• Options for DB schemes – DWP launches consultation on surplus extraction and a public sector consolidator
• Treatment of DB scheme surplus
• Public sector consolidator for DB schemes
• Royal Assent for the Finance Bill
• HMRC Pension schemes newsletter 156
• Pensions Regulator announces organisational restructuring
• Regulator asks trustees to look beyond climate change when considering ESG risks
• FRC launches review of Stewardship Code

Options for DB schemes – DWP launches consultation on surplus extraction and a public sector consolidator

The DWP has published a consultation on two distinct topics that were first highlighted in a call for evidence published in July 2023.  They are:

• Measures to make surplus extraction from DB schemes easier and more attractive
• The design of, and eligibility for, a public sector consolidator scheme for DB schemes

This consultation was promised in the Autumn Statement (see Pensions Bulletin 2023/47), which in turn contained the DWP’s response to the earlier call for evidence.

As these two topics are distinct, we are reporting on them separately in the two articles that follow.  Consultation on both topics closes on 19 April 2024.

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Treatment of DB scheme surplus

The issue of incentivising existing DB schemes to undertake greater investment in productive assets, to invest for surplus, and how such surplus could be used, was first outlined in the DWP’s call for evidence issued in July 2023 (see Pensions Bulletin 2023/28).  But the response to that consultation, issued in November 2023, showed that there was no overall consensus on the way forward.  Nevertheless, the DWP promised to issue a consultation this “winter” to consider in more detail measures to make surplus extraction easier and more attractive and this is what it has now done.

The DWP is now proposing three changes:

• A new statutory override – either to allow schemes to amend their rules to allow for payments from surplus funding or to allow them to make such payments having regard to a new statutory power.  This is in response to the concern that many scheme rules prohibit trustees from extracting surplus, with them not taking the opportunity, temporarily provided by section 251 of the Pensions Act 2004, between 6 April 2006 and 5 April 2016, to amend their rules to include such a power.  This followed the introduction of a buyout measure to determine whether a surplus existed for payment purposes
• Changes in the pension tax system – so that if trustees take extracted surplus to make one-off member payments, such payments would not be treated as unauthorised under pensions tax law.  This change is intended to complement the Government’s earlier decision to reduce the rate of tax payable by employers on repayment of surplus from 35% to 25%, which is to come into effect from 6 April 2024 (and on which the necessary Order is awaited)
• Adjusting the current buyout safeguard for when surplus is extracted – various eligibility criteria are put forward, all intended to ensure there remains a very high probability that member benefits will be paid in full after the surplus payment has been made.  These criteria are centred around having funding above the forthcoming low dependency scheme funding basis plus either a fixed margin or an investment risk-based variable margin, possibly also needing to satisfy a covenant requirement.  It is also suggested that the DWP produces additional guidance for trustees around the considerations required when considering extraction of DB scheme surplus

As an alternative to the third proposal, the DWP seeks views on a potential regime under which employers could opt to pay a higher “super levy” to the PPF in exchange for the PPF offering a 100% level of compensation in the event of insolvency of the sponsoring employer.  The DWP wants to know whether such additional security is still valued and necessary to enable increased surplus extraction, and if so what would be the most appropriate design for any 100% PPF underpin.

The PPF for its part is of the view that there would need to be strict entry requirements and, contrary to views expressed elsewhere, a high levy of at least 0.6% of a scheme’s buyout liabilities each year would be required (because of the PPF’s desire for there to be no cross-subsidy from its existing funds), with costs potentially increasing above these levels in the event of low take-up across the industry.

Comment

The DWP appears to be drawing a line between its three proposed changes, which we suspect could be delivered relatively quickly, and the super levy idea that has been put to it, which is likely to take more time to come to fruition.  But as LCP partner, Jonathan Camfield argues in the first part of his blog, the DWP’s ideas alone are unlikely to give trustees the confidence necessary to more readily distribute surpluses or to have a material impact on their willingness to invest in productive finance.

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Public sector consolidator for DB schemes

Back in November 2023, the DWP announced that a DB consolidator, administered by the PPF, would be established by 2026, and would focus on those DB schemes that are unattractive to commercial providers (see Pensions Bulletin 2023/47).  The DWP said that such a consolidator should enable greater investment in higher-growth UK assets than would otherwise be achievable by eligible schemes.

In this latest consultation, the DWP states that a public sector consolidator would have the following aims:

• Maintain the security of members’ benefits by ensuring that members’ interests are protected
• Provide an alternative endgame solution for DB schemes unattractive to commercial consolidation providers
• Enable greater investment in high growth UK assets than would be achievable by eligible schemes in the absence of a public sector consolidator
• Minimise the potential distortion of the superfund and insurance buyout markets

The consultation then examines a number of aspects of how such a consolidator could be established and operate.  These are outlined below.

