• Funding and investment regulations laid before Parliament
• Pensions Regulator issues guidance on private market investments
• HMRC pension schemes newsletter reveals LTA abolition difficulties
• Validity of amendments #1 – Avon Cosmetics case
• Validity of amendments #2 – Newell Rubbermaid case
• National Audit Office to investigate the Pensions Dashboards Programme
• PPF and FAS – terminal illness eligibility to be extended

Funding and investment regulations laid before Parliament

The regulations ushering in a new DB funding regime, centred around trustees being required to set a long-term strategy for funding and investment purposes and to potentially de-risk so as to limit their reliance on the employer covenant by the time the scheme reaches a measure of significant maturity, have been laid before Parliament in draft form.  The regulations are to come into force on 6 April 2024 and, in the response to the consultation, the DWP says that it intends the new regime to operate in respect of scheme funding valuations with effective dates falling on or after 22 September 2024.

First consulted on in July 2022 (see Pensions Bulletin 2022/29), the now finalised regulations have had some important adjustments made to them.  They include the following:

• Definition of significant maturity – the duration measure has been retained, but to avoid the risk of volatility highlighted by many in the industry, it is now hardcoded into law that this calculation must use financial conditions as at 31 March 2023.  Further details of exactly which duration would constitute significant maturity for which schemes is reserved for the Pensions Regulator to specify in its Code
• Investment constraints – the funding and investment strategy must now take into account an objective that, on or after the date a scheme becomes mature, only those assets to which the minimum funding level relates need to be invested in accordance with a “low dependency investment allocation”, meaning there is more freedom around investment of any surplus above this level.  And importantly, this is only an assumed allocation for the purpose of setting the strategy, with the finalised regulations clarifying that there is no requirement that all the assets need to be actually invested in this manner once the scheme is mature.  This in turn may help to address concerns that the regulations could result in employers having an effective veto over trustee investment policy, via the need for both to agree the funding and investment strategy.  There is also the welcome removal of the requirement for cash flow to be “broadly matched” at significant maturity.  However, this low dependency investment allocation (for funding purposes) must continue to be “highly resilient to short-term adverse changes in market conditions” which will have a bearing on how trustees choose to invest
• Recovery plan – the regulations now provide that the impact of the recovery plan on the sustainable growth of the employer is a matter that trustees must take into account.  However, trustees must still follow a new principle that funding deficits must be recovered “as soon as the employer can reasonably afford”
• Open schemes – in line with the draft Code, it has now been clarified in the regulations that trustees can take account of new entrants and future accrual when determining when their scheme will reach significant maturity, provided that such assumptions are reasonable and based on the financial ability of the employer to support the scheme.  We expect more clarification and potential constraints in the upcoming Code
• Statement of strategy – the information on supplementary aspects that must be set out within the trustees’ statement of their funding and investment strategy has changed and the Pensions Regulator has been given the power to exercise discretion as to the level of detail that it can request

Paul Maynard, the Pensions Minister, said that the regulations are intended to make funding standards clearer and promote planning for the long term and that by listening to those responding to the consultation the DWP has “learned that it is easy to inadvertently drive reckless prudence and inappropriate risk aversion”.  The Government response also reiterates that the introduction of clearer funding standards is designed to enable the Regulator to intervene more effectively to protect members’ benefits.

An impact assessment has also been published which suggests that 1,200 schemes are expected to pay more deficit recovery contributions of around £7.1bn over 10 years.  On average this therefore amounts to around £0.6m additional cash required per scheme per year.  However, there could be 1,400 other schemes who could pay £7.4 bn less by way of deficit recovery contributions over the same 10 year period.  The net impact across the industry is therefore expected to be minimal.

The draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024 now need to be approved by both Houses of Parliament before being made in final form, probably in early March, to come into force on 6 April 2024.  The Pensions Regulator, for its part, now needs to finalise its Code of Practice on which it consulted in two stages, the second being in December 2022 (see Pensions Bulletin 2022/47).  No date for this has been promised, but it is expected to come into force from 22 September 2024.  The Regulator also needs to finalise a number of other documents in order to make the new regime work.  These include its Fast Track parameters and its long-promised covenant guidance.  The Government says that the Regulator is to consult shortly on the statement of strategy and what information will need to be included within it.  This will be a key document for the running of the new regime.

