Research Paper - Parliament UK

Pension Schemes Bill Bill No 12 of 2014/15 RESEARCH PAPER 14/44

21 August 2014

This paper has been prepared for Second Reading of the Pension Schemes Bill 2014/15 on 2 September 2014. The Bill, which extends to England, Wales and Scotland, would: 

Establish a new legislative framework for private pensions, defining them on the basis of the promise they offer for members about their retirement benefits during the accumulation phase. The promise will refer to all of the benefits (defined benefits), some of the benefits (shared risk), or there will be no promise (defined contributions); and



Enable the provision of collective benefits (provided on the basis of allowing the scheme’s assets to be used in a way that pools risks across membership).

The Bill would also give force to measures connected with the announcement in Budget 2014 that people aged 55 and over would have more flexibility about how to access their defined contribution pension savings from April 2015. It would enable a prohibition on transfers out of unfunded public service pension schemes, except to other defined benefit schemes. Measures to introduce a ‘guidance guarantee’ are not in the current Bill but are to be the subject of Government amendments in the autumn. Djuna Thurley Roderick McInnes

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Research Paper 14/44 Contributing Authors:

Djuna Thurley, pension policy, Business and Transport Section Roderick McInnes, statistics, Social and General Statistics

This information is provided to Members of Parliament in support of their parliamentary duties and is not intended to address the specific circumstances of any particular individual. It should not be relied upon as being up to date; the law or policies may have changed since it was last updated; and it should not be relied upon as legal or professional advice or as a substitute for it. A suitably qualified professional should be consulted if specific advice or information is required. This information is provided subject to our general terms and conditions which are available online or may be provided on request in hard copy. Authors are available to discuss the content of this briefing with Members and their staff, but not with the general public. We welcome comments on our papers; these should be e-mailed to [email protected]. ISSN 1368-8456

Contents 1

2

Summary

1

Proposals for ‘defined ambition’

2

1.1

Trends in workplace pension schemes

2

1.2

Consultation process

7

1.3

Proposals for introducing more flexibility in DB

9

1.4

Proposals for providing greater certainty within DC

12

1.5

Collective benefits

15

Occupational pension provision in the Netherlands

15

Proposals for the UK

17

Debate

18

Flexibility for DC pension savers from April 2015

22

2.1

Background

23

The Labour Government’s approach

24

Problems in the annuities market

26

Budget 2014

28

Initial responses

30

Expected impact

33

The guidance guarantee

34

Consultation

34

Issues

37

2.2

2.3

3

The Bill

44

3.1

The legislative approach to ‘defined ambition’

45

3.2

Part 1 – definitions

48

Defined benefits

49

Shared risk

50

Defined contributions

51

Meaning of pension promise

52

Treatment of a scheme as two or more separate schemes

52

Interpretation of Part 1

53

Amendments to do with Part 1

53

Part 2 – general changes to pensions legislation

54

Promise obtained from a third party

54

3.3

3.4

4

Disclosure of information

55

Extension of preservation of benefit under occupational schemes

55

Early leavers: revaluation of accrued benefits

56

Early leavers: transfer values

57

Indexation requirements

59

Removal of requirement to maintain register of independent trustees

59

Rules about modification of schemes

60

Part 3 – collective benefits

61

Approach to legislation

61

Definition

65

Targets

65

Investment strategy

66

Valuation reports

67

Policy for dealing with a deficit or surplus

68

Other provisions

69

. Part 4 – Miscellaneous and general

71

Appendix 1 – Glossary

74

RESEARCH PAPER 14/44

Summary The Pension Schemes Bill 2014/15 was introduced in the House of Commons on 26 June 2014 and is scheduled to have its Second Reading debate on 2 September 2014. There are currently two main types of occupational pension schemes: Defined Benefit (DB) schemes, that promise to pay pension benefits based on fixed factors (typically salary and length of service); and Defined Contribution (DC) schemes, that pay out a sum based on the value of a member’s fund on retirement. A key difference between them is who bears the risks of pension saving, such as longevity, investment and inflation. In traditional DB schemes, they are borne by the employer; in DC schemes, they are borne by the employee. Furthermore, whereas for an employer DC schemes provide certainty regarding cost, for scheme members the level of income they can expect in retirement is highly uncertain. The Government has therefore been exploring ways to encourage new types of pension provision which provide greater certainty for scheme members without the cost volatility for employers associated with DB schemes. Following consultation, the Government decided not to introduce more flexibility into the requirements for DB schemes. However, its new framework would enable the development of schemes that would provide a greater degree of certainty than traditional DC, for example, through the purchase of deferred annuities each year payable at scheme pension age. It would also enable schemes to provide collective benefits. The proposed model for this would have a fixed contribution rate for employers and a target pension income for employees (with provision for this to be adjusted if the scheme is under-funded). Assets are pooled, enabling risk-sharing between scheme members. The Government found that this approach could provide greater stability of outcome for members than traditional DC. However, certain conditions, such as large scale and strong governance, appear necessary for it to operate successfully. Part 1 of the Bill defines three mutually exclusive definitions of pension scheme: defined benefits (DB); shared risk (sometimes referred to as ‘defined ambition’); and defined contributions (DC). The definitions are based on the type of ‘pension promise’ the member has during the accumulation phase about the retirement benefit (income or lump sum) that the scheme offers – whether there is a promise about all of the benefits from the scheme, only some of them, or no pensions promise. The intention is to enable clarity about the distinct requirements that apply to each type of scheme. It is also hoped that opening up a new space for shared risk schemes will encourage innovation and act as an incentive for schemes to offer a mix of benefits. Part 2 makes changes to existing legislation, mostly consequential on the definitions set out in Part 1. Part 3 defines the concept of collective benefits and makes provides for regulation-making powers in relation to them, including matters such as the setting of targets in relation to benefits, valuation, reporting requirements and governance. The Bill would also give force to measures connected with the announcement in Budget 2014 that people aged 55 and over would have more flexibility about how to access their DC pension saving from April 2015. It would enable a prohibition on transfers out of unfunded public service pension schemes, except to other DB schemes. Measures to introduce a ‘guidance guarantee’ are not in the current Bill but are to be the subject of Government amendments in the autumn. The necessary changes to pension tax legislation will be in a Pension Tax Bill, to be introduced to Parliament in the autumn.

1


1

Proposals for ‘defined ambition’

1.1

Trends in workplace pension schemes

The aim of the current Bill is to create a new framework, with three categories of pension – DB, DC and shared risk. There are currently two main types of occupational pension schemes: 

Defined benefit (DB) schemes, that promise to pay pension benefits based on fixed factors, typically salary and length of service; and



Defined contribution (DC) schemes, that pay out a sum based on the value of a member’s fund on retirement. The level of pension depends on factors including the contributions invested, the returns on that investment (minus any charges applied) and the rate at which the fund is converted to a retirement income.

In the private sector, DB schemes are in decline. Total active peaked at 8.1 million in the 1960s and had fallen to 1.7 million by 2012 – with membership of open DB schemes dropping by 300,000 in that year alone (from 900,000 to 600,000).1 The table and chart below shows the number of active members of occupational pension schemes by type and sector:

14

Number of active members of occupational pension schemes by scheme type and sector

Millions of active members

12

Private sector - all

Private sector - DB

Private sector - DC

Public sector

10 8 6 4 2 0

Source: ONS Occupational Pension Schemes Survey 2012 Note: quadrennial survey up to 1995; annual from 2004. Public sector not covered by 2005 survey. Changes to methodology for 2006 onwards mean that comparisons with earlier years should be treated with caution.

