who are younger "have more time to work and save for a pension to replace one that has been wholly or partially lost". Wicks also said that the government is considering making FAS payments for all individuals when they reach 65.
Assistance for those below scheme pension age will be capped. This will be set at a lower level than the PPF cap. Options being considered for the delivery of the assistance include a top-up pension, a cash lump sum, or purchase of an annuity at age 65. The legislation makes it clear that members will not be subject to a means-test to qualify for help under the scheme.
Although the government plans to set up the body to administer the FAS in April 2005, it does not anticipate making payments until after a formal consultation, which is expected to begin in "the spring" of 2005.
The Pensions Regulator
Following criticisms of the way in which the Occupational Pensions Regulatory Authority (OPRA) was established and operates, the Act provides for the dissolution of OPRA and the establishment of what is expected to be a "pro-active" Pensions Regulator. All of OPRA's functions, including the operation of the pensions registry, will be transferred to the Pensions Regulator, which will then be given much wider powers. As the provisions relating to the regulator will take effect from April 2005, OPRA has already made progress in developing the systems required for its operation.
New structure
In order to comply with the requirements of the Human Rights Act 1998, the Act contains detailed provisions relating to the procedures for reviewing and appealing the decisions of the regulator. Its chair will be appointed by the Secretary of State (David Norgrove is the first appointee). The chief executive (who will be Tony Hobman, the current chief executive of OPRA) will also be on the board, along with at least five other people.
There will also be a committee to discharge non-executive functions and monitor the activities of the regulator, and a determinations panel consisting of at least seven members. Decisions made by the panel and the regulator may be appealed to the Pensions Regulator Tribunal and appeals may be made from that tribunal on points of law to the Court of Appeal.
New powers
In addition to those transferred from OPRA, the regulator will have a number of new powers to issue notices in circumstances where it believes that schemes are at risk. These include:
Third-party notices - where any contravention of the legislation arises wholly or partly as a result of the failure of a third party to take action, but which is not in itself in breach of legislation, a notice may be issued to the third party couched in similar terms to an improvement notice.
Freezing orders - these may be made in respect of DB schemes where the regulator believes that there is an immediate risk to the interests of members or the scheme's assets, or to the generality of the members of the scheme. The order will direct that no benefits may accrue during the period of the order and that winding-up may not begin. It may also contain other directions regarding contributions, admission of new members and payment of benefits.
Contribution and restoration orders, financial support directions - the regulator may issue these where it believes that employers are using corporate group structures to avoid pension debts.
Pensions liberation
OPRA has been taking action for some time against "pensions liberation" (OP, April 2003), whereby pension benefits are fraudulently transferred to schemes in the name of fictitious employers enabling people to obtain access to cash. During the Lords' Committee stage, a number of amendments were made to the Bill giving the regulator specific powers to deal with the problem, as the government believes that OPRA's current powers are inadequate.
The Pensions Regulator will have three ways of remedying cases:
Restitution orders - the regulator may ask the court to order that any money "liberated", or property representing such money, be paid into a pension scheme, an annuity or to the scheme member.
Restraining orders - these may be made in respect of any account with a deposit taker, which the regulator believes is held by a person operating a "liberation" scheme. The order may direct that no credit or debit may be made to the account during the period for which the order has effect.
Repatriation orders - these may be made where a restraining order is in force and enables the regulator to direct the deposit taker to pay money from the account into a pension scheme, annuity or to the scheme member.
Other powers
The Pensions Regulator has been given extensive powers to gather information. All schemes will be required to complete an annual return providing detailed scheme information, which will be used by the regulator to compile and maintain a register of pension schemes.
The current whistleblowing requirements have been extended to employers sponsoring schemes, trustees and managers of schemes, and anyone involved in providing advice to schemes. The Act also gives the regulator powers to order the inspection of premises to check that pension legislation is being complied with. The regulator may also apply for a warrant to inspect premises if it has reasonable grounds for believing that an offence has been committed or that scheme assets are likely to be appropriated.
