25 June 2020
PPF compensation cap ruled unlawful
Not quite two years since the Court of Justice of the European Union ruled in the Hampshire case that the PPF compensation cap was unacceptable in reducing the compensation of some PPF members to below 50% of their original scheme benefits (see our News Alert), this week the High Court has handed down judgment that the imposition of the compensation cap at all is, in fact, unlawful.
The compensation cap was first designed as a tool to combat “moral hazard” (the risk that those who run pension schemes would do so less carefully if the PPF would pay full pensions should things go wrong) by limiting the maximum compensation to £25,000 pa back in 2005 for those below Normal Pension Age, as well as limiting costs to the levy payer. It would “bite on relatively high earners many of whom will be in a position of influence within the company” to encourage them to ensure that their pension scheme didn’t fall into the PPF.
In February 2019, Mr Hughes, together with 23 other individuals (including Mr Hampshire of the Hampshire case noted above) and the British Airline Pilots Association, brought a claim against the PPF that the compensation cap involves unlawful age discrimination and should be disapplied, as well as challenging the way the PPF is implementing the Hampshire judgment.
Age discrimination is lawful if there is a legitimate aim, and the measure used is appropriate and necessary for achieving that aim. On the former, Mr Justice Lewis accepts that addressing moral hazard and employer cost concerns are legitimate aims. On the latter, Mr Justice Lewis concludes that the compensation cap is not an appropriate means of achieving the aims as, amongst other reasons, on top of the 10% reduction applied to all members below NPA “it is not easy to see that the imposition of a further, very significant cut in accrued pension benefits for a very small group of employees would realistically or reasonably add weight to the aim of combating moral hazard in the form relied upon”. Furthermore, the PPF’s service-related adjustment to the compensation cap in 2017 and the CJEU decision in 2018 both support the conclusion that the compensation cap mechanism is not an appropriate means of achieving the legitimate aims.
The lawfulness of paying 90% of pension benefits to those below NPA was not challenged in the proceedings, but Mr Justice Lewis accepted that it was open to Parliament to decide if it is an appropriate means of addressing moral hazard.
The judgment also limited claims to past underpayment to six years, confirmed that trustees of pension schemes in assessment should pay benefits that do not exceed PPF compensation and allowed the PPF to decide on the mechanism by which it will comply with the Hampshire judgment (essentially confirming the current approach is permissible).
The PPF has responded to this judgment stating that it will work with the DWP to decide on the next steps; and in the meantime, will continue to pay PPF members their current level of benefits.
The PPF is facing challenges on all sides at the moment with EU case law, RPI reform, investment market issues and a likely surge in insolvencies all testing its finances on top of an ever-shrinking pool of levy-paying schemes.
While the PPF expects that this particular judgment affects around 0.5% of its members and will cost around 1% of its liabilities, the precise effect on each scheme could be very different depending on its membership composition. Schemes with a large number of high earners could see their PPF levies increase by some multiple if uncapped liabilities are recognised in PPF levy valuations.
At the moment it is not clear if the PPF will appeal this judgment, or if there will be a challenge to the current 90% formula applicable to those under NPA. Could recent judgments and anticipated funding strains see the Government take a wider look at PPF compensation?
Corporate Insolvency and Governance Bill – Government takes action on pension concerns, but will it be enough?
In response to rising concern that the Corporate Insolvency and Governance Bill will weaken the position of DB trustees and the PPF, whilst strengthening the position of those who lend to companies (see Pensions Bulletin 2020/24), the Government has tabled a raft of amendments.
These mainly relate to the company moratorium proposal which would appear to grant super-priority to certain unsecured debts so that they will rank above pension debts if a company enters into administration or insolvent liquidation within 12 weeks of the moratorium ending.
The Government’s amendments can be found on the 18 June marshalled list and were accepted into the Bill at Report stage in the House of Lords which took place, along with the Bill’s Third Reading, on 23 June.
- Amendment 79 replaces the previously proposed definition of the debt that could potentially gain super-priority status with the concept of a “priority pre-moratorium debt” which is relevant in the circumstances that are concerning pension schemes. Importantly, these new priority debts exclude any pre-moratorium debts that fall due during the moratorium thanks to the operation of, or the exercise of rights under, an acceleration or early termination clause in a contract or other instrument involving financial services. Many other amendments make consequential changes to the Bill. Importantly, one of them allows regulations to amend the “priority pre-moratorium debt” definition
- Amendment 99 will allow the Pensions Regulator and PPF to be provided with information and exercise rights where an arrangement or reconstruction is proposed under the new legislation for companies in financial difficulty. A number of other amendments ensure that both bodies have notification, information and exercise rights in relation to the company moratorium proposal
In the debate on 23 June, the Government acknowledged that the action being taken in respect of the super-priority issue would not offer a complete protection to pension schemes and pointed to the regulation-making power which it would consider using, if need be.
