KEY ISSUES ARISING FROM "SIMPLICITY, SECURITY AND CHOICE : WORKING AND SAVING FOR RETIREMENT - ACTION ON OCCUPATIONAL PENSIONS"

The SPC welcomes the fact that the government has made a number of clear decisions on policy for company pension schemes, and looks forward to playing a full part in further consultation on the implementation of these decisions.

We have written to Andrew Smith, Secretary of State for Work and Pensions, in order to highlight what we see as the key issues that are raised by the announcement, and also to draw attention to a number of areas of detail that need to be covered in that consultation.

KEY ISSUES

Simplicity

As the government has recognised, there is no justification for most of the differences between the rules for Personal Pensions and Occupational Pensions. The abolition of most of the differences has already been announced with the simplification of the tax regime. The only remaining difference is that of indexation, where occupational pensions have to be indexed while personal pensions do not. There is no justification for this difference (certainly where money purchase pension are concerned) and it just confuses members. (Anyone who wants to can get round the rules, so they only impact on the unsophisticated member.)

Pensions Protection Fund

Taking the US experience as a guide, we should expect that some employers will use any or all loopholes to dump their pension liabilities on to the Pensions Protection Fund, which will impose additional costs on employers who are maintaining their pension promises, and generally discredit the system. A number of advisers have already been investigating loopholes, and have discovered quite a few. We would be keen to work with you to get these loopholes closed as fast as possible.

Full buyout on voluntary winding up

This requirement is likely to act as a further disincentive to the provision of defined benefit schemes, as suppliers of capital may regard the requirement as increasing their risks. However, the trend away from defined benefit schemes was already well established (with three-quarters of such schemes being closed to new employees) so the additional impact may not be particularly significant.

Co-ordinated implementation

Occupational pension schemes will need to make substantial changes to administration systems and rules in response to the decisions which you announced last month and to the new simplified tax regime for pensions. The cost of making these changes must be minimised and a key factor in achieving this will be to ensure that the changes required by the two government initiatives can be made as a single exercise. It is essential that the government works closely with schemes, and their advisers and service providers, to ensure that its initiatives are introduced in a way which does not require schemes to revisit changes made in response to one part of the government's programme as a result of the introduction of the other part.

DETAILS REQUIRING CONSULTATION

The Pensions Protection Fund

There will be many challenges in moving from the outline of a Protection Fund in the government's announcement to an effectively functioning compensation scheme. As examples:-

• The Pensions Protection Fund will inevitably be most vulnerable at times of economic downturn, when investment values are low and corporate bankruptcies high. These are also the times when both pension schemes and employers will find their resources strained, and so additional levies from the PPF could be damaging to continuing schemes.

• Achieving the right balance between employers' premium levels and scheme funding levels. There must be a clear reward for employers maintaining a high funding level in terms of lower premium to the compensation fund. There is also tension between the proposal for risk based premiums and the government's intention to replace the minimum funding requirement by a scheme specific funding standard. The basis for setting the risk-based premium could easily become in effect a new minimum funding requirement. It should also be recognised that risk comes not only from the funding level, but also the investment policy, and the strength of the employer’s covenant. Ideally, these factors should be taken into account in the risk-based levy.

• What benefits need to be covered? The fund would pay a maximum of 100% of pensions in payment, but would this extend to pension increases? There is a clear case for arguing that any benefits, already secured through the purchase of an annuity, do not need to be covered by the pensions protection fund, in the same way that benefits guaranteed by the government will not be covered.

Full buy-out

The announcement suggests that trustees, exercising their fiduciary duties, could agree a lower amount than full buy-out costs, if this would avoid putting the company itself at risk. Is the intention that trustees should rely on the Bradstock judgment in agreeing a lower amount? In that case a full scale independent analysis of the company’s finances was required, together with an application to the Court. This involves substantial expense, and would not be practical for many schemes.