1

DWP, Pension Schemes Bill Impact Assessment. Summary of Impacts, June 2014, DEP2014-0911, para 5

2


Number of active members of occupational pension schemes by sector Millions

1953 1956 1963 1967 1971 1975 1979 1983 1987 1991 1995

Private sector 3.1 4.3 7.2 8.1 6.8 6.0 6.1 5.8 5.8 6.5 6.2

Public sector 3.1 3.7 3.9 4.1 4.3 5.4 5.5 5.3 4.8 4.2 4.1

Total 6.2 8.0 11.1 12.2 11.1 11.4 11.6 11.1 10.6 10.7 10.3

2000

5.7

4.4

10.1

2004 2005 2006 2007 2008 2009 2010 2011 2012

4.8 4.7 4.0 3.6 3.6 3.3 3.0 2.9 2.7

5.0 .. 5.1 5.2 5.4 5.4 5.3 5.3 5.1

9.8 .. 9.2 8.8 9.0 8.7 8.3 8.2 7.8

Note: This is not a continuous time series 1. Due to changes in the definition of the private and public sectors, estimates for 2000 onw ards differ from earlier years. From 2000, organisations such as the Post Office and the BBC w ere reclassified from the public to the private sector. 2. The 2005 survey did not cover the public sector. 3. Changes to methodology for 2006 onw ards mean that comparisons w ith earlier years should be treated w ith caution. 4. Components may not sum to totals due to rounding. .. denotes data not available. Source: Office for National Statistics

The decline in the proportion of employees with a DB occupational pension has to some extent been offset by an increase in DC scheme membership (including group personal and group stakeholder pensions), although this has not been enough to replace the fall in DB membership.2 The growth in workplace DC provision has been particularly in the contractbased sector of the market (in which employer facilitates the provision of a pension and makes contributions, but the contract is between the individual and the pension provider).3

2

DWP, Framework for the analysis of future pension incomes, September 2013, para 4.3 DWP, Pension Schemes Bill Impact Assessment. Summary of Impacts, June 2014, DEP2014-0911, para 7 and chart 3 3

3


The table and chart below show the proportion of employees with workplace pensions by type of pension, 1997 to 2013: Proportion of employees with workplace pensions: by type of pension, 1997 to 2013 United Kingdom Percentages Occupational Occupational Group personal and defined benefit defined contribution group stakeholder Any pension 1997 45.7 8.7 0.8 55.2 1998 44.5 9.3 0.8 54.7 1999 43.8 7.9 3.5 55.2 2000 43.2 7.5 4.6 55.3 2001 42.0 7.6 5.7 55.3 2002 41.6 7.5 7.6 56.6 2003 40.7 8.0 7.6 56.3 2004 38.8 7.3 7.7 53.7 2005 35.3 6.7 8.5 53.2 2006 34.3 7.3 9.7 54.3 2007 33.4 6.4 9.8 52.3 2008 32.8 6.0 9.8 50.9 2009 32.9 6.1 10.1 50.1 2010 32.1 6.4 10.0 49.7 2011 30.4 6.3 10.0 47.6 2012 28.0 7.0 10.2 46.5 2013 29.4 8.3 11.6 49.8 Source: ONS Annual Survey of Hours and Earnings (ASHE) 1. Results for 2005 onw ards are based on a new questionnaire and may not be comparable w ith earlier results. 2. ASHE estimates for 2011 onw ards are based on a Standard Occupational Classification (SOC) 2010 basis.

4


The Pensions Commission, set up in 2002 to advise on whether the then existing system of voluntary private pension provision would deliver adequate results, said that a delayed response to the rising costs of DB had meant that the manner of the adjustment, when it happened, had exacerbated inequalities in pension provision: The exceptional equity returns in the 1980s and 1990s allowed many private sector DB schemes to ignore the rapid rise in the underlying cost of their pension promises. When the fool’s paradise came to an end, companies adjusted rapidly, closing DB schemes to new members. A reduction in the generosity of the DB pension promises which existed by the mid1990s was inevitable. That generosity had not resulted from a consciously planned employer approach to labour market competition, and would never have resulted from voluntary employer action well informed by foresight as to the eventual cost, or operating within rational expectations of equity market returns. But the suddenness of the delayed adjustment, its extremely unequal impact as between existing and new members, and the major shift of risk occurring as many people move from DB to DC provision, have severely exacerbated the gaps that have always existed in Britain’s pension system.4

The Commission recommended the introduction of auto-enrolment as a way of addressing the decline in pension saving.5 This was legislated for by the Labour Government in the Pensions Act 2008. The current Government, following a review, decided to continue with its implementation.6 Under these reforms, employers are required to enrol workers into a pension scheme that meets set criteria. A new pension scheme, the National Employment Savings Trust (NEST) was set up under the 2008 Act, available to any employer who chooses to use it.7 Workers can choose to opt out of the scheme they are enrolled into. Where they remain in the scheme, minimum contributions must be made on a band of “qualifying earnings”. Once the reforms are fully introduced, the minimum contributions will be 8% of qualifying earnings: 3% from the employer; 4% from the employee and 1% tax relief. The reforms are being phasedin by employer size, between October 2012 and February 2018. The minimum contribution is also being phased-in, reaching the full amount in October 2018.8 The policy is expected to increase the number newly participating or saving more in a workplace pension saving scheme by between six and nine million. It is also expected to reduce the numbers facing inadequate retirement incomes.9 However, the vast majority of those automatically enrolled will be saving into DC pension plans, in which outcomes are uncertain and individuals bear the risks of pension saving.10 A key difference between the two current categories – DB and DC - is who bears the risk: -

3. In traditional DB schemes the employer, rather than the individual, bears the risks of longevity, investment and inflation and longevity (at least up to the statutory minimum

4

A New Pension Settlement for the Twenty-First Century; The Second Report of the Pensions Commission, November 2005, p123 5 Ibid, Executive Summary 6 Paul Johnson et al, ‘Making automatic enrolment work. A review for the Department for Work and Pensions’, October 2010; HC Deb 27 October 2010 c12WS 7 Pensions Act 2008, Part 1, Chapter 5 8 The Employers’ Duties (Implementation) Regulations 2010 (SI 2010/4) as amended 9 DWP, Framework for the analysis of future pension incomes, September 2013, para 1.5; DWP, Scenario analysis of future pension incomes, August 2014 10 DWP, Pension Schemes Bill Impact Assessment. Summary of Impacts, June 2014, DEP2014-0911, para 8

5


or the level specified in the scheme rules), all of which affect the cost of meeting their obligations. -

4. In DC schemes, the individual bears all the risks associated with pension saving (investment and inflation) as they save in their pension. The individual then bears the risk of the conversion rate – which is informed by the economic and longevity risks at the point the individual buys their retirement income. If the individual buys an annuity, longevity and investment risks are passed on to an insurer – inflation risks can also be passed on.11

The growing importance of DC pensions generally, and the introduction of automatic enrolment in particular, has therefore focused the attention of policy-makers on how to encourage the development of pension scheme able to give greater certainty for members than traditional DC pensions about the final value of their pension pot and have less cost volatility for employers than a DB pension. The Government has used the term ‘defined ambition’ for this sort of arrangement.12 A further important difference between the two types of scheme is that contribution rates tend to be lower in DC than in DB. The table below shows average contribution rates to private sector occupational pension schemes from 2002 to 2012: Weighted-average contribution rates to private sector occupational pension schemes, by benefit structure and contributor, 2000 to 2012 United Kingdom

Year 2000 2004 2005 2006 2007 2008 2009 2010 2011 2012

Defined benefit Member Employer 4.2 9.9

Total 14.0

Percentages Defined contribution Member Employer Total 2.7 4.3 7.0

4.3 4.4 4.7 4.9 4.9 5.2 5.1 4.9

14.5 16.0 15.0 15.6 16.6 16.5 15.8 14.2

18.8 20.4 19.7 20.5 21.6 21.7 20.8 19.2

2.9 2.7 3.0 2.7 3.0 2.9 2.7 2.8

6.0 6.3 5.9 6.5 6.1 6.4 6.2 6.6

8.9 9.0 8.9 9.1 9.0 9.3 8.9 9.4

4.9

15.2

20.2

3.1

6.6

9.7

Sources: ONS Occupational Pension Scheme Survey 2012, table 8; ONS Pension Trends ch. 8 Notes: 1) Includes schemes w here standard contributions w ere zero. 2) Excludes normal contributions paid as fixed amounts. 3) Includes rates for open, closed and frozen schemes. 4) Excludes schemes w ith few er than 12 members. 5) Components may not sum to totals due to rounding. 6) Caution should be exercised w hen comparing the figures for 2010 onw ards w ith earlier estimates, due to a change in survey methodology.

The debate about measures that could be put in place to improve outcomes for DC pension savers, in particular by introducing measures to improve scheme quality and value for money (addressing issues such as charges and governance) are discussed in Library Note SN 6956 Improving outcomes for DC pension savers (7 August 2014).

11 12

DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, chapter 1 DWP, Reinvigorating workplace pensions, Cm 8478, November 2012, p56

6


1.2

Consultation process

In its November 2012 discussion paper, Reinvigorating workplace pensions, the Government said that while engagement with pensions might increase as auto-enrolment was implemented, many individuals would not be comfortable with the level of risk and uncertainty involved in saving in DC pension schemes. It was keen to explore the scope for what it termed ‘defined ambition’ (DA) schemes. These would: […] seek to give greater certainty for members than a DC pension about the final value of their pension pot and less cost volatility for employers than a DB pension. 13

In November 2013, it launched a public consultation, Reshaping workplace pensions for future generations. This set out the challenges it thought DA needed to respond to: 

Structural: the polarisation of risks represented by traditional DB and DC pension schemes creates the perception of an incomplete system, with the burden of risk falling wholly on the employer or, increasingly, being placed on the individual. DA should provide the space for a greater amount of risk sharing.



