• LDI – House of Lords blames accounting standards
• LDI – MPs call for further evidence
• Pensions tax – IFS sets out its thoughts
• Actuaries propose to take into account adverse 2022 mortality in latest mortality projections
• FRC takes stock on sector-specific Technical Actuarial Standards
• McCloud remedy tax regulations finalised
• Pensions Dashboards Bill now in the Lords
• PPF levy ceiling increases once more

LDI – House of Lords blames accounting standards

The House of Lords’ Industry and Regulators Committee has published the findings of its investigation into liability driven investment (LDI) used by DB pension schemes (see Pensions Bulletin 2022/43) in the form of a letter to the Pensions Minister and the Economic Secretary to the Treasury.

In summary, the Committee:

• Blames marked-based accounting standards (eg IAS 19) for the rise of LDI and the lack of investment in wider growth assets
• Calls on Government to review the underlying investment regulations to ensure they are appropriate in the way they permit pension schemes to borrow and leverage investments
• Calls for investment consultants to be more fully brought into the FCA regulatory perimeter
• Calls on regulators to focus more on systemic risk, including suggesting a new statutory objective for the Pensions Regulator in this area

The next step will be for the Government and regulators to consider the recommendations and respond in due course.

Comment

Whilst new accounting approaches in the 1990s largely initiated a “market-based view” of DB liabilities, this has long-since been overtaken by scheme funding regulations as the key driver of decisions to use LDI within DB schemes.  These regulations reflect the UK Government’s increasing focus on the security of DB pensions and have widely led to a bond-based approach to the valuation of DB liabilities.  Therefore, blaming “accounting standards” seems to be only one part of the picture, and to us is not the right area of focus to address.

We are pleased to see that the Lords are once again asking whether there is a different way to measure and report risk that can encourage a wider range of investments in DB schemes, and less herding into index-linked gilts.  We also strongly agree with the need for greater focus on systemic risk.

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LDI – MPs call for further evidence

Meanwhile, the Work and Pensions Committee has opened a further call for evidence (closing 3 March 2023) to assist it with an upcoming session with the Pensions Minister and the Economic Secretary to the Treasury.  It welcomes comments on two specific developments:

• The Pensions Regulator’s consultation on its draft funding code of practice for DB schemes launched in December (see Pensions Bulletin 2022/47)
• The Bank of England Financial Policy Committee’s recommendations in its December Financial Stability Report that the Pensions Regulator should take regulatory action (in coordination with the FCA and overseas regulators) to ensure LDI funds remain resilient and, longer term, set out appropriate steady state minimum levels of resilience for LDI funds including in relation to operational and governance processes and risks associated with different fund structures and market concentration

The Committee also intends to launch a further inquiry on DB schemes and will announce its terms of reference “in due course”.

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Pensions tax – IFS sets out its thoughts

The Institute for Fiscal Studies has published its thoughts on how the UK could go about taxing pension savings, with the aim of at least reducing the problems it has identified with the current system.

A blueprint for a better tax treatment of pensions takes as its premise that pensions tax should operate on an exempt-exempt-taxed (EET) basis – namely contributions made should not be subject to tax, nor should investment returns, but withdrawals, typically in the form of pension income, should be taxed.

This is in essence how the current system works.  However, the IFS says that on closer inspection, and noting that national insurance contributions are just another form of taxation, there are some aspects that are more generous, resulting in an exempt treatment throughout (EEE) on them.

The IFS looks to turn this last “E” into a “T” wherever it sees it and it is practicable to do so, and as a result its proposals include the following:

• Reform the tax-free lump sum available at retirement – at the very least by limiting the tax-free element to no more than £100,000, or by removing it altogether, but substituting with a 6.25% taxable top-up on all pension withdrawals
• Make employee contributions employee NIC deductible, but gradually subject pension withdrawals to employee NICs
• Subject employer contributions to employer NICs. This new tax on employers would be offset by introducing a new tax credit on all employer contributions, at a level decided by the Government from time to time

The IFS notes that the gains from the current system relative to an EET benchmark are focused towards the top of the earnings distribution; so that it is this grouping who would lose out under its proposals (whilst those lower down would gain).  Their proposals also aim to give a better deal to the self-employed.