The announcement says that the full buy out debt applies only where the employer triggers the winding up. However, the draft regulations state that full buy out applies in any winding up where the employer is solvent. This looks like a drafting error, based on a misapprehension that only the employer can trigger winding up. In fact, many schemes’ trust deeds give the trustees power to trigger winding up.

Codes of Practice

We support the idea of Codes of Practice as a way of simplifying legislation. Codes of Practice work best when they deal with basic principles, in plain English. If they attempt to cover everything in precise detail then they effectively turn into legislation, of exactly the type that we are trying to get away from.

Better informed and better trained trustees

In this area, the government intends to add to the already excessive burden of legislation carried by pension schemes.

We are sure that trust law already requires all that is necessary in this area. We are concerned that the main consequence of the proposed legislation will be to squeeze out capable lay trustees with a particular affinity for the scheme for which they have responsibility. This seems to be contrary to the declared government policy of encouraging greater member involvement in the running of pension schemes.

Extension of transfer of undertakings legislation

We support the government's proposals in this area, but the position of schemes with a current employer contribution of less than 6% will need to be clarified.

Better protection for early leavers

There needs to be a default position to cover the case where the member does not make a choice between a refund of contributions and a CETV within a reasonable period. The only satisfactory default position is the refund of contributions.

Implementation of the option for a CETV must recognise that very few personal/stakeholder pension providers will have any commercial incentive to attract the modest amounts of contributions which will usually be generated.

Where CETVs are subject to reduction, because the scheme is under-funded, the member’s choice should be between the reduced CETV or a refund of contributions, with the default being the refund.

Easing the indexation requirements

The government's decision on changes in the indexation requirements give rise to a number of concerns :-

• By relaxing the requirement only for future service, it creates another layer of legislation for schemes which wish to take advantage of the relaxation and complicates communication with scheme members. For defined benefit schemes which close for future accrual, to existing members, as well as being closed to new members, which we expect to increasingly happen, there will be no cost saving. We suggest that schemes should be permitted to make the new rate of capped indexation retrospective. This would have a real impact on funding costs and increased flexibility of investment strategy.

• We are disappointed to see no change in the indexation requirements for deferred pensions, matching those for pensions in payment.

Increasing flexibility to modify the structure of members' accrued rights

We welcome the government's intention to increase flexibility in this area. The practical value of amendments to section 67 of the Pensions Act 1995 will depend very heavily on getting right the detail of the amendments, and we look forward to assisting in consultation aimed at ensuring this is achieved.

Greater member involvement in running occupational pension schemes

The government's intention is to ensure that all members are able to nominate some of the trustees of their pension scheme. It will need to be clarified whether this includes pensioners, deferred pensioners and those who have partially retired and are in receipt of some of their benefits.

Streamlining the rules on contracting-out

We welcome the planned package of measures to simplify the operation of contracting-out and encourage the government to continue its consideration of options to simplify the administration of Guaranteed Minimum Pensions, should schemes wish to move in this direction.

There was no reference in the June announcement, to the possibility, raised in the Green Paper, of simplifying the Reference Scheme Test for contracting-out. It would be helpful to have confirmation of whether change in this area has now been ruled out.

As central to all administrative processes for contracted-out schemes, it is essential that any changes to contracting out take effect at the same time as all the other changes.

Streamlining the procedure for dealing with disputes between trustees, managers and scheme members or beneficiaries

This is a particular area where the burden of current requirements is completely out of proportion to any benefit to any of the parties to the scheme, and we look forward to proposals for radical streamlining.

Increase in the earliest age from which a pension may be taken

It is important that the government makes known as soon as possible (a) the actual date, from which the earliest age from which a pension may be taken will be increased from 50 to 55, and (b) whether the increase will be phased in.

Annual benefit statements by defined benefit schemes

We do not see a justification for going further than existing requirements in respect of deferred members of defined benefit schemes, who can already obtain a benefit statement on request.

Other areas of change

We were surprised to see no reference to the planned measures for registration of same sex partnerships among the other initiatives referred to towards the end of the June document. We would welcome early confirmation that any measures affecting pension schemes, arising from this initiative, will not be retrospective.