Regulatory: the criticism that the DB promise brings too great a regulatory and funding burden to the employer. DA should consider reducing some of the regulatory requirements on DB and any new DA framework should be clear about the limits of employer liabilities, and avoid creating new regulatory burdens.



Supply/demand: demand from employers and employees for something between DB and DC is not being met by the market. There is a need to examine the extent to which Government intervention is needed to stimulate innovation.



Member-driven product design: the extent to which uncertainty about pension savings and retirement incomes from a DC scheme (however good) is a disincentive to save in a pension.14

It proposed a number of principles for their development: A DA scheme should be:

13 14



Consumer focused – address consumer needs (members and employers).



Sustainable – affordable to the providers/members) over the long term.



Intergenerationally fair – not biased to pensioners, but also take on board needs of future pensioners.



Risk sharing – incorporate genuine risk sharing between stakeholders.



Proportionately regulated – the regulatory structure needs to be permissive to enable innovation in risk sharing, while protecting member interests.



Transparent – there should be high governance standards with clarity for members about any promise made and any associated risks.15

stakeholders

(employers/pension

DWP, Reinvigorating workplace pensions, Cm 8478, November 2012, p56 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p10

7


The Government said it would review the regulatory structure, with a view to enabling a more equitable sharing of risk. The aim would be to “ensure the voice of the consumer is heard while there is less prescription about the offer that employers or the market should make.”16 From its discussions with employers, it found that: 

They were positive about offering pensions but wanted schemes that were simple to set up, where costs will not increase in future;



They had concerns about generating a pension liability that would have an adverse impact on business accounts;



Some positioned themselves to match the market rather than lead it. In some sectors, a major factor influencing decisions was what other employers were offering; and



Availability of employee benefit consultants to advise and recommend new products, and of established pensions administrators to support them, was key to these products becoming established in the market.17

Key considerations for employers were that the new schemes should not cost more than traditional DC and that there should be no funding liability on the employer’s balance sheet. For savers, the Government said that: Offering […] a greater level of certainty (at an appropriate cost) can reduce the anxiety sometimes induced by investments and prevent consumers viewing pensions as a gamble. Certainty may also encourage better planning and higher contributions. 18

An industry working group, chaired by chair of the Association of Consulting Actuaries Andrew Vaughan, looked at a number of possible models, including: introducing more flexibilities into the requirements for DB schemes, DC pensions with an element of guarantee, and collective DC schemes. The responses to the consultation indicated a general support for creating a new space in the legislative framework for DA pensions to develop. The Royal Society of Arts (RSA), for example, has argued the case for a new type of pension provision: Britain is witnessing the collapse of its Defined Benefit pension system throughout the private sector. Individual DC pensions are struggling to fill the gap. But they alone cannot provide an efficient pension savings system for everyone. Collective, pooled pensions such as Target Pension Plans provide employers with an alternative way to offer pensions that meet the needs of their employees, without taking on additional burdens themselves.19

The National Employment Savings Trust (NEST) has also welcomed proposals for DA, arguing that it was unlikely that any traditional DC scheme could give satisfactory answers to three basic questions put by savers: What will I get out at the end?

15

Ibid p 11 Ibid p 11 17 Ibid p13-14 18 DWP, Government response to the consultation. Reshaping workplace pensions for future generations, Cm 8883, June 2014, p9 and 12 19 RSA, Collective pension plans briefing note, 2014 16

8

RESEARCH PAPER 14/44 What happens to my money when it’s in the scheme (‘where does my money go?’) How safe it my money?20

The Association of British Insurers (ABI) has welcomed the opportunity to debate a “range of alternative ways to improve certainty for pension savers.”21 However, the Trades Union Congress (TUC) doubted that a new legislative framework would be enough: While we welcome changing the law to allow Dutch-style target pensions, this will not automatically result in any being set up. We need government action to ensure that workers have access to target pensions as the bigger they are, the better they work. Leaving it to the market is never a solution when it comes to pensions. 22

The National Association of Pension Funds (NAPF) agreed it was important to have a legislative framework that would develop as the pensions landscape continued to evolve.23 However, it said the focus must remain on providing good outcomes for DC scheme members: CDC may well have a role to play in this, but the fundamentals still apply. Good outcomes for members are built on strong governance, low charges and investment strategies based on members' needs. The real goal here has to be schemes operating at scale. Scale is a necessary precondition for CDC but it also enables a much wider range of member benefits. As a result of automatic enrolment we are already seeing the emergence of large pension schemes in the form of master trusts, which are able to offer their members high quality investment strategies and great value for money.24

The trade union Unite stressed the importance of employer contribution rates and action on charges to improve outcomes for DC scheme members.25 In June 2014, the Government said the consultation had confirmed the need for a new framework that would “create a clear DA space with its own regulatory protections to encourage innovation in risk sharing and enable new kinds of collective models.”26 It had decided not to proceed with proposals for flexible DB.27 Regarding its proposals for providing greater certainty for DC scheme members, it thought that the detail of some of its proposals (capital and investment guarantee, retirement income insurance and pension income builder) should be worked out within the legal parameters of the new legislative framework.28 It would also legislate for schemes to provide benefits on a collective basis.29 1.3

Proposals for introducing more flexibility in DB

The reason for the decline in DB schemes has been the subject of much debate. The Government has said that:

NEST, Reshaping workplace pensions for future generations – consultation response, 2014 ABI response to the DWP Defined Ambitions Pensions consultation, November 2013 22 TUC Press Release, ‘Pensions bills pull in opposite directions, says TUC’, 4 June 2014 23 NAPF, Reshaping workplace pensions for future generations – the NAPF’s response, December 2013 24 NAPF Press Release, ‘NAPF comments on Queen’s speech, 4 June 2014’ 25 Unite response to Reshaping workplace pensions, December 2013, p11 26 DWP, Government response to the consultation. Reshaping workplace pensions for future generations, Cm 8883, June 2014, p40 27 Ibid p28 28 Ibid p15 29 Ibid p22 20 21

9


There are a number of complicated factors which have combined to make them more costly and less attractive to employers. Some of these are inherent in the nature of this type of scheme, some result from regulation to increase member protection and some are linked to wider macroeconomic and societal factors.30

A report by the Pensions Policy Institute (PPI) in 2012 identified a number of contributory factors including: increased life expectancy; investment risk; inflation; changes in regulation and legislation. It found that overall these factors had significantly increased the cost and risks to employers of providing DB pensions.31 In October 2007, the Labour Government set up a Deregulatory Review of Private Pensions. The reason was that the development of regulation over 30 years had contributed to a belief by some employers that the costs and risks of having their own pension scheme had become too great: 3. The present regulatory system governing occupational pensions has grown incrementally over the course of the past thirty years. It is now, by common consent, lengthy, complicated and hard to understand. Although each successive layer usually had the aim of protecting scheme members or simplifying the regulatory structure, there have been unintended consequences, leading to undesirable outcomes. Whilst by no means wholly attributable to the growth of regulatory burdens, there is little doubt that the weight of regulation has contributed to a belief by some employers that the costs and risks of having their own pension schemes are becoming too great. 32

The Government’s objective was to reduce legislative burdens while recognising that there was a balance to be struck between reducing legislative complexity and protecting members’ interests.33 A review team – headed by Chris Lewin (formerly Head of UK pensions at Unilever) and Ed Sweeney (then joint Deputy General Secretary of Amicus) - reported in July 2007.34 In response, the Labour Government said it was “difficult to strike the right balance between removing legislative burdens and protecting members.” It did not believe that there was “a single measure or even a series of measures which would guarantee that employers would continue to provide and even strengthen their existing pension provision.” It agreed with the reviewers that “it would not be appropriate to make changes which would affect rights which have already accrued.”35 Following further consultation, it legislated in the Pensions Act 2008 to: 

reduce the cap applying to the revaluation of deferred pension rights from 5% to 2.5% (intended to apply to future rights, accrued from January 2009); and



repeal the rules on “safeguarded rights”, which applied when a pension is shared on divorce or dissolution of a civil partnership.36