The Bill now returns to the House of Commons for consideration of the amendments introduced in the House of Lords. Royal Assent should then quickly follow.
The first amendment would appear to go some way to addressing the super-priority concern, but whether it will be enough to prevent pension scheme debt from being subordinated by financial institutions in many common unsecured lending situations may depend on what (if anything) is to come in regulations.
The second amendment, whilst clearly being good news for the Pensions Regulator and the PPF, would appear to be no more than a bit of necessary housekeeping of this rushed Bill and commensurate with powers that both have in other insolvency situations.
LCP launches mortality trends report
LCP’s third annual report on mortality trends focuses on helping trustees and sponsors understand the impact of longevity risk and assumptions on their DB pension schemes. This topic is becoming more important as DB schemes de-risk their investment strategies and longevity becomes one of the key remaining uncertainties.
This latest report has been written during an exceptional time in the UK, with a tragically high number of people dying due to Covid-19. Whilst Covid-19 is quite rightly dominating headlines and pension scheme agendas at the moment, it is of course only one of a number of factors that will drive a pension scheme's mortality experience and assumptions.
As well as taking a look at the impact of Covid-19, the report also considers wider mortality trends and takes a look at what might happen in the future.
A particular item of interest in this report is the result of our modelling which implies that the short-term financial impact for a typical pension scheme of members' deaths in 2020 is likely to be modest, at a fraction of a percent. The knock-on effects of the pandemic in the medium to long-term may ultimately dominate the consequences of Covid-19, particularly the effects on life expectancies of a severe recession and changes to UK healthcare provision.
Pensions Regulator sets out interim framework for supervising superfunds
On 18 June the Pensions Regulator published interim guidance on the regulatory framework it will apply to superfunds (also referred to as DB consolidators) before a full legislative framework is in place. This guidance, the result of significant work following the Department for Work and Pensions’ December 2018 consultation on DB consolidators (see Pensions Bulletin 2018/50), requires superfunds to seek “approval” from the Regulator in respect of their proposed way of working. In addition, sponsoring employers are expected to obtain clearance before scheme trustees transact with a superfund.
Alongside the guidance the Regulator published its response to a targeted consultation with key stakeholders (held last year behind closed doors), outlining the thinking behind the framework it has settled on.
The launch of the guidance was accompanied by a written statement from Guy Opperman who said that the Government will continue to develop the permanent regime before legislating. The operation of the interim regime will be kept under review by the Government, with both it and the Regulator taking “prompt, robust action” should it be necessary to protect and advance the interests of scheme members.
See our News Alert for more information.
This announcement paves the way for the first pension scheme transfers to a superfund. It also provides long-awaited clarity on the likely shape of the future regulatory framework, albeit that this seems to be some way off and certainly not for the Pension Schemes Bill currently before Parliament. The DWP’s response to its consultation remains outstanding, with no news as to when this might be forthcoming.
The Regulator has had to tread a fine line between adequate member protection and a commercially viable framework that can attract the significant external investment necessary for the fledgling superfund model to take-off. But in some areas it has come down on the side of members – for example, investors have to wait until the full legislation is in place to access any return on their investment unless the scheme has been fully bought out.
Is the pension triple lock about to be suspended?
Speculation and calls for reform of the pension triple lock have made headlines since the Treasury published its forecasts for the UK economy back in May. The latest and not least important has come from Mel Stride, Chair of the Treasury Committee, who last Friday called for a temporary suspension of the wages element of the triple lock on State pension increases.
The triple lock delivers the greatest of earnings growth, CPI inflation and 2.5% and since it was introduced in 2010 each of these elements have had their turn in driving the increase to state pensions. But nowhere near as much as what could happen for the April 2022 increase where it is quite possible that the earnings growth element could be well into double-digits, as a result of workers seeing their 2021 earnings back on track after the drastic Covid-19 induced fall this year.
In addition, current falling earnings along with the rapid tail off in inflation could also result in the 2021 increase in state pensions being set at 2.5%.
The prospect of this extraordinary increase in state pensions in April 2022, could be the cue for the Government to announce next month the suspension of the triple lock measure. However, an Act of Parliament will be required to decouple state pension increases from the growth in earnings.
With State pensions predicted by some to increase by around 20% over the next two years due to the triple lock’s ratcheting effect, while wages increase by less than 10%, and prices increase by much less, it is no surprise that there are so many calls for the triple lock to be suspended. The intergenerational fairness debate continues.
