As 2019 is now well and truly underway, it's clear that employers are going to face a set of challenges and opportunities in relation to their occupational pension schemes.
Here, we set out a summary of current hot topics, covering the following key issues.
Key points in this briefing
The Government and The Pensions Regulator plan to tighten the regulatory system in a way that could place further burdens on employers.
A market for consolidation vehicles, or "superfunds", is starting to emerge, which could enable more employers to remove pension liabilities from their balance sheets.
Trustees are going to have to equalise guaranteed minimum pensions. There are various methods to use and choices to make, and employers - who ultimately foot the bill - should ensure that their opinions are heard when trustees make decisions on how to go about this.
The next increase to automatic enrolment contributions takes effect on 6 April 2019. There are steps employers may need to take to prepare for this in advance.
We also provide an overview of new audit requirements and the requirement for "section 172 disclosures".
Changes to the regulatory regime
In response to the insolvency of BHS, and the collapse of Carillion last year, the Government published the white paper "Protecting Defined Benefit Pension Schemes" (the White Paper). The White Paper reassured employers by concluding that, on the whole, employers are managing their schemes well, and wholesale reform is not needed. However, some improvements are planned in the following areas.
Strengthening TPR's powers and introducing stronger sanctions for bad behaviour
The White Paper was followed by a consultation in June 2018 (Protecting defined benefit pension schemes - a stronger Pensions Regulator). In February 2019, the DWP issued a response to this consultation which confirmed that the government would legislate "as soon as Parliamentary time allows" to:
- improve The Pensions Regulator's and trustees' ability to scrutinise corporate transactions (via a revised notifiable event regime and the introduction of a new Declaration of Intent to be submitted by 'transaction corporate planners');
- introduce a new system of sanctions to promote good governance (including new criminal penalties with up to seven years' imprisonment and/or unlimited fines for wilful or reckless behaviour in relation to a pension scheme); and
- strengthen and streamline The Pensions Regulator's "anti-avoidance" powers (by amending the regime for Contribution Notices and Financial Support Directives).
Review of the scheme funding framework
The Regulator will produce a revised code of conduct intended to support both employers and trustees in making long term funding and strategic decisions for schemes. The revised code of conduct will focus on the definition of "prudence" when calculating and considering scheme liabilities, and set out factors that are appropriate to take into account when formulating recovery plans and ensure that a long term view is adopted.
The government's proposals are likely to affect all employers who sponsor occupational pension schemes, particularly when corporate transactions are planned. However, this will not result in an immediate impact as it requires new primary legislation which will not be forthcoming until the next Parliament. Subject to the successful implementation of Brexit, we expect a Pensions Bill to feature in the Queen's Speech in June 2019.
What are they?
The DWP considers that a number of schemes could benefit from "consolidation", i.e. transferring their assets into independent larger pension schemes which would assume their liabilities, via a bulk transfer without member consent. This offers an alternative route for employers looking to remove pension liabilities from their balance sheet, at a lower cost than buy-out with an insurance company.
A market is evolving for this and there are currently two entrants into the market, with more expected to follow.
In place of the employer covenant, superfunds have a capital buffer, provided by external investors. The return to those investors derives from any excess return which is not required for the purposes of pension provision.
How might this market develop?
We expect the market for superfunds to take off. The current entrants are likely to appeal to employers with weaker covenants (such that buy-out is not a realistic prospect for the trustees to target) but relatively well-funded schemes.
This is rather different to the market the White Paper originally expected superfunds to serve, which was small, inefficient schemes that could access better returns and administrative efficiency if they combined to form larger schemes. We therefore expect new entrants to the markets and new business models to continue to be developed.
Schemes that can realistically expect eventually to buy-out with an insurance company should still see that as their endgame, and are not suitable candidates for transfer to a superfund. However, employers with schemes that cannot be confident of ever being bought out now have another option to remove pensions liabilities from their balance sheet.
How will such funds be regulated?
The Government has put proposals for how superfunds will be regulated out to consultation, but in the meantime, schemes wishing transfer to a superfund should seek clearance from the Pensions Regulator.
What is the issue?
The High Court handed down, on 26 October 2018, an important judgment on equalisation of guaranteed minimum pensions (GMPs) in Lloyds Banking Group Pensions Trustees Limited v Lloyds Bank plc and others (Lloyds). The pensions industry now faces the cost and complexity of deciding how to implement the equalisation of GMPs in practice.