30

DWP, Reinvigorating Workplace Pensions, Cm 8478, December 2012, p12-13 PPI, The changing landscape of pension schemes in the private sector in the UK, 27 June 2012, Executive Summary 32 DWP, Deregulatory review – Government response, October 2007, p35; For an account of how and why DB pension regulation had developed up to that point, see PPI, The changing landscape for private sector Defined Benefit pension schemes, October 2007, p25-29 33 DWP, Deregulatory review – Government response, October 2007, p35, para 4 34 Deregulatory Review of Private Pensions, An independent report to the Department for Work and Pensions, July 2007, Executive Summary 35 DWP, Deregulatory review – Government response, October 2007, Executive Summary 36 Sections 101 to 102. For more detail see SN 4515 Deregulatory Review of Private Pensions (September 2009) 31

10


In its November 2013 consultation document, the current Government said its motivation for allowing more flexibility for DB scheme sponsors was to stem the long-term decline in DB: […] Without government intervention to allow more flexibility and reduce constraints for employers sponsoring DB pensions, DB is likely to disappear almost completely from future pension arrangements.[…] A clear message from our discussions with employers is that, unless options to reduce cost volatility are introduced, the case for maintaining DB schemes will continue to weaken and they would have to consider moving away from DB completely.37

It said there was already some scope to amend DB scheme rules - for example, providing future benefits on the basis of career average revalued earnings rather than final salary, or placing a cap on ‘pensionable pay’ – although these features were not in widespread use. The abolition of contracting-out associated with the introduction of the single-tier State Pension from April 2016 will mean the falling away of requirements on contracted-out schemes to automatically provide rights for survivors on future accruals.38 The Government wanted to build on this, while saying it did not think that employers should have the power to transfer or modify accrued rights beyond what was allowed under current legislation.39 The specific proposals it set out in November 2013 were: 

The ability to pay fluctuating benefits – whereby schemes could choose to provide additional benefits – such as indexation or a one-off additional payment – above a simplified DB level when the funding allowed;40



Automatic conversion to DC for early leavers – whereby if a scheme member left before retirement, their accrued rights would be crystallised and the cash value transferred to a nominated DC fund;41



Ability to change scheme pension age – enabling future pension provision to be based on the projected number of years in retirement rather than being tied to a particular age.42 (Numerous respondents to the consultation thought it was already possible to adopt this scheme design under existing legislation).43

Responses to the consultation were mixed. The manufacturers’ organisation, EEF, did not think the proposals would make much of a difference. Many of its members had closed their DB schemes in recent years and others were on a ‘flight path towards closure.’ Those who had going through the difficult process of closing a DB scheme were unlikely to consider another form of DB in future.44 The TUC was also sceptical, saying that employers willing to accept pensions risk already had ways to reduce costs. It was concerned about the impact of the proposed changes on scheme members.45 Against this, there was support from the NAPF

37

DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p16-17 Ibid p17 para 9 39 Ibid p25 para 47-50 40 Ibid p18-19 41 Ibid p20-21 42 Ibid p22-23 43 DWP, Government response to the consultation. Reshaping workplace pensions for future generations, Cm 8883, 24 June 2014, page 34 44 EEF response on reshaping workplace pensions for future generations - summary 45 TUC press release, ‘TUC welcomes paper on defined ambition,’ 7 November 2013; Unite, ‘Response to Reshaping workplace pensions for future generations’, December 2013; See also NASUWT, Consultation response, Reshaping workplace pensions for future generations, December 2013 38

11


which argued that deregulation might encourage some existing providers to keep DB schemes open for longer.46 In its response to the consultation in June 2014, the Government announced that it would not proceed with the proposals for flexible DB: It was clear that there are already flexibilities available to employers, such as linking the scheme’s normal pension age with State Pension age, to reduce cost and volatility without the need for new legislation. We have therefore considered the consultation responses and have concluded that introducing new legislation, to make it easier to sponsor DB schemes, will not be our priority at the present time. Separate research findings have shown that, to make enough of a difference to employers, the suggested changes would need to apply to accrued pension rights. We are absolutely clear that we will not be making changes that affect past accruals that could reduce the pension benefits that individuals have already built up with their employer. The view most respondents expressed was that the greater prize was to deliver changes that enable collective schemes and greater ability to share risks in the DC world.47

1.4

Proposals for providing greater certainty within DC

The introduction of the single-tier State Pension for future pensioners from 6 April 2016 is intended to give people more certainty about the level of income they can expect from the state.48 To build on this, the Government has looked at whether there are ways of providing greater certainty about private pension income. Research by the National Employment Savings Trust (NEST) found a strong bias among savers for certainty. It said: Everyone understands that the goal of a pension is to grow their contributions but people are less clear where this growth will come from. Many people expect their pensions to grow in a uniform upward fashion. People in a pension scheme struggle to picture what happens to their money or where it actually goes. For unpensioned workers retirement planning is about safety and securing the future, and therefore at odds with ideas of chance, risk and uncertainty. For the automatically enrolled member risk is inherently negative and is more to do with the chance of making a loss than making a gain. Similarly, uncertainty is always perceived in a negative light and suggests the possibility of a disappointing or worst-case scenario outcome, rather than the possibility of getting a better outcome than expected or even just slightly less.49

NAPF, Reshaping workplace pensions for future generations – the NAPF’s response, December 2013 DWP, Government response to the consultation. Reshaping workplace pensions for future generations, Cm 8883, June 2014, page 28 48 HC Deb, 4 April 2011, c795 [Steve Webb]; For more detail see Library Note SN 6525 Single-tier state pension 49 NEST, Pensions insight – 2014 46 47

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Consumer research for DWP also suggested that the provision of greater certainty held an overall appeal, although when specific models were discussed, questions were raised around issues such as the cost of providing guarantees.50 The Government thought the ability to provide greater certainty for DC pension savers would become of more interest to employers once auto-enrolment was implemented and their DC funds started grow in size. Some commentators did not support any form of guarantee due to the impact on the investment strategy. However, the Government believed that some within the target group for auto-enrolment might respond to the certainty that only guarantees could offer. All guarantees raised common challenges including: • Cost to the provider and ultimately the member. Guaranteeing capital, returns or an income stream brings with it a number of solvency or funding requirements to provide protection for the consumer to ensure the provider remains in a position to meet its guarantee. But they come at a significant cost. Although these costs are borne by the provider, ultimately they are passed on in some form to the employer or the individual.

• Impact of the guarantee on investment strategy. There is a risk that the guarantee ends up driving the investment strategy. If the fund manager and guarantor are the same, there is a strong incentive to manage the fund solely to meet the guarantee rather than to maximise the fund value. In theory, separating out these two functions could help create the right incentives for each party, but even then, there is a risk that insurers will only guarantee funds that meet the level of investment risk they wish to insure.

• Counterparty risk. Any guarantee is only as good as the solvency of the guarantor. Therefore the provision of a guarantee opens up the beneficiary to a risk that their counterparty might not be able to meet their commitment, in the event of the guarantee being invoked.

• Trade-off between financial and behavioural value/consumer preferences. It is important that we recognise guarantees come at a cost to the member, which will reduce the value of their fund relative to a guarantee not being purchased. However, the intention of a guarantee in a DA scheme is not to maximise financial returns for the individual: it is to provide greater certainty and confidence to the consumer. This implies a low-level guarantee, the intention of which is to encourage people to stay in pension saving, which is particularly important in a pension system where there is no compulsion to save.51

An industry working group considered a number of models for providing greater certainty for DC scheme members, including: 

Money-back guarantee – intended to ensure that the amount of accumulated savings at retirement did not fall below the nominal value of contributions made to the scheme.



Capital and investment return guarantee – intended to offer guarantees at the midpoint of the pension cycle: when a member had built up a sum and was concerned to protect the loss of capital, while still maintaining a need to grow the fund further.

50

Defined Ambition: Consumer perspectives. Qualitative research among employers, individuals and employee benefit consultants, DWP RR 866, June 2014, Executive summary, p14 51 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p28

13




Retirement income insurance – this would involve a fiduciary using a portion of the member’s fund to buy, on the member’s behalf, an income insurance product that insures a minimum level of income, which would grow each year as further insurance was purchased. Products of this type already existed in the United States.