Comment

The now finalised regulations address many of the concerns raised by those responding to the consultation and as such are now much closer to the Regulator’s expectations set out in its draft Code.  This is most welcome.  However, there remains a worry that the now settled law does not provide sufficient investment flexibility for schemes once they reach significant maturity.  Sponsors and trustees will therefore need to work closely together to ensure the expectation of future surpluses are managed carefully.

As for the impact on schemes at their next valuations, for some there will be little change, whilst for others the new funding regime could result in significant changes in how trustees think about investment and funding strategies and the way in which they think about the employer covenant.

These regulations start to bring to a close a topic, discussion on which long predates the pandemic, and which started when the underfunding challenge was uppermost in policymakers’ thinking.  Whilst the new regime should deliver greater leverage to the Regulator, it may have much less need to use it given the recent dramatic improvements in funding positions for many DB schemes.  And it remains to be seen how it will marry up with the “productive finance” agenda and policies announced as part of the Mansion House speech last year, with further consultations there expected in the coming months.

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Pensions Regulator issues guidance on private market investments

New guidance has been published by the Pensions Regulator with the aim of encouraging occupational pension scheme trustees to consider investing in private market assets, where they are not doing so already, in order to deliver better outcomes for their pension savers.

The guidance explains what private market assets are (including a useful description of productive finance assets), sets out the opportunities and risks of investing in such markets, contains a reminder of trustees’ legal duties, some key considerations when deciding whether to invest in such assets, and then addresses some matters specific to DB and DC schemes in turn.

One topic under the heading of key considerations is that of liquidity risk management.  In it, the Regulator identifies that trustees of all schemes (ie both DB and DC) should pay particular attention to liquidity requirements and suggests that schemes could benefit from developing a liquidity risk management plan.

The guide is introductory in nature and is primarily an educational resource, with little by way of actual “guidance” from the Regulator until the later sections are reached.  On these, in the DB section there is a useful high-level illustration of the categories of private market assets that might be more suitable for average schemes of different maturities.  

The DC section by contrast looks at the various challenges that trustees need to examine when weighing up how to introduce an element of private market investment to an overall design that is typically based on daily pricing and a high level of liquidity. From this although there are plenty of initiatives under way to make private market assets more accessible to DC trustees, it is a far from straightforward decision for such trustees to take.

Comment

This welcome guidance has been a very long time coming, first being flagged in 2021 (see Pensions Bulletin 2021/41) and then being given some urgency as a result of the Mansion House reforms.  Its content and length help to expose many of the challenges that trustees will need to overcome before they can successfully operate part of their investment portfolio in private markets, whatever type of scheme they are running.

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HMRC pension schemes newsletter reveals LTA abolition difficulties

HMRC’s first pension schemes newsletter of 2024 focusses on the Finance Bill provisions that are implementing LTA abolition, revealing a number of errors in the Bill and concerns about how to operate the new regime.  The Finance Bill itself has passed Committee stage in the House of Commons and will have its Report Stage on 5 February 2024.

LTA abolition

The newsletter confirms the unintended consequences arising from how the new ‘pension commencement excess lump sum’ has been drafted, stating that HMRC is considering how this can be addressed and whether legislative change is needed.  This new ‘tax label’ has been introduced so that those with considerable pension wealth who have exhausted their tax-free lump sum allowance can choose to take any further retirement savings as a taxed lump sum.  There is a broadly equivalent provision under the current tax law which is being repealed as a consequence of the abolition of the LTA.

HMRC also set out three areas where it believes legislation will be necessary to address errors in the Bill – scheme-specific lump sum protection, the “Event 24” reporting requirement for scheme administrators and calculating tax due on lump sum death benefits.

10 FAQs are then set out addressing various pensions tax technical issues, with a promise of further detail in newsletters – which HMRC intends to publish every two weeks – or workshops.  The initial FAQs provide a welcome confirmation of some details of the Bill, but contain little by way of new information.  One exception is FAQ 8 which covers the transitional tax-free certificate and says that the member “must apply to the scheme from which the first lump sum is being paid … after 6 April 2024”.  However, this limitation does not appear to be in the Finance Bill.