Approach to eligibility

The consolidator is likely to have to operate under a statutory objective to make its services available only to those schemes that are unattractive to commercial consolidation.  There may also need to be some broad eligibility criteria too, such as the scheme having to demonstrate an inability to join a commercial consolidator or secure insurance buyout.

Proposed model

The consolidator must be a public sector vehicle, set up for the purposes of effecting consolidation of certain private sector DB pension schemes’ liabilities, the employer link is to be severed when the scheme transfers, apart from paying off any deficit over time that is identified on entry, and the consolidator will operate on an unsegregated basis, on  a run-on basis, rather than target insurance buyout.

Member benefits

Rather than replicating the transferred scheme’s benefits, the DWP proposes that the consolidator pays the actuarial equivalent of these benefits, via a small number of standardised benefit structures.  The benefit set up process would be designed to ensure no reduction in the headline level of benefits was necessary.

Governance

The DWP proposes that the consolidator operates as a statutory fund administered by the Board of the PPF and this fund will be kept entirely separate from the PPF’s existing funds (just as the PPF and Fraud Compensation Fund are kept entirely separate from each other).

Legislation will subject the PPF Board to a range of requirements for the consolidator that are likely to align with the authorisation criteria for DB superfunds.

Funding

The consolidator could be required to meet the same funding standards as commercial consolidators (who under current superfund guidance must be funded on a “technical provisions” basis within a range of gilts plus 0.5% to 0.75% and must also maintain a risk-based capital buffer provided by investors).

The entry price is likely to be set so that it is in line with the target funding basis and is to reflect market conditions at the point of transfer, the risk characteristics of the individual scheme and the anticipated onboarding and running costs.

Treatment of entering scheme deficits and surplus

Where, on entry, the scheme is in deficit against the consolidator’s pricing basis, for the transfer to proceed the employer has to enter into a contract to make good the deficit by instalments over a specified time period.  Should the employer become insolvent before the instalments were complete, the members that had been transferred would either have their benefits reduced in line with the proportion of instalments made, or the transferred scheme would be put through PPF assessment in the normal manner.

Where the scheme is in surplus, employers and trustees could share it alongside entering the consolidator and/or purchase a higher level of benefits from the consolidator.

Investment strategy

The intention is that the consolidator will maintain an investment strategy that supports a prudent funding basis as well as increasing productive asset allocation.

Underwriting

Just as commercial consolidators use third party capital to provide a limited buffer fund should funding drop below certain pre-defined levels, it is envisaged that the consolidator will be underwritten either by the Government or by the PPF’s reserves.

Should the consolidator fail, its members would have recourse to PPF compensation, which also means that the consolidator would be expected to pay the PPF levy.

Comment

There is a clear DWP blueprint emerging for this idea, but it will take much more work on the design and an Act of Parliament before the PPF can take on this new role.  A key design aspect is eligibility.  Many DB schemes will currently be unattractive to commercial providers, despite their significant recent increase in funding levels.

Without any narrowing as to what type of schemes this consolidator is for, the promise of it being up and running by 2026 (which we suspect is ambitious), could start to influence corporate strategy now as LCP partner, Jonathan Camfield argues in the second part of his blog.

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Royal Assent for the Finance Bill

The Finance Bill, containing the abolition of the pensions Lifetime Allowance and its replacement by two new lump sum allowances, received Royal Assent on 22 February 2024, following its second and third reading in the House of Lords the day before.

The now Finance Act 2024 sets out in a lengthy Schedule 9, the complex and extensive changes to the pensions tax law that are necessary to remove references to the Lifetime Allowance and to introduce the Lump Sum Allowance and the Lump Sum and Death Benefit Allowance.  The new pensions tax law is to come into operation from 6 April 2024.

However, ahead of this, HMRC intends to lay regulations that will address at least some of the errors and omissions in the new law that have come to light since the Bill was laid before Parliament in November 2023.

Comment

This reform has been rushed through for clear political reasons necessitating HMRC having to engage in a patch and mend job to fix those errors and omissions that have come light.  But there will likely be many more yet to be discovered.

Whilst for most pension savers this new regime will have little if any impact on how they take pension benefits and the pensions tax they will face, it is a different story for pensions administrators who need to adjust their systems, processes and member communications so that for those benefits taken from 6 April 2024, compliance is by reference to the new law that is focussed on lump sum checks.

Given that the Lifetime Allowance and its associated benefit crystallisation events are one of the cornerstones of the pensions tax regime that has operated for 18 years, it will be quite some time before all the detailed technical changes being made by the Finance Act 2024 have been assimilated by the pensions industry.  The worry is that despite the significant burden of introducing this new regime it may yet prove to be short-lived, as a change of Government could well see some kind of reinstatement of the Lifetime Allowance.

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HMRC Pension schemes newsletter 156

HMRC’s latest pension schemes newsletter issued on 23 February 2024 mentions the above Finance Bill in passing and promises another lifetime allowance newsletter, with further information and guidance relating to the new pensions tax regime within the next two weeks.