Pension income builder - similar to the Dutch General Practitioners’ pension fund and the mandatory ATP scheme in Denmark). In this model, contributions are used for different purposes. A proportion is used to purchase a deferred nominal annuity each year, payable from pension age. The residual proportion is invested in a collective pool of risk-seeking assets. 52

As the Pensions Policy Institute has pointed out, a common feature of these models (and of collective DC) is that none place any risk on the employer. In each case, the employer would determine their level of contributions into the scheme but take no further risk.53 Overall, the Government said it favoured models which sought to guarantee some of the income that would be received in retirement and that would show it building up over time: 64. We […] favour models which seek to secure a guarantee on the income that will be received in retirement that builds up gradually during the savings period. This approach has the benefit of allowing the member to see ongoing growth, combining certainty with a focus on the primary objective of pension savings – retirement income. It also assists employers’ needs in respect of workforce management. We also favour models that spread the risk of conversion at retirement. 65. A focus on income also works well with the change to a single-tier State Pension, giving the consumer a clearer understanding of what their income in retirement will be and how their private saving will build on the State foundation. 66. From the supply side, it is clear that at present UK insurers have little appetite for providing guarantees. The ABI in their recent publication, Identifying the Challenges of a Changing World, questioned whether customers would be prepared to meet the premium required to provide guarantees. They also raised concerns about increasing pressures from conduct and prudential regulators to avoid policyholder detriment. 67. On the money-back guarantee model, we have considered whether the Government should intervene directly and concluded that, in light of the significant hurdles that would need to be negotiated, we cannot justify direct Government intervention in providing money-back guarantees. We will however, continue working with providers, who have modelled the possibilities and found some market-based models affordable. 68. In relation to models 2 and 3 [capital investment return guarantee and retirement income insurance] we are continuing to work with industry on the legislative areas highlighted above to enable these models to work within the market […and] establish a new legislative framework to support the operation of these, as well as other forms of guarantees. 69. On the pension income builder (model 4), it is legitimate to debate whether members would be better served by using their contributions to seek higher returns through their pensions, rather than using it to guarantee their own entitlements. However, given the consumer demand for guarantees and the unwillingness of

52 53

Ibid, chapter 4; For more detail see Library Note SN 6902. PPI, Briefing Note 65 - Defined Ambition in Workplace Pension Schemes, December 2013

14


employers and insurers to provide them, this model could represent a creative way of meeting a consumer desire and help to engage members with pension saving. 54

In June 2014, it said the more detailed design features of models such as the capital and investment return guarantee, retirement income insurance and the pension income builder should be worked out within the parameters of the new legislative framework.55 1.5

Collective benefits

The Government explored the possibility of Collective Defined Contribution (CDC) schemes as a possible structure for DA. Its model for this is drawn from the experience of occupational pension provision in the Netherlands. While its proposed model would have important differences – it is not proposing compulsory participation for employers in industry-wide schemes, for example – it has looked at what positive lessons can be learned from the Dutch system. Key features of the schemes are that they feature risk-sharing between members and cost certainty for employers through a fixed contribution rate.56 Occupational pension provision in the Netherlands The Dutch pension system has three pillars. The first pillar is the state old age pension (AOW), the second is constituted by occupational pensions, and the third by individual savings for retirement.57 In arrangements dating back to 1949, participation in the second pillar is mandatory for employers where the government has agreed that it should be so, in response to a request from a sufficiently representative portion of an organised industry or sector. 58 For employees, participation is mandatory through their contract of employment. These arrangements have resulted in extensive coverage, with more than 90% of employees covered by supplementary funded pension schemes. They have also helped to ensure industry-wide funds with sufficient economies of scale, enabling cost efficient management of schemes: more than 80% of active scheme members are in sectoral funds.59 The bulk of assets are managed by non-commercial pension funds, which are legal entities separate from the employer. They are usually trust-based, governed by employer and employee representatives.60 The dominant model originated from a pure DB system. However, whereas in traditional DB the sponsoring employer generally stands behind the pension promise, in the Dutch model it depends on returns in the financial markets, interest rates and inflation rates.61 An overview of the system by the Dutch associations of pension funds explains: The majority of the Dutch DB (Defined Benefit) pension schemes are in fact not pure DB schemes, but are hybrid schemes. This means that if a fund gets into financial difficulties, all parties involved, employer, employees and those drawing their pension, contribute to the recovery.

54

DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p42 DWP, Reshaping workplace pensions for future generations: government response to the consultation, Cm 8883, 25 June 2014, chapter 2 56 DWP, Reinvigorating Workplace Pensions, Cm 8478, November 2012, p39 57 For more detail, see OECD, Pensions at a glance 2013: country profiles – the Netherlands; Dutch Association of Industry-wide Pension Funds and Dutch Association of Company Pension Funds, The Dutch Pension System: an overview of the key aspects, 2010 58 O.W. Steenbeck and SG Van der Lecq, Costs and Benefits of Collective Pension Systems, 2007, chapter 10 59 Lans Bovenberg, Roel Mehlkopf and Theo Nijman, The Promise of Defined-Ambition Plans Lessons for the United States, Network for Studies on Pensions, Aging and Retirement, March 2014 60 OW Steenbeek and S.G. van der Lecq eds, Costs and Benefits of Collective Pension Systems, 2007 61 Broeders D and Ponds E, Dutch pension system reform – A step closer to the ideal system? CESifo DICE Report 3/2012, 65-78 55

15


> The pension contributions can be increased. This will increase the wage costs for the employer and decrease the net salary for the employee. Another option is that the employer commits paying the extra contributions required to incidentally pay an extra contribution. > The indexation can be limited. Most pension schemes include a clause stating that indexation is conditional. Each year the pension fund’s executive board will decide whether the fund’s financial position will permit indexation of the pensions and accrued rights. In indexed average salary schemes such indexations constraints affect pensioners, members still contributing and early leavers. > An extreme measure is to reduce the pension rights. In many pension schemes the contribution amount as well as the level of indexation depends on the coverage ratio. This is known as intergenerational risk sharing for pension funds. Furthermore, when determining the investment mix a balance must be found between the needs of those drawing a pension for security and on the other hand, the needs of the younger contributor for the opportunity to achieve a good return on investment.62

The effect of these arrangements is that investment and longevity risks are borne collectively rather than by the individual. If a scheme becomes underfunded, its governing body decides how to restore it to a full funding position over a period of three years (extended to five recently). The minimum funding level is 105% (i.e. assets exceed liabilities by 5%). In addition, the fund must have buffers to be able to cope with financial setbacks. The average pension fund needs to be 125% funded, with the exact level dependant on factors such as the scheme’s investment strategy and the age profile of its members.63 In general, scheme participants are treated uniformly. This means that scheme members accrue benefits at the same rate (around two per cent of salary a year), all active members contribute at the same rate and the indexation rate is the same for all participants, although some funds differentiate between active members and retirees.64 Contribution rates are high, as are the benefits provided. In 2012, the average contribution rate was about 17.5% (6.2% from employees and 11.3% from employers). In 2013, schemes typically aimed at an annuity level of about 80% of average pay (including the AOW) after 40 years’ service. 65 Reforms have been introduced over time in response to funding pressures. In 2003, there was a shift to providing pensions based on career average rather than final salary, and the introduction of a conditional indexation mechanism, whereby accrued rights would only be increased in line with inflation if the scheme was fully funded.66 Further reforms have been under consideration following the financial crisis in 2007-08, when the funding level fell in many schemes. A fall in the total funding from 130% to 95% in 2008,

62

Dutch Association of Industry-wide Pension Funds and Dutch Association of Company Pension Funds, The Dutch Pension System: an overview of the key aspects, 2010 63 Ibid 64 Broeders D and Ponds E, Dutch pension system reform – A step closer to the ideal system? CESifo DICE Report 3/2012, 65-78 65 Lans Bovenberg and Raymond Gradus, Reforming Dutch occupational pension schemes, 2014 66 Theo Nijman, Pension Reform in the Netherlands: Attractive options for other countries? Bankers, Markets and Investors No 128, January-February 2014

16


meant many funds had to put in place recovery plans and take action to restore funding levels.67 A recent academic study explained the effects: The biggest wave of cuts in pensions in payments occurred in 2013. During that year, 68 pension funds (out of 415) were required to cut nominal pension rights. The cuts in 2013 affected around 2.0 million active participants (who pay contributions), 1.1 million retired participants and 2.5 million inactive participants who neither pay contributions nor receive benefits.[…] Around 2 million participants faced a relatively large cut of 6 to 7 per cent. A cut of 7 per cent is observed frequently because the Dutch government allowed pension funds to cap the level of pension cuts in 2013 at 7% and defer the remainder to 2014. Moreover, most pension funds have been unable to provide (full) indexation in recent years. […] on average retirees have experienced a decline of around 10% of their replacement rates as a consequence of inadequate indexation. This decline is expected to increase further because the current low funding rates will not allow pension funds to provide full indexation in the near future.68

Funding levels have since recovered somewhat and were expected to reach an average of 112% in May 2014.69 Thirty funds had to curtail pensions in April 2014, affecting 200,000 retirees, 300,000 members and 600,000 early leavers (people with non-contributory entitlements that remain with previous employers). These difficulties led to proposals for reform. In 2010, the social partners - employers and trade unions - agreed in a Pension Accord that pension contracts needed to be modified.70 In particular, it was agreed that: -

unexpected increases in life expectancy should be met by changes in pension rights rather than in recovery contributions paid by employers and workers;