Separately, the IFS sets out reforms to the tax treatment of death benefits, as per its December report (see Pensions Bulletin 2022/47).  It also says that a reformed lifetime allowance could apply only to DB arrangements, whilst a reformed annual allowance could apply only to DC arrangements.

Comment

The IFS believes that its proposals would be more equitable and more economically efficient.  And as the new parameters in its proposed system would be decoupled from NIC rates, policymakers would have a freer hand to decide how these parameters should be adjusted.

As ever, an interesting set of proposals from the IFS, but it does seems unlikely that the Government will embark on such a major overhaul of the current system.  There are simply too many obstacles, with the (long term) reward not worth the (short term) political cost, particularly if one tries to make the change at speed.

It seems that adjustments to the current system are more likely to be under consideration, and perhaps even for the March Budget.  Abolishing the money purchase annual allowance and perhaps the annual allowance taper might be more relevant to addressing current political aims to encourage young retirees to return to the workforce, and to address complaints from senior doctors.

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Actuaries propose to take into account adverse 2022 mortality in latest mortality projections

The Continuous Mortality Investigation (CMI) of the Institute and Faculty of Actuaries, has issued a consultation to help shape the next edition of its mortality projection model, which is used by the majority of pension scheme trustees and sponsors in setting their funding and accounting assumptions.  The consultation focuses on how to respond to the very high mortality rates seen in England & Wales in 2022, to which the model is calibrated.

The CMI believes mortality in 2022 may be indicative of future mortality to some extent, unlike the exceptional mortality seen in 2020 and 2021 during the peak of the pandemic.

The key proposal is to give 25% weight to the 2022 mortality data in the CMI_2022 projection.  The CMI also intends to update the model to use the latest population estimates based on the 2021 Census.

In the coming years, the CMI plans to steadily increase the weight given to new mortality data until it reaches 100% for data in and around 2025.

Consultation closes on 28 February and the CMI intends to confirm its plans by the end of March 2023 and publish CMI_2022 by the end of June 2023.

Comment

If these proposals go ahead then life expectancy assumptions at age 65 are likely to fall by around 6 months, equivalent to 2%, when adopting the new core model, all else being equal.  This is a larger fall in life expectancies compared to recent model updates, but we share the concern expressed by the CMI that higher death rates seen in the latter part of 2022, and continuing into January 2023, may be indicative of future mortality.

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FRC takes stock on sector-specific Technical Actuarial Standards

The Financial Reporting Council has responded to its May 2022 call for feedback that focused on sector-specific Technical Actuarial Standards (see Pensions Bulletin 2022/19), summarising the responses it received and setting out its latest thinking on how it may adjust these TASs.  It has also launched a consultation on the most straightforward of the three sector-specific TASs – that on Funeral Plans (TAS 400).

There were few respondents to the call for feedback and, of those who did, most focused on TAS 300 which deals with pensions actuarial work.  The FRC is intending to expand this TAS to reflect developments in the pensions market, with it consulting on its proposed revisions in the first half of 2023.  New topics are likely to include bulk transfers to insurers and superfunds and actuarial obligations in relation to CDC schemes.  Possible changes in relation to scheme funding issues (which forms the bulk of the existing TAS 300) have been deferred until the scheme funding regulations and DB Code of Practice are settled.

Comment

The FRC is giving little away as to how it intends to draft the new TAS 300, but the proposed TAS 400 might give an insight into how the FRC now intends to restructure all of its TASs, following some challenging feedback it received to its consultation on TAS 100 (see Pensions Bulletin 2022/24) on which it has yet to respond.

The proposed TAS 400 is arranged under a number of topic headings, each starting with “provisions” around how practitioners should go about their work, and many concluding with a number of provisions around how they should communicate the result of their work.  Despite the core of the TAS more than doubling in length compared to the current TAS 400, the proposed TAS is eminently readable.