A major part of the regulator's work will be providing information, education and assistance to schemes and advisers. To this end, the Act provides that it must publish codes of practice covering all aspects of legislative requirements on pensions and OPRA has started consultation on the first codes. Regulations have already been made that bring into force many of the sections of the Act relating to the regulator from 17 December 2004.
Financial planning
In the action plan setting out the details of how it intended to progress the Green Paper proposals, the government set out its objective of giving people "choice over how and when they save". No detailed provisions relating to financial planning are contained within the Act. Instead, it gives power to the Secretary of State to make Regulations covering a number of relevant matters, including:
the promotion and facilitation of planning for retirement;
requiring trustees or managers of both occupational and personal pension arrangements to issue combined pension forecasts; and
requiring certain employers to enable employees to obtain information and advice about pensions and saving for retirement.
The combined pension forecasts must contain information about the basic state pension, second-tier state pensions and the benefits likely to accrue under pension schemes. The government is keen to promote the use of combined pension forecasts and is looking for organisations to provide them voluntarily. If the voluntary approach is not successful, then Regulations requiring companies to issue the statements are unlikely to take effect before 2007.
No specific conditions are laid down in the Act regarding employers that must offer access to information and advice about pensions to their staff. However, in the action plan and during the Committee stages, the government made it clear that it envisages the provisions applying to employers with five or more employees who contribute 3% or less to a pension arrangement. The type of information required will be set out in Regulations, but the government has already been piloting pension information packs with small organisations. The results of the pilot study are expected in the summer of 2005, and the provisions may be implemented the following year.
Implementing the IORP Directive
For the most part, the requirements of the Directive on the activities and supervision of Institutions for Occupational Retirement Provision - the IORP Directive - must be incorporated into the domestic legislation of member states by 23 September 2005. In the case of the UK, the Pensions Act 2004 is intended to make the required legislative changes and the intention is to bring these into effect sometime in September 2005.
Scheme funding
It is ironic that, despite having started consultation on a replacement for the current minimum funding requirement some five years ago and also having played a lead role in drafting the IORP Directive, the UK government still had to adjust the earlier scheme-specific funding standard that had emerged after extensive consultation to fit in with the requirements of the Directive published in September 2003. There may still be some difficulties in reconciling the requirements of the Directive and of the funding standard set out in the Act (see OP, January 2004).
Scheme categories
The Pension Schemes Act 1993 sets out in its very first section a definition of what is meant by the terms "occupational pension scheme" and "personal pension scheme". These were rather unclear (especially in relation to group personal pensions), but in practice this usually did not matter because the tax legislation made it clear whether any particular scheme was an occupational or a personal pension scheme. In 2006, however, the new tax regime will generally apply to all registered schemes alike and so the tax treatment will cease to be a distinguishing characteristic between the two types of pension provision.
The IORP Directive relates to "institutions for occupational retirement provision" and its articles 3 and 4 deal with the extent to which it will apply to the "occupational retirement provision business" of insurance companies.
These two factors combined to require an amendment to the key definitions given in s.1 of the 1993 Act. The change was necessary to realise the government's policy aim of having two separate forms of tax-privileged work-based pension provision. On the one hand occupational pension schemes, which will include schemes that are fully insured, are to be regulated by the Pensions Regulator and are subject to the IORP Directive. On the other hand, personal pensions, which include group personal pension arrangements, are regulated by the Financial Services Authority and are subject to the EC Life Insurance Directive (2002/83/EC).
It should be noted that under the new statutory definition of "occupational pension scheme", both employees and the self-employed will be permitted to become members of occupational pension schemes, and that any particular occupational pension scheme can have both employed and self-employed active members. This is currently prohibited under the tax legislation.