Other topics

The newsletter concludes with a number of topics not related to the Finance Bill.  Amongst these is an article on action that needs to be taken if the Pension Schemes Online service or the Managing Pension Schemes service can no longer be accessed due to three years or more of inactivity.

There is also an article on the Managing Pension Schemes service, which amongst other things announces that the new function that will allow submission of the Pension Scheme return, which was going to be available from April 2024, has been deferred (to an unknown date).  This return is only required where HMRC requests it and it tends to only be needed from small self-administered occupational pension schemes or non-occupational pension schemes that are investment-regulated (generally SIPP type schemes).

Comment

LTA abolition is a huge technical challenge, first for HMRC in putting through correct changes to legislation, and second for pension scheme administrators who need to know how to operate the new regime.  Introduced at break-neck speed for clear political reasons, the news that there are a number of flaws in the Bill is not the least bit surprising.  We suspect there are more, waiting to be discovered.

The pension commencement excess lump sum issue creates uncertainty for those with considerable pension wealth who are considering drawing their benefits in the coming months.  Precisely which benefit options are available to them may not be clear until after any legislative changes are made.  Communications with any impacted members will be key.

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Validity of amendments #1 – Avon Cosmetics case

The High Court has given its judgment in the case of Avon Cosmetics v Dalriada Trustees.

In 2006 a deed was executed to amend the Avon Cosmetics Pension Plan to convert the benefit basis from final salary to “CARE” (career average revalued earnings).  The ongoing link to final salary for calculating members’ then accrued benefits was severed, with the individual being treated as an early leaver at the conversion date (and so having their accrued benefits revalued in line with a measure of price inflation going forward).

However, the Plan’s amendment power contained a restriction that amendments could not be made “which affects prejudicially … benefits accrued or secured up to the date on which the amendment takes effect”.  So were the 2006 amendments valid?

The answer is that they were not wholly invalid.  This is because the nature of the amendment gave rise to winners and losers.  Some members would be better off with inflation revaluation on their new CARE formula (Revaluation Winners) and some would be better off had the final salary link been retained (FS Winners).  It all depended on how each individual’s salary grew, relative to the price inflation measure used, subsequent to the amendment.

Following a lengthy review of the case law the judge concluded that the amendment was invalid for the FS Winners but valid for the Revaluation Winners.  As a result, it seems that the FS Winners will now have their CARE benefits subjected to a final salary underpin, noting that it is not possible to establish which category the individual falls under until they crystallise their rights under the Plan.

Comment

The parties needed a decision on the extent of invalidity because there are professional negligence claims against the advisers in the pipeline and the amount of loss will need to be quantified.

It is notable that we have a judgment that an amendment is not completely invalid; the courts will rule that defective amendments are only invalid in relation to members made worse off.

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Validity of amendments #2 – Newell Rubbermaid case

This High Court judgment involved a challenge to a final salary to money purchase conversion in 1992 in the now Newell Rubbermaid UK Pension Scheme, but which at the time related to the Parker (the well-known pen company) Pension Plan.

What happened was that the then final salary plan closed to those aged under 40 at the time, and these members were automatically transferred to a new money purchase section (with their accrued rights, valued on an enhanced basis, also transferred).  Those between 40-44 had the option of staying or transferring and those aged 45 and over had to stay in the final salary section.  The main issue before the Court was whether the transfer and conversion of the under 40s and 40-44s to a money purchase section was valid in terms of the factual execution of the necessary documents and as a matter of law.

As was common practice then the amendments to the scheme were done by way of an “interim amending deed”, a short deed with explanatory booklets attached, followed up by the detailed provisions in a new definitive deed and rules.

There was also a restriction on the amendment power “that no … alteration cancellation modification or addition shall be such as would prejudice or impair the benefits accrued in respect of membership up to that time”.