-

the new pension contracts should be transparent and complete and pension funds should communicate to participants the risks implied by the pension contract (including investment policies); and

-

eligibility for the public pension (AOW) and the accrual rate in occupational pensions would be linked to life expectancy.71

It appears that the proposals to move towards a new ‘defined ambition’ contract are still under consideration, with complex issues, such as whether the new contracts should apply to accrued rights and the extent to which pension funds should offer nominal guarantees, as yet undecided.72 Proposals for the UK In its November 2013 consultation, Reshaping workplace pensions for future generations, the Government said that some employers currently sponsoring DB schemes were interested

67

IMF Country Report No. 11/209, July 2011 - Netherlands: Publication of Financial Sector Assessment Program Documentation - Technical Note on Pensions Sector Issues 68 Lans Bovenberg, Roel Mehikopf and Theo Nijman, The Promise of Defined Ambition Plans – Lesson for the United States, Netspar Occasional Papers, March 2014 69 ‘Dutch pension funds at three-year high as ratios improve’, Financial Adviser, 26 June 2014 70 Stichting van de Arbeid, Memorandum Detailing the Pension Accord of 4 June 2010 71 Lans Bovenberg, Roel Mehikopf and Theo Nijman, The Promise of Defined-Ambition Plans – Lessons for the United States, Netspar Occasional Papers, March 2014, Section 6 72 Ibid

17


in CDC as an alternative.73 It set out the core characteristics of the models under discussion for the UK. These included: -

A fixed rate of employer contribution, with the employer having no further liability to the scheme (unless it chose to support it further) and no balance sheet risk;

-

Rather than being retained in an individual fund for each member, or each member having rights to their own specific contributions and investment returns attributable to those contributions, in a CDC scheme assets are pooled. When they retire, members do not select an individual retirement income product, rather the income is paid from the asset pool. The rights of a CDC scheme member are therefore not related to the contributions made by or on behalf of that member;

-

Large scale provides for efficiencies in the costs of administration and investment management. It also enables the collective element to function more efficiently – “very simply, for a scheme that shares risks among members, the more members there are, the greater the opportunities for risk sharing”;

-

In one of the main models of the scheme, individuals are provided with a target pension income they might receive in retirement (often including a fluctuating conditional indexation payment). The actual pension income received is dependent on the available assets in the scheme. If funding is insufficient, there are a number of pressure valves to enable the scheme to continue to deliver benefits, such as not paying the conditional indexation element or reducing the target pension income for members, with a decision to be made on how risks are shared between different classes of members;

-

One form of CDC includes the possibility of benefits in payment being reduced in order to manage the fund. An alternative would be to fix a core part of the pension which cannot be changed once it is in payment, so it would be only the conditional indexation payments that could be cut.74

In its response to the consultation published in June 2014, the Government said that such schemes were currently not catered for in pensions or tax legislation. It would therefore define collective schemes in primary legislation and create a framework for them.75 Debate Differing views on the possible advantages and disadvantages to providing pension benefits on a collective basis are discussed below. Outcomes An assessment of how CDC schemes might work in the UK conducted by the Labour Government in 2009 found that CDC schemes could produce higher pensions and greater stability in outcomes for individuals: -

In the median case, CDC schemes produced higher pensions than standard DC schemes. This was mostly due to the fact that CDC schemes could remain invested in equities throughout the entire accumulation period, whereas typical DC schemes

73

DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013 Ibid, p45-6 75 DWP, Reshaping workplace pensions for future generations: government response to the consultation, Cm 8883, 25 June 2014, p22 74

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tended to move into safer, but lower-returning assets as the member approached retirement.76 -

There was greater stability in outcomes for individuals i.e. an individual’s starting pension was less dependent on whether they happened to retire in a downturn or a boom. However, there was uncertainty about indexation throughout retirement, as it was only granted when investment returns permitted. 77

A report published by the RSA in November 2013 included modelling to show that: 

On the best like-for-like comparison, a collective pension would on average have outperformed an individual pension by 33%



That in 37 of the past 57 years, a collective pension would have outperformed the individual pension



That the variability of the pension, and thus the risk the saver would have taken, would be lower with a collective rather than an individual pension.78

Modelling for the current Government also showed CDC out-performing individual DC. It said this was primarily driven by lower costs and remaining for longer in risk-seeking assets, factors not necessarily inherent to CDC: 14. There is a lively debate within the industry around the theoretical benefits of CDC plans compared to individual DC plans; in particular, the extent to which CDC outperforms DC. This was explored by the DWP and GAD in 2009. The modelling indicated that there was a good likelihood of better outcomes compared to individual DC, although this arose from CDC following a more aggressive investment strategy over time, which is not inherent in the design, and the same strategy could be replicated in DC. It also indicated that a stable active membership was required to keep the scheme sustainable. The modelling also indicated this effect was radically diminished where there was no continuing stream of new member contributions. 15. As part of the Department’s current work on CDC, consultants Aon Hewitt have modelled the position of an individual who for 25 years set aside 10 per cent of their salary for a pension. It then looked at how they would have fared had they retired in 1955, and then in every other year up until the present. 16. The median of the average salary replacement has been compared for the following; (i) a CDC plan invested 80 per cent in equities and 20 per cent in bonds; (ii) an all equity individual DC plan; and (iii) a lifestyle individual DC plan. In Aon’s results the average replacement rate for the CDC plan is 32 per cent, for DC equity it is 27 per cent, and for lifestyle it is 22 per cent. The dispersion of the individual DC plans is significantly greater than for the CDC. 17. Our understanding is that out-performance is driven primarily by lower costs and remaining invested for longer in risk-seeking assets. Neither of these is inherent to CDC schemes and it is possible to achieve both low costs and to hold risk-seeking assets for as long as desired in individual DC schemes. 79

76

Ibid para 3.2 DWP, Collective Defined Contribution Schemes – An assessment of whether and how such schemes might operate in the UK, December 2009 78 David Pitt-Watson, Collective Pensions In the UK II, RSA, November 2013 79 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p46 77

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However, it said the ability to share risks amongst members did seem to create more stable outcomes than are possible in individual DC: and the more members the greater the ability to share risk and so the lower the dispersion in outcomes.80 Viability of CDCs in the UK When the Labour Government looked at this in 2009, it decided to take no further action. Part of the reason for this was that it thought demand for employers was likely to be limited: […] employers (including DB scheme sponsors considering closing their schemes) seem to be reluctant to subscribe to a new type of pension scheme which their employees may not fully understand and remain sceptical of their potential liability if investment performance is poor.81

However, in November 2013, the current Government said some employers were interested in CDC as an alternative to DB: We know that some DB employers are interested in CDC as an alternative to DB schemes, rather than moving to individual DC schemes. CDC schemes may also be feasible as multi-employer schemes, perhaps sector based as in the Netherlands. Longer term, once established they might enable smaller employers to participate, offering them and their employees the benefits of scale.82

It commented that CDC schemes perform better on a larger scale. This is because: Scale can provide the potential for efficiencies in the costs of administration and investment management. However, these advantages apply equally to other forms of pension scheme, and it is important to note that while CDC needs scale, it does not provide it automatically. The other benefit of scale for CDCs is that it enables the collective element to function more efficiently – very simply, for a scheme that shares risks among members, the more members there are, the greater the opportunities for risk sharing.83

The Pensions Policy Institute has suggested that intervention by industry or Government may be needed for sufficient scale to be achieved.84 There may also be cultural barriers to their introduction in the UK. Morten Nilsson, CEO of Now:Pensions, has pointed out that such schemes in the Netherlands and Denmark operate in a very different context: Whilst innovations such as collective DC schemes have been successful in Denmark and the Netherlands, both of these markets are highly unionised and have had mandatory or quasi mandatory pension saving for many years. The populations are relatively homogenous and the collective DC schemes operate on an occupational basis with people from similar professions sharing risk with one another – a much fairer approach than manual workers sharing risk with white collar workers. The UK is a much more fragmented market and while changing legislation to allow these schemes could have merit, in many ways it feels as though we are running before we can walk. Like it or not, UK companies have limited appetite for pension liabilities and consumers have limited interest in locking themselves up in risk sharing arrangements. As the

80

Ibid DWP, Collective Defined Contribution Schemes, December 2009, p12 82 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p44 83 Ibid, p45 84 PPI, PPI Briefing Note 65 - Defined Ambition in Workplace Pension Schemes, 2013 81

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market grows and matures, this position might alter but I think we have some distance to travel.”85

