Puzzles and paradoxes

    Q    When can you simplify law and make it more complicated at the same time?

    A     When it is pensions law.

    Q    How can you make pensions more secure, less complicated, cost less but better funded?

    A    Become a Government Minister and say so.

Last year the Pensions Act 2004 attempted to deregulate some parts of pensions law and make pensions safer. It also sought to introduce a new funding requirement to make them more secure. Some but not all of its provisions have come into force.

The Finance Act 2004 (now amended by the Finance Act 2005) will introduce from April 2006 a simplified Revenue and Customs regime.

These two measures were examined in the article “Securing the future” in April’s Journal (page 19). This article is an update on where we have got to now.

Simplification

It may be recalled that at present we have a complicated approval system to enable a pension scheme to gain the tax exempt advantages. This involves keeping benefits provided within the permitted types and keeping those within the permitted level of benefit. From 6 April 2006 (“A-Day”) this is to be swept away by a “simplified” system, based on a lifetime allowance of £1.5m for the individual’s pension fund and annual contribution limits. Most of the statutory instruments under this legislation have now been made. Revenue & Customs have begun (without wide consultation) to issue the “simplified” manual but by the internet. The format and content are equally baffling.

There are opportunities here which solicitors must seize both personally and as advisers. Whether employees or, more particularly, self-employed, solicitors should be examining their pension plans and advising clients to do likewise.

This considerable liberalisation of rules in 2006 should be taken advantage of and planning begun now.

Self-employed

The self-employed may privately provide for pensions through a personal pension scheme, which will attract tax advantages. Rather than investing through a provider such as the insurance company, the individual also has the option of a SIPP or self-invested personal pension scheme. This was examined in David Canning’s article in the September Journal (page 30).

Employed (including directors)

In addition to use of the personal pension scheme and SIPPs, the employed may also use a group or occupational pension scheme. Again this may take the form of an arrangement which is fully insured and no doubt insurers will be continuing their executive pension plans as before within the context of the new rules.

There is also the option of self-administering the assets, which became familiar as a small self-administered scheme (or SSAS). From April 2006 essentially these will continue to be available, but on a much simplified basis – without many of the restrictions which had accresced to them previously. The rules will now be similar to those for a SIPP but with some differences, such as the power to lend to the sponsoring employer. The SSAS may come back into its own and will have some attractive features including, perhaps more readily, the ability to shift the value between generations who are members of the scheme. They should certainly not be overlooked in planning.

Group schemes

Those advising employers with or trustees of group pension schemes should also be suggesting a number of areas for review, some of which relate to higher level policy decisions and some of which relate to administrative issues.

At the higher level the following require examination:

• benefit design issues. There are several changes, particularly in relation to benefits which can be provided, perhaps most strikingly in relation to death benefits. These should be reviewed.
• potential flexibilities at retirement. Although minimum retirement age is going to rise by 2010 from 50 to 55, retirement will be more flexible and can be combined with carrying on working or be on a phased basis.
• voluntary contributions require to be reviewed.
• the position of high earners requires particular attention.
• there is a lot of planning needing done:
  – financial planning to get the best out of the rules, whether that has to be done before or after A-Day;
  – administrative planning to ensure that the system can handle the new regime and also store historical data, which will still be needed in future; and that staff have the knowledge and training to implement.

Pensions Act 2004

Significant parts of the Act came into force on 6 April 2005, with some parts intended to come in later, particularly April 2006. The past period has been one of constant consultations over draft regulations, the making of regulations and consultations over draft codes of practice.

The next part of this article looks at some of the significant developments following the coming into force of the Act.

Corporate transactions

There have been a number of issues on defined benefit schemes which have a major effect in relation to corporate transactions, although these also affect companies even when not having transactions and in particular affect the trustees.

Following scheme wind-up or on withdrawal from a scheme, an employer can become liable for a statutory debt of (or of its share of) any deficit. Initially this was measured by the now discredited minimum funding requirement (MFR), which in fact might provide as little as 40% of the amount required to purchase annuities to cover the benefits. This was changed for schemes winding up after 11 June 2003 by the Occupational Pension Schemes (Winding Up and Deficiency on Winding Up etc) (Amendment) Regulations 2004 (SI 2004/403), which applied on a total winding up with the employer solvent. Creeping amendments culminating in the Occupational Pension Schemes (Employer Debt etc) (Amendment) Regulations 2005 (SI 2005/2224), now also catch partial discontinuances, on or after 2 September 2005.

The net effect of this is that the deficiency is now measured not on the MFR basis but on the horrifying annuity purchase basis.

Not only that, but the legislation has some bizarre turns. Where all employers cease involvement, the date for assessment of the deficiency is “the applicable time” selected by the trustees. Where one employer discontinues and another carries on, the applicable time for assessing the deficit is the date when the ceasing employer ceases to have employees in the category of employment to which the scheme relates. It will be seen that that is a rather unhelpful definition and can cause some bizarre results, for example where the last member of a scheme section with one of several employers just dies.

Subject to requirements in the regulations (including Regulator approval), it is open to the parties, including the trustees, to agree that the deficit will be shared differently. The requirements for this are set out in the 2005 Regulations.

In the April article it was pointed out that the Pension Protection Fund is itself sought to be protected by various provisions. To stop corporate “jiggery pokery” there are so-called “moral hazard” provisions in the forms particularly of contributions notices and financial support directions, which could enable the Regulator to require contributions or other payments from employers or other connected persons (including indeed individual shareholders) who are seeking to escape a deficit. Clearly this has very significant and indeed frightening aspects for corporate transactions.