The proposed TAS 100, by contrast, was a complex structure of Principles, Provisions in relation to these Principles, followed separately by Applications in relation to the Principles, with the promise of guidance in a number of areas.  It was very difficult to digest.

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McCloud remedy tax regulations finalised

Regulations that set out changes to how the pensions tax rules will apply to pension scheme administrators and members of public service pension schemes, to help manage through the McCloud remedy reforms, have been finalised following a consultation last November by HMRC (see Pensions Bulletin 2022/44).  These reforms, which following the Public Service Pensions and Judicial Offices Act 2022, include retrospective changes to benefits in the 2015-2022 remedy period, and elements deferred for future member decision.

The Explanatory Memorandum to the final regulations states that, compared to the earlier draft and as a result of this consultation, HMRC has “extended provisions in relation to reporting and paying annual allowance charges so that they apply more widely [but only in relation to public sector schemes] as well as making minor amendments to the regulations to clarify the policy intent”.

The Public Services Pension Schemes (Rectification of Unlawful Discrimination) (Tax) Regulations 2023 (SI 2023/113) come into force on 6 April 2023.

Comment

The provisions in this instrument “aim, as far as possible, to put individuals in the tax position they would have been in had the discrimination being remedied not happened”.  They do seem to go quite a bit further in generosity in some areas, presumably to smooth what is already an incredibly complicated situation.

These regulations are limited in their application to public sector schemes.  However, an example of one area of interest to private sector schemes relates to the situation where one of its current pensioners finds that as a result of the remedy, benefits they had previously started from a public sector scheme are retrospectively uplifted and count as having used up more lifetime allowance.

The private sector scheme would need to revisit its own benefit testing against the lowered remaining lifetime allowance, but the regulations helpfully allow that if this creates a new lifetime allowance charge, and the private sector scheme applies for a discharge to such a liability, then the duty to manage the charge (and adjust member benefits) reverts to the public sector scheme.  We hope that separate guidance is issued for the private sector readership to draw out this sort of limited area of interest.

All in all these are a very complicated and extensive set of regulations, rushed through consultation and finalisation because of the timetable set to have the remedy in place, with the huge amount of work (including tax work) that involves.  More regulations are to come to deal with the pensions tax issues where niche events have impacted benefits in the remedy period, such as divorce or transfer out.

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Pensions Dashboards Bill now in the Lords

The Private Member’s Bill that fills in some legislative gaps in relation to pensions dashboard policy cleared the House of Commons on 20 January 2023 and is now awaiting Second Reading in the House of Lords on 3 March 2023.

The Pensions Dashboards (Prohibition of Indemnification) Bill is supported by the Government and it now seems that its passage through Parliament is assured.  The Bill, which was introduced to Parliament in July 2022 (see Pensions Bulletin 2022/28) makes it a criminal offence for the assets of an occupational or personal pension scheme to be used for the purpose of reimbursing any trustee or scheme manager, in respect of penalties imposed under pensions dashboards regulations.

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PPF levy ceiling increases once more

The overall pension protection levy “ceiling” for 2023/24 will be £1,246,964,705 – as set out in the Pension Protection Fund and Occupational Pension Schemes (Levy Ceiling)(No.2) Order 2023 (SI 2023/117) made by the DWP on 6 February 2023.

This is a 5.8% increase on the 2022/23 ceiling due to there being significant growth in average weekly earnings in the year to July 2022.

The actual maximum levy the PPF can take in 2023/24 is further constrained by other rules and is substantially less than the £1.25 billion permitted by this particular Order.  The PPF is intending to raise £200m in 2023/24 (see Pensions Bulletin 2022/46).

Comment

The ceiling formula was set as part of the establishment of the PPF but no longer has any meaning.  This and other aspects of the Pensions Act 2004 design are in need of alteration to reflect the much diminished importance of levy raising to back PPF compensation.

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