Intergenerational equity The design of pension schemes can raise difficult questions of fairness between generations and between different groups of scheme members (e.g., different generations, active and deferred members, new entrants and existing scheme members, people with different career paths, men and women). The recent reform of public service pension schemes, for example, involved a switch to pension benefits based on career average earnings rather than final salary, on the basis that final salary schemes disproportionately benefited career ‘high flyers’.86 A number of commentators have objected that CDCs are unfair to younger contributors. Huw Evans of the ABI, has said, for example: CDC can hit the young. CDC schemes work by sharing risks between all members, pooling the investment in one fund. This brings down overheads but involves transferring risks from old to young, with younger scheme members bearing the risk of reduced future payouts to ensure the benefits of older members are preserved. 87

The Government acknowledges this as a potential issue but points out that the way in which risk is shared between different groups of members depends on how the scheme is designed: 11. CDC schemes share risk between members. Scheme design governs which members bear risk and how much of it. For example, in a scheme where the design reduces the benefits of active and deferred benefits before it does so for pensioners, the risk in relation to investment returns and funding position is borne to a greater extent by younger members where the target is reduced. The variation on this design – to make a promise on the pension in payment – would increase the element of intergenerational risk transfer further. This intergenerational risk sharing, which arises from collectivisation, requires a considerable increase in the level of trust required from members of those running these schemes in comparison to traditional DC. 88

This is borne out by recent analysis of proposals for reform of CDCs in the Netherlands, which said: Typically, in case of high funding ratios, the elderly benefit from excess indexation. They also stand to gain from a higher discount and contribution rate. These measures will increase pay outs in the short run. By contrast, at low funding ratios, benefit cuts, a less ambitious indexation target and more prudence are favorable to the young. The young stand to gain from benefit cuts at low funding ratios, greater prudence via more buffering and a less ambitious indexation target, which will all reduce benefit pay-outs in the short run.89

One study of the Dutch system argued that it was important to be transparent about the nature and extent of any subsidy between different groups of members in collective Now:Pensions press release, ‘Now:pensions comments on pension proposals outlined in Queen’s speech’, 4 June 2013 86 Independent Public Service Pensions Commission: Interim Report, 7 October 2010, p96; See Library Research Paper RP 12/57 Public Service Pensions Bill, section 5.4 87 Huw Evans, Ten things you should know about CDC, ABI blog, 28 January 2014 88 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013 89 D Broeders and E Ponds, Dutch pension system reform – A step closer to the ideal system?, CESifo DICE Report, 3/2102, 70DW 85

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schemes, and to make the case for risk-sharing. It concluded that consensual support for the arrangements would be all the more important if members could exit the scheme. Put differently, it said limits must be set on the extent to which new entrants could be charged for funding shortfalls that had arisen before their time.90 Compatibility with the Budget 2014 announcements Others have questioned whether CDC would work in an environment where, following the announcement in Budget 2014, individuals aged 55 and over would have flexibility to draw their pension saving as and when they choose, subject to their marginal rate of income tax.91 Responding to the Queen’s Speech, Shadow Pensions Minister, Gregg McClymont asked: Finally, the Minister made great play of his defined ambition agenda, which is buried in his statement. How can one develop the collective pensions to which he subscribes when they depend on intergenerational risk-sharing? As we understand it, intergenerational risk-sharing becomes extremely difficult, if not impossible, if people exit the system at the age of 55.92

Craig Berry of the Sheffield Political Economy Research Institute, for example, said the risk that a large number of savers could choose to take their money in a lump sum would make the CDC business model unworkable on the kind of scale needed to make a difference: The CDC business model depends, fundamentally, on retirees’ pensions being paid directly out of the scheme’s funds, rather than via an externally-held annuity. This means cash can remain invested in high-return assets right until the very moment it is needed to be used to make monthly pension payments. It also means members must be required to take their pension from the scheme rather than “shopping around”. 93

However, Towers Watson argued that people could be allowed to transfer their money out if the value was adjusted first: Portability and individual control were at the heart of the Budget reforms, but are called into question with CDC. You can allow people to transfer out of a CDC fund, but that is likely to mean adjusting the value of their savings first. How this is done must be transparent and could prove controversial. It’s also unclear whether starting to receive a CDC retirement income will be a big one-off decision that you cannot reverse, like buying an annuity. If retirees can cash out their CDC pensions at any point, that could play havoc with the longevity risk-sharing they are meant to provide.94

Part 3 of the Bill defines the concept of collective benefits and makes provision for regulationmaking powers in relation to them.

2

Flexibility for DC pension savers from April 2015

The Bill also makes provision for some of the measures associated with the announcements made in Budget 2014 regarding increased flexibility for people aged 55 and over to access their DC pension savings from April 2015. As presented to Parliament, the Bill allows the government to remove the option to transfer from a public service defined benefit scheme to a defined contribution scheme. In addition, the Government has said it will bring forward 90

J B Kune, Solidarities in collective pension schemes, in O.W. Steenbeek and S.G. van der Lecq (Eds), Costs and Benefits of Collective Pension Systems, July 2007; Lans Bovenberg and Raymond Gradus, Reforming Dutch occupational pension schemes, 2014 91 HM Treasury, Budget 2014, March 2014, para 1.164-5 92 HC Deb 20 March 2014 c953 93 Craig Berry, The Queen’s speech leaves pensions in a royal muddle, The Conversation, 4 June 2014 94 Towers Watson, Collective pensions are no magic wand, 4 June 2014

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amendments in connection with its proposed ‘guidance guarantee.’ The necessary changes to pension tax legislation will be in a separate Pensions Tax Bill.95 The section below aims to set the Budget 2014 announcement in context and to discuss the guidance guarantee. The wider changes are discussed in more detail in Library Note SN 6891 Flexibility for DC pension savers from April 2015 (August 2014). 2.1

Background

Individuals with defined contribution (money purchase) pensions build up a pension fund using contributions, investment returns and tax relief. At present, most people (75%) with a DC pension use it to buy an annuity – a financial product which provides a regular income, usually until death.96 The current pension tax system has strongly encouraged this outcome. It does this by categorising payments from schemes as ‘authorised’ or ‘unauthorised’. Unauthorised payments attract an extra tax charge (55%), such that HMRC does not expect many to be paid.97 Lump sum payments are only authorised in certain circumstances - a common example being the 25% tax free lump sum.98 A summary of the payments that are authorised under current rules is in HMRC’s Tax Information and Impact Note – Pension Flexibility 2015 (p2-3). The main alternatives to purchasing an annuity under current rules are: 

Those with small amounts of overall pension saving, or very small individual pots, may have the option from age 60 to take it as a lump sum;99 and



Income drawdown, which allows the individual to draw an income from their fund while leaving the rest of it invested. However, except where the individual can show that they have other pension income over a set amount, there is a cap on the amount they can draw down each year.

Income drawdown accounts for a much smaller share of the market than annuity purchase. In its review of the annuities market in February 2014, the Financial Conduct Authority said: Although income drawdown is increasing in popularity, annuities are still the most common product in this market. In 2012 420,000 annuities were sold, 16 times more than income drawdown products, with a premium value of £14bn compared to £1.2bn for income drawdown.100

The Association of British Insurers (ABI) produces regular figures on annuities. In February 2014 it gave the following overview of the market: In 2013 there were 353,000 annuities sold by ABI members in the UK, worth £11.9bn in total. 14 providers offer annuities on the open market.