In addition there are a series of events known as notifiable events, which are now more fully defined following the issue of the Pensions Regulator (Notifiable Events) Regulations 2005 (SI 2005/900) and the Regulatory Code of Practice 02. Both employers and trustees will require to have a good working knowledge of the list of notifiable events which relate either to strength of employer covenant or adequacy of coverage of benefits.

Regulatory clearance

Clearance for a transaction may be sought from the Regulator under the Pensions Act 2004, sections 42 and 46. A new industry has developed in getting clearances, for which 144 applications were received by the Regulator in the first six months.

The Regulator’s advice is to enter into discussions with trustees at as early a date as is possible.  The trustees are in a particularly difficult position and have a great deal to consider including the financial position of the various sponsors, strength of covenant, impact of restructuring and the strength of the business going forward. They have to look at it as would any creditor and take decisions on the prudent person principle.

There are three different types of event that could impact on whether a clearance statement would be issued:

(1) change in the level of security available after the transaction, e.g. granting of a fixed or floating charge;

(2) reduction in the overall assets of the company which could be used to fund a pensions deficit after the transaction, e.g. payment of dividends, return of capital;

(3) change in control or group structure, e.g. where credit rating is reduced.

The trustees are expected to negotiate as an unsecured creditor.

Ways in which the pension scheme security may be improved include:

• a new contribution schedule;
• insurance of contributions;
• funds placed on deposit;
• improvement in priority in winding up of the employer in relation to security holders;
• the giving of negative pledges.

The Regulator expects employers fully and accurately to disclose information, recognise pension schemes as a creditor, provide reasonable timescales when requesting clearance, act in accordance with issued guidance, to help the trustees to get independent advice and work in partnership with the trustees and Regulator.

Transfer of Undertakings (Protection of Employment)

The Pensions Act 2004 (sections 257, 258) also affects asset deals. It will be recalled from the Beckmann and Martin cases that the exclusion from TUPE applies only to retirement benefits at normal retirement date. The exclusion does not cover pension benefits payable other than at that date. It also does not cover redundancy payments. Accordingly retirement benefits payable other than at normal retirement date and benefits on redundancy transfer to the new employer. The remainder of the exclusion is much reduced by the 2004 Act provisions which require the new employer to provide:

• defined benefits on the basis of the reference scheme test under the Pension Schemes Act 1993, or
• money purchase contributions matching those of the member up to 6%.

Whistleblowing

The duty to inform the Regulator of breaches of law is now extended beyond the actuary and auditor. Previously others were only authorised to make such denunciations. Now the requirement is much wider and extends in particular to professional advisers, including lawyers. Trustees and their professional advisers should therefore have in place systems for reporting breaches of the law and for supporting and guiding themselves in doing so.

It should be noted that this is different from notifiable events (mentioned above), which apply only to defined benefit schemes.

The Pensions Regulator

The new Pensions Regulator has now been operating for more than a half year, which has allowed it to bring out a number of codes of practice in draft, although actually to finalise fewer. It has said that it aims to be proportionate and pragmatic in what it does to attain its aims. Its approach and style are certainly different from those of the Occupational Pensions Regulatory Authority, but whether they prove better or worse remains to be seen.

Funding and investment

The April article mentioned that the EU Pensions Directive (2003/41(EC)) has various requirements on funding and investment, which were sought to be reflected in the 2004 Act. Anyway the previous measure (the minimum funding requirement or MFR) had discredited itself.

The 2004 Act introduced a new statutory funding objective, which was anticipated to be brought into effect from September 2005 in line with the requirements of the directive, but that was postponed to 31 October and now to 31 December. The European consequences remain to be worked out. Draft investment regulations were produced and then amended but have, at the time of writing, still not yet been made.

Pension Protection Fund

About 30 cases have gone into the Pension Protection Fund. The initial stage is to go into an assessment period, which lasts about a year and so none has actually emerged into the sunlit uplands of the Pension Protection Fund itself.

Financial Assistance Scheme

This is of more immediate and significant importance to practitioners. For those whose scheme commenced to wind up between 1 January 1997 and 5 April 2005, with an insolvent employer, there is an opportunity of a claim under the Financial Assistance Scheme Regulations 2005 (SI 2005/1986).

Only those who had attained or were within three years of retirement on 14 May 2004 will benefit. There will be a cap on benefits of £12,000 per annum. The aim is to provide for those eligible 80%, but nothing will be provided for those not eligible.

The urgent thing is that trustees and their advisers will have to review their position in relation to eligible schemes as notification must be given by February 2006. They should visit the FAS pages of the Department of Work and Pensions website immediately for details on how to notify and therefore how to qualify and establish eligibility of members.

Others requiring attention

Internal dispute resolution procedures may now be simplified. Regulations are in place.

Trustee knowledge and understanding is not a statutory requirement until April 2006, but will require a lot of preparation – it would be good to start now.

Member-nominated trustee provisions are not effectively amended until April 2006, but again exploratory discussions with employees might be held.

Early leavers, paternity leave and adoption leave. These amendments come into force in April 2006 but again are quite complicated and could usefully involve preparation now.

Civil partnerships. The provision by a contracted-out scheme of benefits to a civil partner under the Civil Partnerships Act 2004 requires to have been in place by 6 December 2005.

Internal controls. Again the Pensions Directive requires certain internal controls. A draft code of practice has been issued for consultation.

There are many other parts of the legislation ticking along but it is hoped that some flavour is given of those requiring a degree of urgency.

Iain Talman, Partner, Biggart Bailliee: italman@biggartbaillie.co.uk