Employer achieves rectification victory in RPI hard-coding case
Can mistakes in pension scheme documents be fixed? How do we know what is or isn’t a mistake? We now have some very full guidance in the Univar case which centred on an RPI hard-coding error made when consolidating the deed and rules.
Until 1997 increases to pensions in payment from the scheme in excess of guaranteed minimum pensions were provided at the employer’s discretion. In 1997 statutory requirements (section 51 of the Pensions Act 1995) came in which required pensions accrued after 1997 to increase in line with the retail prices index (RPI), subject to a cap. The governing deed at that time did not mention these statutory increases but the scheme provided them anyway. Similar requirements had applied to revaluing pensions in deferment for many years. The deed did provide for this revaluation but via a “sign-post” to the statutory basis.
The deed and rules were consolidated in 2008 and hard-coded the reference to RPI in calculating pension increases in payment and by referring to such increases, hard-coded the reference to RPI in deferment too. The hard-coding would have been fine except that in 2010 the inflation index in the statutory formula was switched from RPI to the (usually lower) consumer prices index (CPI).
The employer asked the court to rectify the 2008 rules, arguing that there was never any intention to provide increases more than that required by statute.
The judge set out the principles applying to applications for pension scheme rectification claims and went on to find that the employer had established – after a full trial with both oral and documentary evidence – that it was neither the employer’s nor the trustees’ intention to switch away from statutory increases. It helped that the solicitors who drafted the document readily admitted that there had been a mistake. Another vital piece of evidence was that a “schedule of changes” had been prepared as part of the drafting process. Changes to pension increases and deferred pension revaluation did not feature in this schedule which was compelling evidence of an absence of an intention to make the changes.
As well as a useful statement of the principles of rectification, possibly the main learning point is the importance of the benefit specification usually prepared as part of the drafting process when significant overhauls of scheme documentation are carried out. Great care is needed to ensure these are accurate and that any intended changes are highlighted.
Pension Schemes Bill gets going once more
Progress on the Pension Schemes Bill will resume shortly, with Report stage in the House of Lords due to take place on 30 June. Committee stage concluded over three months ago, on 4 March (see Pensions Bulletin 2020/14).
In recent days the Government has tabled a suite of amendments to be moved at Report stage. They cover the following areas:
- Collective money purchase pension schemes – a number of amendments ensure that regulations necessary to fill in the important detail of the operation and supervision of these schemes are explicitly approved by Parliament. Separate amendments clarify that the legislation does not have to be limited to schemes set up by single employers. Regulations can be made to extend the type of permissible schemes to include those established by non-employers or used by multiple employers not all of whom are connected with each other
- Pensions dashboard – amendments require the Money and Pensions Service (MaPS) to provide, as part of its pension guidance function, a pensions dashboard service to deal with the information from occupational and personal pension schemes. MaPS is also enabled to include state pension information within its service and carry out functions relating to pension dashboard services generally, including those relating to pension scheme and state pension information
- Climate change risk – amendments may require trustees when assessing climate change risk to consider different future scenarios for climate change, adopting prescribed assumptions as to future events including assumptions involving the achievement of the Paris Agreement or other climate change goals
- Transfer values – the right to take a cash equivalent is potentially further constrained by regulations requiring members in certain situations to obtain information or guidance from sources such as the Money and Pensions Service and evidence this to the trustees, and for the trustees not to process the transfer until this has happened. Regulations may also specify that members are to be informed of these requirements as part of the transfer process
Opposition amendments include attempts to:
- Limit the two new criminal offences of avoidance of employer debt and conduct risking accrued scheme benefits, along with the related financial penalties, to those connected with the DB scheme sponsor
- Set down a number of principles that the Secretary of State must have regard to when regulating the detail on the modified scheme funding approach, including treating differently from closed schemes those that are open to new members
Most of the Government amendments are not unexpected; it is coming under some Parliamentary pressure in relation to the first two areas. In relation to the third, climate scenario analysis is necessary in order to deliver reporting in line with that recommended by the Task Force on Climate-related Disclosures, which we understand is the intention behind the climate clauses of the Bill. It will be interesting to hear precisely what analysis the Government has in mind. The fourth appears to be new policy, but is similar to that legislated for under the Financial Guidance and Claims Act 2018 in relation to DC benefits, but yet to be activated (see Pensions Bulletin 2018/19).
Investment cost transparency – more tools provided
A year from the launch of the Cost Transparency Initiative’s templates and guidance (see Pensions Bulletin 2019/20), this industry-led body has now made available additional resources for the 2020/21 reporting timeline and is encouraging remaining pension schemes and asset managers to adopt the standards.