The court was asked a number of questions including:

• Were the booklets actually annexed to the interim amending deed (this was necessary for the deed to be valid)?  On considering the (more than 30-year-old) evidence (the original deed itself having not been found) the judge held that they had been
• Did the deed and booklets effectively establish the money purchase section?  Yes
• Did the restriction on the amendment power protecting accrued benefits prevent the conversion?  No

However, when it came to examining whether the restriction on the amendment power prevented the breaking of the final salary link, the answer was that it did (notwithstanding the transfer taking place on enhanced terms).  This then meant that there needed to be consideration about the best “remedy” for the broken final salary link.  As conversion per se was found to be valid the remedy only needed to be something that made allowance for the broken salary link by way of an enhancement to the money purchase benefit, rather than by the restoration, to some extent, of a final salary benefit.

The issue then turned to whether such an additional money purchase benefit should be determined on a “prospective” or “retrospective” basis.  Under a prospective approach a present-day comparison of money purchase and final salary benefits would be undertaken in order to work out any shortfall.  By contrast, under a retrospective approach, any shortfall on actual transfer would be established, after having taken account of subsequent actual salary growth, with interest then added.

The judge held that the remedy should be retrospective, with adversely affected members receiving a top-up to their money purchase accounts, accumulated with interest, and applying where the transfer sum used as their starting balance was lower than the value of their accrued final salary benefits transferred, such a value being based on the standard (ie unenhanced) transfer value assumptions but with allowance for subsequent actual salary increases and final pensionable salary.

There were also some other questions about the validity of transitional arrangements for those aged over 40 when the amendments were made, including a failed claim that there was unlawful age discrimination.

Comment

The relevance of this case (and the Avon one above) is that if the history of a scheme is subject to scrutiny, for whatever reason, it may be discovered that a change in the past thought to be valid is not, or its validity is challenged.  This may have very significant financial implications in the here and now.  This may happen because there was some sort of procedural error or because the scope of the power of amendment and any restrictions on it was not properly understood at the time.

In the Newell Rubbermaid case we have both.  To focus on the alleged error, “were the booklets actually annexed 30 plus years ago?” may seem like an incredibly mundane question.  But the answer can cost many millions of pounds.  The big learning point here is about evidence.  Just because a document has gone missing does not mean that you can’t prove that it actually existed in the correct form so long as you had good practices for filing and storage.

As to the retrospective approach to determining the remedy, this is likely to be the least disruptive, with compensation amounts also lower than had the prospective approach been favoured.  A formal final salary underpin solution, the most cumbersome and costly of all, was not appropriate in this particular case.

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National Audit Office to investigate the Pensions Dashboards Programme

The National Audit Office has announced that it is carrying out an investigation into the Pensions Dashboards Programme.  The investigation will set out the purpose of the PDP and how it was set up, what progress the DWP and MaPS have made against delivery plans, what has caused delays in implementation, what progress the DWP and MaPS have made in resetting the programme, and what changes have resulted from the reset.

It appears that the investigation is scheduled to conclude in Spring 2024.

Comment

This has to be a worry for the parties involved.  National Audit Office investigations are not routine matters, but rather are undertaken when there are concerns about public spending issues, such as service failures or financial irregularities.  As the NAO says elsewhere, its reports from such investigations are “timely, focused and set out the facts regarding service quality, failure and financial management”.  Hopefully, when the NAO reports it will become clear precisely why the reset was necessary and why the fix is taking so long to deliver.

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PPF and FAS – terminal illness eligibility to be extended

A Private Member’s Bill that extends the ability of the Pension Protection Fund and Financial Assistance Scheme to make terminal illness payments has been published ahead of its Second Reading in the House of Commons on 2 February 2024.

The Pensions (Special Rules for End of Life) Bill, introduced by Laurence Robertson MP, with assistance from the DWP, amends the definition of terminal illness in both the PPF and FAS so that people with a life expectancy of up to twelve months (instead of six months) can receive terminal illness payments.

The rationale for this change is to bring the PPF and FAS provisions in line with similar social security provisions that were extended from six to twelve months by the Social Security (Special Rules for End of Life) Act 2022.

Comment

This is clearly Government business on a matter that is consequential to changes elsewhere and, as such, we assume that this Bill will have a speedy passage through Parliament.

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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.

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