This change probably results from the judgment of the European Court of Justice in Allonby v Accrington & Rossendale College (OP, March 2004; [2004] OPLR 83). This ruling held that, in the absence of any objective justification, any requirement imposed by state legislation of being employed under a contract of employment rather than a contract for services as a precondition of membership of the Teachers' Pension Scheme was not compatible with the EU equal treatment requirements. The formal classification of a self-employed person under UK law does not change the fact that a person can be classified as a "worker" within the meaning of Article 141 of the EC Treaty, which requires equal pay (including pensions) for equal work.
Restrictions on payments
The Act also requires those private sector occupational pension schemes established in the UK, and those established outside the EU that have employees in the UK to be set up, in effect, under trust. (The actual requirement is that they must be set up as trusts if they are to receive funding payments.) Currently the tax legislation requires private sector exempt approved occupational schemes to be set up as trusts. Yet no such requirement will be imposed by the Finance Act 2004 in relation to the new tax regime in 2006. The requirement has therefore had to be transferred from the tax to the social security legislation.
Apart from inherent prudential reasons, the requirement has been maintained because the IORP Directive requires each member state to ensure that there is a legal separation between a sponsoring employer and an IORP so that the assets of the institution are safeguarded in the interests of members and beneficiaries in the event of the insolvency of the sponsoring employer. The new Act does not require pension schemes established in other EU member states with UK-based employees to be set up as trusts since they are covered by the cross-border provisions described below.
Scheme activities
The IORP Directive requires member states to limit the activities of IORPs established on their territory to "retirement-benefit related operations". Currently this measure is enforced in the UK by the tax legislation, which requires exempt approved schemes to provide only "relevant benefits".
A similar requirement is made by a provision in the Finance Act 2004, but for good measure the new Pensions Act also makes a comparable stipulation. In short, as law firm CMS Cameron McKenna points out, pension schemes cannot offer mortgages!
Obligations on trustees
Some of the new obligations placed on trustees by the new Act have been prompted by detailed requirements made in the IORP Directive. For example, Regulations made under the replacement provisions governing the duty of trustees to prepare a statement of investment principles are likely to require the trustees to review their statement at least once every three years, as is required by paragraph 24 of the Directive's preamble. The Act introduces provisions aimed at ensuring compliance with the Directive's requirement that investments are made in accordance with the prudent person principle.
Similarly the new requirements in the Act limiting trustees' borrowing powers were prompted by the Directive. Regulations made under the Act will:
specify that trustees may borrow only where this is on a temporary basis and for liquidity purposes; and
prohibit trustees from guaranteeing loans.
It is probable, however, that the Regulations will also grant an exemption from these limitations to certain small schemes.
Cross-border activities
Part 7 of the Act introduces into domestic UK legislation the requirements of the Directive relating to cross-border pension scheme membership (OP, November 2003). A key objective of the Directive is to put in place a regulatory framework that will enable an occupational pension scheme located in one EU member state to accept contributions from an employer based in another member state - an objective long sought in particular by UK companies with European-wide operations.
To realise this objective, the Act sets out:
the conditions a UK occupational pension scheme must meet before it can begin to operate as a cross-border scheme;
how such a UK scheme intending to commence cross-border activities can obtain general authorisation to do so from the Pensions Regulator;
how a UK scheme must identify the specific European employer(s) from which it wishes to receive contributions and how the regulator must transmit this information to the regulatory authorities in each of the member states where the relevant employers operate;
how the regulator must send information to the UK scheme that it has received from the other regulatory authorities on the relevant social and labour law in those member states;
the requirement on trustees/managers of a UK cross-border scheme to operate in accordance with the relevant social and labour laws of the host member state;
how the regulator can require a UK scheme to ringfence some or all of the relevant assets or liabilities in relation to contributions received from an employer in another member state;
what duties are placed on the regulator when a non-UK-based IORP accepts contributions from a sponsoring employer located in the UK; and
how the regulator must act when it receives a request from another EU regulatory authority asking for assistance in prohibiting the disposal of UK-held assets held by an IORP established in that regulatory authority's home state.