The CTI framework is an industry standard designed to allow investment managers and asset owners to collect and compare costs and charges in a standardised and transparent form. In its first year the CTI framework has been adopted by the Local Government Pension Scheme and other large schemes, representing around £440bn in assets and 25 million members.
The new material includes a new Fiduciary Management Template, an updated Liability Driven Investments (LDI) Template, additional FAQs and guidance and case study and webinar resources.
The CTI hopes that this new material along with a high level of awareness of the initiative will help drive yet further adoption of the templates and guidance as schemes move through this year’s cycle of reporting periods.
With the large take-up rate in its first year, we could expect the initiative soon to be well embedded as a regular process for institutional investors and asset managers.
DWP publishes workplace pension participation and saving trends analysis
The Department for Work and Pensions has published its latest annual round up of statistics on workplace pension participation and saving trends. The statistics provide a means by which the progress of automatic enrolment implementation can be evaluated in two key areas – the increase in the number of savers and the increase in the amount of savings.
This year, the report’s main findings, for 2019, are that 88% of eligible employees were participating in a workplace pension, 70% of those saving into a workplace pension in 2016 were saving persistently over the following three years, and nearly £100bn was saved into pension schemes by eligible savers over the year.
The overall story on participation is one of a reduction in gaps by a variety of measures, such as by earnings, age, gender etc, as more and more people participate, but there remain some areas for concern. In particular the decline in participation by the self-employed has continued and significant gaps continue to exist when measuring participation by ethnic group.
Pensions dashboard – market engagement starts
The Money and Pensions Service has started a six-week period of informal market engagement with potential suppliers of the digital architecture necessary to allow the delivery of pensions dashboards – such as to build the pension finder service. Potential suppliers are being invited to register their interest and complete an online request for an information questionnaire by 31 July. The formal procurement process is anticipated to start in the autumn.
In addition on 6 July MaPS will publish an industry-wide call for input relating to the data scope and data definitions working papers which were published in April (see Pensions Bulletin 2020/16). Further information about this will be made available shortly on the newly launched Pensions Dashboard Programme website. A Data Working Group will also be convened to help finalise a set of data standards later in the year and this in turn will feed into the necessary regulations coming out of the Pension Schemes Bill compelling schemes to supply data.
As the dashboard project moves into its implementation phase its complexity is becoming very apparent.
No date has yet been set for the MaPS dashboard to go live, or the necessary data onboarding process before then, but the public launch will clearly depend on the successful and secure supply of pensions data from many sources, hopefully including state pensions from the start, initially to reconnect individuals with all their pensions and finally to enable them to make more informed choices about their pensions.
Covid-19 pension-related announcements
Since last week’s Pensions Bulletin, announcements and posts influenced by the Covid-19 health emergency in the world of pensions include the following:
- On 22 June regulations were laid before Parliament to exclude from an income tax charge that would otherwise arise, the £60,000 lump sum paid to the families of eligible workers who die from coronavirus in the course of their “frontline essential work” (see Pensions Bulletin 2020/18). The regulations relate to two life assurance schemes in England and Wales which for tax purposes would, unless specifically excluded, be regarded as providing “relevant benefits” from an employer-financed retirement benefit schemes (EFRBS) and so attract an income tax charge
- On 22 June Parliament’s Work and Pensions Committee published a report on the Department for Work and Pensions’ response to the coronavirus outbreak. In relation to pensions, the MPs note the additional pressure placed on the pension system in recent months, and whilst being supportive of the more flexible approach the Pensions Regulator is taking towards businesses says that “it must remain alert to the risks of abuse by unscrupulous employers”. The MPs also make clear that people facing financial hardship who may look at their pension savings as an extra form of support, need to be protected from decisions not in their best interests so as not see their savings “fall into the hands of opportunistic scammers”
Help shape our report on the challenges DB schemes are facing
Covid-19 has caused unprecedented changes in the economy and many DB pension schemes have been hit by changes in financial markets increasing their deficit or a challenged sponsor, or, worst of all, both.
But now we’re through the immediate shock, we need to move forward. Trustees and sponsors still have to make decisions on how to fund their scheme and manage their investments to make sure members benefits are protected and continue to be paid. There is also the challenge of considering the impact of the Pensions Regulator’s funding consultation and recent statements.
In the summer, we will be publishing a report on how the industry’s plans and views have changed and we are inviting trustees to contribute their experiences to inform our research. The survey takes no more than three minutes to complete and we will send the report to you when it is published.
Take part here by Tuesday 30 June: https://www.surveymonkey.co.uk/r/8C9WQ8R.
This Pensions Bulletin does not constitute advice, nor should it be 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.