A small step towards deregulatory reform

Like the two leaders of the deregulatory review (Chris Lewin and Ed Sweeney), the government faces a difficult task. In its executive summary, the DWP acknowledges that this is “complex and difficult territory”, with no single measure or even a series of measures that could guarantee that employers would continue to provide and even strengthen their existing pension provision.

The report states: “There are many factors which affect employers’ decisions about pension provision - a number of which are outside any governmental control. And, as the reviewers themselves found, it is difficult to strike the right balance between removing legislative burdens and protecting members.” Qualifying its position further, the DWP says: “Changes that would produce the most savings for employers - and therefore provide potentially most encouragement to employers - would be those that would have most impact on members, and could undermine confidence in pensions. However, the government believes that the proposals outlined … are a step in the right direction.”

Clarifying the extent to which it is prepared to introduce regulatory reform, the government response makes it clear that it will not consider any changes that would affect members’ accrued rights. In addition, it rejects the idea of removing the statutory requirement for employers to index pensions in payment, on the basis that the potential benefits in terms of sustained employer provision are unlikely to outweigh the disadvantages for future pensioners.

Lewin and Sweeney produced some interesting cogitations on the topic of revaluing deferred pensions in their deregulatory review, ultimately ensuring they remained blameless for any decision that the government might take in this area. The wording in the report ran: “We carefully considered representations put to us that the cap on the revaluation of deferred pensions should be reduced from 5% to 2.5%. We both recognise the strength of the arguments for and against and on balance recommend no change.”

They continue, saying: “However, we acknowledge that there needs to be significant lessening of the current regulatory regime to encourage employers to continue to provide work-based pensions. We would understand if government took the view that, when looking at the package as a whole, a reduction in the cap from 5% to 2.5% was one of the measures needed to provide that encouragement.”

The government has concluded that a reduction in the cap would deliver potential savings for employers if inflation remains above 2.5%. It has therefore proposed that the cap on revaluation for all pension rights accrued on or after a future date be reduced to 2.5%. It hopes to make this change in the Pensions Bill that is expected to be introduced shortly. Rights accrued before the set date will continue to be revalued in accordance with current statutory requirements and, of course, some schemes may continue with their current practice.

Arguing its case for the change, the DWP report points out that it would bring the cap on revaluation into line with limited price indexation (LPI), which is applicable to pensions in payment. Its initial analysis suggests that if employers take advantage of the reduction, the measure could lead to long-term savings of around £250 million to £400 million per year (2007/08 prices). Total overall savings to 2050 are estimated to be in the region of £4.4 billion, depending on future deferral patterns and inflation rates.

As part of their endeavour to encourage sponsorship of risk-sharing schemes, Lewin and Sweeney asked the government to provide reassurances about the compatibility of certain flexible scheme-design features with s.67 of the Pensions Act 1995, which limits the modification of accrued benefits (see feature on Law on modification of accrued rights). They were particularly concerned about situations where a contingent promise is made in relation to benefits, as opposed to a guarantee.

Responding to this, the DWP report states: “Many in the pensions industry are concerned that s.67 is open to misinterpretation and that a contingent promise could be construed to result in an accrued benefit, even in circumstances where the contingency has not occurred. In this event, some fear, a court could hold s.67 to require a benefit to be paid, or paid at a higher level, than had been intended by those who established the scheme … Section 67 acts to limit the detrimental application of modification powers, so provided the contingencies are written into the rules in such a way that no further exercise of a modification power is necessary, the subsisting rights provisions in s.67 should not apply.”

The DWP does go on to say, however, that the government is “mindful that it is ultimately for the courts to determine how statute applies in particular circumstances”. “Any employer or scheme considering amending existing scheme rules or setting up a new scheme should consider taking their own legal advice so that the particular circumstances in their case can be fully taken into account,” it says.

Other issues highlighted by the deregulatory review to help encourage flexible scheme design relate to two areas: the calculation of the Pension Protection Fund levy for risk-sharing schemes; and the ability of scheme sponsors to pay into a “pre-fund” (with tax relief) to provide top-up payments to members at retirement age. The DWP has undertaken to explore both of these ideas. It is also investigating ways to share information about the various types of risk-sharing schemes currently in existence, to help companies that do not have access to consultancy expertise.

Responding to the reviewers’ concerns about the circumstances in which debt in relation to a multi-employer scheme is triggered, the government concedes that the current provisions may create difficulties for some employers. It has already accepted the reviewers’ recommendation that where a company that participates in a DB multi-employer scheme ceases to have employees actively participating in that scheme but the scheme continues, the debt should not be triggered if, within a period of up to one year, the employer acquires more employees who participate in the scheme. However, the government does not appear to be confident that other issues can be easily remedied through a change in legislation and says it will work with the industry over the coming months to seek a solution.

Similarly, the DWP says it recognises that some employers have concerns about funds building up in their scheme when the test for recovering any surplus remains so stringent. Currently, the position is that where the rules of a scheme allow payments to be made to the employer from the scheme’s funds, legislation prohibits such a payment unless the scheme is funded to a full buyout level, and the trustees are satisfied that a payment is in the interests of the scheme’s members. The DWP says it will explore the scope for “addressing these concerns”, but does not accept the reviewers’ recommendation that a return of surplus should, with trustees’ agreement, be available once the scheme-specific target is reached. It is “minded” to remove the specific legislative requirement of a return of surplus to be in the “members’ interest”, provided it can find a way to do so without calling into question the trustees’ fiduciary duties to scheme members. The review’s report suggested that some trustees were interpreting this requirement very narrowly.

The government will also look at how a “framework of outcome-related principles, accompanied by guidance” can be introduced in place of the existing disclosure legislation relating to the day-to-day running of a pension scheme. It intends to take forward further discussion with stakeholders to see how a principles-based approach can work. It regards the move to outcome-related principles for disclosure as a test bed for the approach.

The DWP has taken a more decisive stance in relation to pension sharing. It agrees that some of the requirements regarding pensions and divorce are unnecessary, and says that at the next suitable opportunity it will repeal the legislative requirements relating to safeguarded rights, which are shared, contracted-out rights.

It has taken a less conciliatory approach, however, to the issue of trustee knowledge and understanding. The reviewers felt the legislation should be amended so that individual trustees are not required to have particular standards of knowledge and understanding on a range of issues - instead they would like to see this type of requirement applied to the trustee board as a whole.

The DWP states that the government and the Pensions Regulator believe that the legislation as it currently stands does not actually require trustees to have comprehensive knowledge of all the issues and it therefore would be inappropriate to amend legislation. It believes, however, that there are “widespread misconceptions about the existing requirement for trustee knowledge and understanding”, and says it will work with the Pensions Regulator to examine how best to “put right these misconceptions”. The DWP also rejects the notion that schemes should reimburse trustees when they have incurred “reasonable, personal legal expenses” arising from the performance of their duties.