Trustees have a duty to equalise GMPs. Trustees of pension schemes with GMPs are under a legal duty to adjust benefits to address the current inequality between men and women which is inherent in the GMP.
Methods to equalise - various methods are lawful, but some are not. There is more than one method of adjustment that is permissible, although there are some that are not permissible. Schemes and employers will need legal and actuarial advice in order to decide what method should be adopted.
Arrears will need to be paid with interest. For pensions that are already in payment, arrears need to be paid, with interest, to make good the past underpayments.
Forfeiture clauses may limit the duty to pay arrears. No statutory limitation period applies to such arrears, but forfeiture clauses in scheme rules may limit the duty to pay arrears. Trustees may have discretion in this area which could materially affect the extent of any increase in the pension scheme's liabilities.
Employers should be aware that Lloyds allows for more than one method to equalise GMPs, and that a decision is likely to be needed over whether to apply a forfeiture clause to limit back payments.
It will be the employer which ultimately funds the costs of GMP equalisation - both the additional pensions liabilities and the administrative and adviser costs of making the changes.
We recommend that employers obtain a seat at the table in trustee discussions over this issue, and they may want to take independent advice to ensure that the costs being incurred are no more than the minimum necessary to comply with the Lloyds judgment, and to help them put the case to trustees for their preferred solutions.
Employers may also need advice to determine the appropriate accounting treatment to reflect any additional GMP liability in company accounts, and the provision to be made for GMP equalisation in pension scheme valuations.
From 6 April 2019, the minimum contributions for auto-enrolment will increase for the second time.
After this increase, minimum contributions will enter steady state, and are not expected to change again in the near future.
For DC pension schemes with contributions based upon "qualifying earnings", the minimum contributions will increase as set out below:
Table showing how minimum pension contributions are set to increase
||Employer minimum contribution
||Total minimum contribution
||Before 5 April 2018
||6 April 2018 to 5 April 2019
||6 April 2019 onwards
For employers relying on certification, the percentages are different but there will still be a corresponding increase to contribution rates from 6 April 2019. Employers who are using their occupational pension scheme to comply with auto-enrolment requirements should act now to:
- Check that scheme rules reflect the increase to contributions and consider whether rule amendments may be needed; and
- Review their communication strategy with employees to inform/remind them of the forthcoming change.
If you would like us to review your scheme's rules, or if you have any other questions about the forthcoming changes, then please let us know.
Room for improvement in pensions audits
The Financial Reporting Council (FRCs) examined the audits of 51 employers with DB pension liabilities on their balance sheet. They found that at least half of these needed to be improved and auditors needed to be more thorough in their examination of pension-related disclosures to ensure that shareholders could fully understand the risks that funding the pension scheme puts on the business.
FRC guidance highlights the nine areas in which auditors need to improve their reporting, including reporting on how a company's future viability may be affected by a large pension deficit and clearly evidencing the work done by actuaries. The guidance also suggests improvements for companies' audit committees. Employers with a significant pension scheme balance should discuss the outcomes of the FRC guidance with their audit committees and auditors.
Section 172 Disclosures
What is the issue?
The Companies (Miscellaneous Reporting) Regulations 2018 requires qualifying companies with accounting periods beginning on or after 1 January 2019 to report on their compliance with section 172 of the Companies Act 2006. The statement should detail how the company's directors have had regard to their employees and other interests when performing their duty to promote the success of the company.
What is the impact?
The obligation applies to large companies who satisfy two of the following three thresholds:
- Turnover over £36m.
- Balance sheet assets over £18m. as a separately identifiable statement
- More than 250 employees.
FRC guidance states that employers' statements should show stakeholder engagement, how this featured in the board's decision making and how the interests of those stakeholders were treated during board deliberations. Emphasis is placed on employers disclosing their relationships with pension schemes, pensioners and their entire workforce.
The statement should be set out in the annual strategic report as a separately identifiable statement and must be published on a website maintained by or on behalf of the employer. Unquoted companies should ensure that this can be read as a standalone statement. Any disclosures made by cross-referencing other parts of the annual report should also be published online. This requirement can be discharged if an employer publishes its entire annual or strategic report.
Unquoted companies which do not publish their annual report should make arrangements to ensure they have an appropriate website to make this statement accessible online.