It then turns to the delay in being able to file the pension scheme return for the 2024/25 tax year on the Managing Pension Schemes service, mentioning short guidance it has published to assist administrators carry out this task.  From the 2024/25 tax year it will no longer be possible to file such a return using the Pension Schemes Online service.

The newsletter then concludes with an article which sets out the tax treatment of interest that arises under the public services pensions “McCloud” remedy, taking in turn interest on compensation paid under the Public Service Pensions and Judicial Offices Act 2022, interest on authorised pensions, interest on authorised top-up lump sums and finally interest on unauthorised payments.  As can be seen, the tax treatment depends on the reason why interest is being paid.

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Pensions Regulator announces organisational restructuring

The Pensions Regulator has announced that from April 2024 it will create three new regulatory directorates – regulatory compliance, market oversight, and strategy, policy and analysis – and will be recruiting three new Executive Director roles in these areas.

• The Regulatory Compliance directorate – will be concerned with protecting pension savers' interests through the effective and efficient delivery of regulatory compliance services, targeting schemes and employers.  This directorate appears to be as a result of splitting the current Frontline Regulation directorate, taking from it the Enforcement, Intelligence, Customer Service and regulatory transactions functions.  It is also to include the Automatic Enrolment team, currently in a separate directorate and which deals with employer compliance with automatic enrolment duties
• The Market Oversight directorate – will enhance the market through strategic engagement with schemes and others who influence pension savers’ outcomes, with a strong focus on delivering value for money and trusteeship.  This appears to be substantially new, taking in the Regulator’s supervision team and its Communications function
• The Strategy, Policy and Analysis directorate – is to use insights from the Regulator’s regulatory approach and elsewhere to evolve the regulatory framework and support market innovation in savers’ interests.  This appears to be a renaming of the current Regulatory Policy, Analysis and Advice directorate with presumably some change of emphasis and role

The Regulator says that this restructuring is in response to the pensions landscape evolving into a marketplace of fewer, larger schemes, which in turn presents different risks and opportunities for pension savers and the economy.  It goes on to say that the Regulator will engage with the pensions market differently from now on, will be swifter to address compliance failures and market-wide risks, while being more dynamic in its industry engagement and bringing innovation to the fore.

Comment

The big news is the integration of the auto-enrolment function with the enforcement team, but perhaps the most interesting aspect of this re-organisation is the creation of the Market Oversight directorate, given that the Regulator will increasingly need to monitor and in some cases, authorise and supervise, larger schemes.

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Regulator asks trustees to look beyond climate change when considering ESG risks

The latest blog from the Pensions Regulator, this time on the topic of ESG risks and opportunities, encourages trustees to expand their ESG focus beyond climate change.

Mark Hill, the Regulator’s Climate and Sustainability Lead, says that trustees should continue to improve their understanding of wider material ESG considerations, including their inter-relationship with climate change and, if appropriate, revise their scheme policies.

He says that the case for becoming familiar with the Taskforce on Nature-related Financial Disclosures (see Pensions Bulletin 2023/37) and arguably requirements of the UK Transition Plan Taskforce and the UK Taskforce on Social Factors (see Pensions Bulletin 2023/42) will only become stronger.

He suggests some actions that trustees should consider, under the headings of becoming early adopters, building on experience, and increasing collaboration with others and sharing knowledge.

On climate change reporting he pushes back on feedback that existing reporting requirements may get in the way of decision-making and action, saying that the disclosures required should be the output of the strategic decisions that trustees are making.

Comment

We are seeing increasing interest amongst trustees in addressing a wider range of ESG factors and this blog will assist them on that journey.

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FRC launches review of Stewardship Code

On 27 February 2024 the Financial Reporting Council launched its promised review of the 2020 edition of its Stewardship Code (see Pensions Bulletin 2019/41).  The FRC promises a “fundamental review process” focussing particularly on the extent to which the Code supports long term value creation through appropriate investor-issuer engagement that drives issuers’ prospects and performance, creates reporting burdens on issuers as well as Code signatories, and has led to any unintended consequences, such as short-termism in targets and outlook for issuers.

The review is to be undertaken in three phases:

• Targeted outreach – focussed around issuers, asset managers, asset owners and service providers, on the topics outlined above.  The FRC expects these outreach discussions to uncover a range of issues that will inform the second phase
• Public consultation – planned to launch after the 2024 AGM voting season during the summer months
• Publication – of the revised Code likely early 2025

Earlier, on 21 February 2024, the FRC announced the successful signatories to the UK Stewardship Code following the latest round of applications.  The FRC reports that there are now 273 signatories, representing £43.3 trillion in assets under management.  This includes 188 asset managers, 66 asset owners and 19 service providers.  81 organisations successfully renewed their signatory status (including LCP), and one organisation was added.

Comment

We have long been a supporter of the 2020 edition of the Code and look forward to participating in its review.  As to when the 2025 edition will come into force, the FRC is not saying at this point, but presumably it will be a few months after the new edition is published.

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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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