Pensions Ombudsman
The Act makes some modest changes to the operation of the Pensions Ombudsman's office.
It permits one or more people to be appointed as Deputy Pensions Ombudsman. The Act allows these deputies to "perform the functions of the Pensions Ombudsman at any time when the Pensions Ombudsman is for any reason unable to discharge his functions". However, it is clear from the Commons Committee stage debate that it is intended that these deputies will be able to sign off determinations. Currently, although determinations are drafted by members of the Ombudsman's staff, the Ombudsman has to authorise each one. It seems likely that lawyers will in future spend much time analysing whether there have been small differences of approach between each of the deputies and the Ombudsman.
Another provision in the Act will allow one-off acts of administration to be brought within the Pensions Ombudsman's jurisdiction. This change is being introduced because in the case of Britannic Asset Management Ltd v Pensions Ombudsman ([2003] OPLR 93), the Court of Appeal distinguished between carrying out a one-off act of administration in connection with a pension scheme and being concerned with its administration. Britannic managed to wriggle out of the Ombudsman's jurisdiction as a result. The government was concerned that this prevented someone bringing a complaint "arising from an act of administration carried out, for example, by an insurance company at the request of the scheme administrators". This gap has been filled and in future one-off acts of administration will be within the Ombudsman's jurisdiction.
Finally, the Act repeals an enabling provision introduced by the Child Support, Pensions and Social Security Act 2000 which would have allowed, had it ever been introduced, the Ombudsman to consider complaints that would affect other (non-complaining) members of a scheme. The outcome is that the Ombudsman will still not be able to deal with so-called class actions. If resolving a complaint from one member would have the effect of disadvantaging another member, the Ombudsman cannot investigate. This significantly restricts the Ombudsman's jurisdiction.
State scheme
The Act makes changes to state pension provision in four areas. Three are relatively minor in scope:
a married woman or widow/widower who is entitled to more than one category B state retirement pension (a pension based on a spouse's national insurance contributions and earnings) will be given the right to notify the Pensions Service, part of the Department for Work and Pensions, which category B retirement pension he or she wishes to receive and, in default, the Pensions Service will pay the one that is the most favourable;
the Secretary of State will be given authority to disclose to relevant third parties information on an individual's state pension rights to make it easier for scheme members to be given a combined pension forecast; and
individuals living permanently in the UK who had previously lived in Australia can have the period of their residence in Australia counted as periods for which Class 3 NI contributions have been paid for the purpose of determining their entitlement to UK state retirement and bereavement benefits.
The fourth change involves amending the existing arrangements for those who defer their state pension, by bringing forward to 2005 planned changes originally due to be introduced in 2010. These changes include an increase in the incremental rate, and the abolition of time limits, as well as introducing the option of taking a taxable lump-sum payment as an alternative to the benefit of receiving weekly increments for life. The measures in the Act closely follow those set out in the earlier Bill (OP, April 2004).
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This feature draws primarily on a reading of
the Pensions Act 2004, the explanatory notes for the Bill and the Hansard
reports. We have also drawn on various commentaries published by consultants
and law firms including Pensions Act 2004 - your plain English guide published by CMS Cameron McKenna on
its website (www.law-now.com ). |
DB scheme eligibility criteria for application to PPF and FAS
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Pension Protection Fund |
Financial assistance scheme |
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Scheme required to pay levy from April 2005. |
Members lost or at risk of losing benefits
due |
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Scheme has not begun wind-up prior to 5 April 2005. |
Scheme begins (or began) winding up between 1 January 1997 and 5 April 2005. |
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Sponsoring employer experiences a "qualifying" insolvency event after 5 April 2005 (can also have had an insolvency event prior to that date). |
Employer insolvent at time of winding up (issues concerning the definition of employer solvency are being considered by the government). |