95

HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014, para 5.3 96 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 2.17 97 RPSM09205200 - Member Pages: Member Benefits: Taxation: Unauthorised Member Payments; Finance Act 2004, sections 208-13 and 239-241; HMRC website: Unauthorised payments from pension pots. 98 HMRC Registered Pension Schemes Manual, RPSM 9100330; Finance Act 2004, s 166 and Sch 29 paras 1 to 3 and 12 99 Finance Act 2004, s 164 and Schedule 29 para 7 to 9; SI 2009/1171; RPSM09104905 100 FCA, Thematic Review of Annuities, TR14/2, February 2014

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12 providers offer enhanced annuities based on health or lifestyle factors, of which 11 offer these on the open market. The average (mean) annuity in 2013 was bought with a pension fund of around £35,600; but the median was around £20,000, so half of people buy an annuity with less than this. Among ABI members, 7% of annuities are investment-linked and there are around 21,000 new drawdown customers every year.101

The Labour Government’s approach Up until the age of 75, individuals had the option of an ‘unsecured pension’, from which withdrawals could be made while the rest of the fund remained invested. However, individuals were required to turn their pension fund into an income stream from age 75. The Labour Government supported the continuation of this policy for a number of reasons: 15. Pension funds built up with the benefit of tax privileges must be turned into retirement income using annuities by the time people saving for pensions reach age 75. This is because: 

tax relief on pension contributions is provided so people can save for an income in retirement, not for other purposes;



annuities pool people’s risk, ensuring that they are the most financially efficient way of turning capital into an income stream; and



annuities make sure that people continue to receive an income from their savings no matter how long they survive, thus reducing their possible future need for income-related support from the Government.102

However, it introduced flexibility to the rules. From 2006, it introduced the option of continuing with an unsecured pension beyond aged 75. The ‘Alternatively Secured Pension’ (ASP) was introduced as an alternative to an annuity in response to the concerns of some religious groups who had principled objections to the pooling of mortality risk. The Government did not expect the option to be widely used, arguing that it was “likely to be an inferior choice for pension savers without dependents and who do not have a principled objection to the pooling of mortality risk.”103 There were limits on the amount that could be drawn down each year.104 Critics of the ‘requirement to annuitise’ argued that people should be able to exercise choice over their pension funds, provided they did not fall back on means-tested benefits. In opposition, a number of Conservative backbenchers introduced Private Members Bills with the aim of introducing an alternative. These provided that people with pension funds large enough to buy an annuity providing a minimum retirement income above the level of means-

101

ABI, The UK Annuity Market: Facts and Figures, February 2014 DWP and Inland Revenue, Modernising annuities. A consultation document, February 2002; See also HM Treasury, ‘Simplifying the taxation of pensions: increasing choice and flexibility for all’, December 2002, para 5.45 103 HM Treasury and Inland Revenue, Simplifying the taxation of pensions: the Government’s proposals, December 2003 104 Finance Act 2004, section 165 ; HM Treasury, Removing the requirement to annuitise by age 75, July 2010, para 2.5-7 102

24


tested support should be able to re-invest any residual funds in a ‘Retirement Income Fund’ which they could use as they liked. 105 The current Government’s approach Before the 2010 General Election, both Conservative and Liberal Democrat parties had been arguing for a change in the rules.106 The Conservative-Liberal Democrat Coalition’s Programme for Government included a commitment to “end the rules requiring compulsory annuitisation at 75.”107

In July 2010, the Government launched a consultation on a proposal that from April 2011, there would “no longer be a specific age by which people effectively have to annuitise.” The option of income drawdown would be available throughout retirement, rather than just up to age 75. Except for those who could show they had secured a sufficient minimum income to prevent them from “falling back on the state,” there would be a cap on the amount that could be drawn down each year: 2.15 The Government will go further than capped drawdown by creating additional flexibility for individuals who wish to draw down more than the capped annual limit. Under this flexible drawdown model, individuals will be able to draw down unlimited amounts from their pension pot, provided that they can demonstrate that they have secured a sufficient minimum income to prevent them from exhausting their savings prematurely and falling back on the state. The requirement to demonstrate a minimum income will apply at the point at which an individual wants to exceed the annual capped drawdown limit. The Government wants to ensure that the requirement to secure a minimum income is transparent and fair and can be implemented without undue complexity or burdens on individuals or business.[…] 108

The level of the existing cap on withdrawals (120% of the value of an equivalent annuity) would be reviewed to see whether it remained appropriate in an environment where income drawdown remained an option throughout retirement.109 To ensure that people did not use pension saving as a “tax-privileged means for passing on wealth” any unused funds remaining on death at age 75 or over would be taxed at a rate designed to reflect the value of tax relief received.110 The Government published its response to the consultation in December 2010. It proposed that, to be eligible for flexible drawdown, people would need to be able to show they had at least £20,000 other secure pension income per year.111 For those not eligible for flexible drawdown, the cap on the amount they could withdraw each year would be set at 100% of a comparable annuity. Investment reviews would take place every three years before age 75 and annually after that. These measures were intended to limit the “risk of individuals exhausting savings in later life.”112

These included David Curry’s Pension Annuities (Amendment) Bill 2001/02, Edward Garnier’s Retirement Income Reform Bill 2002/03 and Adrian Flook’s Retirement Income Reform Bill 2003/04 106 See, for example, Theresa May, Providing for Pensions. Principles and Practice for Success , Politeia, 2010; The Liberal Democrat Manifesto 2010 107 The Coalition: our programme for government, 20 May 2010 108 HM Treasury, Removing the requirement to annuitise by age 75, July 2010, p9 109 Ibid, para 2.16-7 110 Para 2.9 and 2.22 111 HM Treasury, Removing the requirement to annuitise by age 75. A summary of the consultation responses and the Government’s response, December 2010, para 3.49 112 Ibid para 3.9-10 105

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In April 2013, the limit on annual withdrawals applying to those in capped drawdown was increased from 100% of a comparable annuity to 120%.113 This was in response to concern from those in capped drawdown, who found the maximum amount they were able to withdraw reduced on review.114 Problems in the annuities market The past year has seen the publication of two influential reports highlighting problems in the annuities market. In a report published in December 2013, the Financial Services Consumer Panel (FSCP) said the research showed that the “market does not work well for the majority of consumers.” One of its key findings was that consumers were poorly placed to drive effective competition amongst providers and distributors of annuities. It said: There are many barriers inhibiting consumers’ full engagement when they decide to annuitise: low financial capability; fear of product complexity and of making an irreversible, high-cost mistake; general distrust of professional advisers, and inability to find appropriate advice at acceptable cost. 115

A literature review highlighted the complexity of the process for consumers, finding that:    

Annuitisation was a very complex process for most DC consumers; A ‘good annuity outcome required expert help in most cases; A high proportion of DC customers did not shop around for the best deal; and Many consumers did not understand the differences between advice channels or know where to go for professional help.116

The review found that negative views of annuities among consumers had been exacerbated by the impact of annuity rates, which had been falling steadily over the past 20 years, reaching a historic low in mid-2012.117 The FSCP recommended regulatory and structural reform: Recent initiatives, such as the Code of Conduct introduced by the Association of British Insurers (ABI), and market developments, such as the online automation of the annuity purchase process, may prove helpful, but rely on effective enforcement by the ABI and may overload consumers with information. The chances of mass consumer detriment are, in our judgement, too high to trust to current market-driven solutions alone: hence our recommendations for further regulatory and government-led structural reform.118

The Financial Conduct Authority (FCA) announced the findings of its Thematic Review of Annuities in February 2014. It also emphasised the complexity of the decisions consumers are required to make at retirement: There are a number of decisions that consumers must engage with to make a wellinformed decision about buying an annuity. Alongside the timing of their retirement, they must also consider whether or not to take benefits through income drawdown, and

113

HC Deb, 5 December 2012, c878; HM Treasury, Autumn Statement, Cm 8480. December 2012, para 2.58 HC Deb 20 Mar 2012 c618W; See Library Note SN 712 Pensions: Income drawdown (May 2014) 115 FSCP, Annuities: Time for Regulatory Reform, December 2013, para 3.1 116 Annuities and the annuitisation process: the consumer perspective – A review of the literature and an overview of the market, Summary of findings, paras 1.2-5 117 Ibid p2 and 6 118 Ibid para 3.13 114

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RESEARCH PAPER 14/44 if they choose an annuity, the ‘shape’ of annuity to purchase. Consumers often have not engaged in building up their pension savings and this affects how they engage with their retirement income choices. Once consumers are confronted with annuity choices they are faced with decisions that require them to consider their future circumstances, and attribute a future value to options such as joint versus single life, guaranteed periods, inflation protection and death benefits. These decisions all require making judgements about what will happen in the future and the relative values placed on protecting their income against uncertain events. This is something that is very challenging, even for consumers with high levels of financial capability.119

It recognised that most consumers found it “difficult to assess risk and uncertainty in financial products”. This resulted in a “general lack of engagement in the annuity purchase, with many consumers struggling to evaluate the options to find the best deal at retirement.”120 The FCA concluded that “some parts of the market were not working well for the majority of consumers”: More specifically we have identified the following concerns:

119 120



The majority of consumers (60%) do not switch providers when they buy an annuity, despite the fact that we estimate 80% of these consumers could get a better deal on the open market, many significantly so.



We estimate that the aggregate benefits that consumers miss out on by not shopping around and switching is the equivalent of between £115m and £230m of additional pension savings. We recognise that this may not be realisable, as changes in switching behaviour would be likely to result in changes within the market.



In part consumers miss out on the benefits available from shopping around and switching due to their lack of engagement in pensions and annuities, the confusing trade-offs they face and the impact of behavioural biases that makes it difficult for consumers to make the right choices and may result in many of them not shopping around effectively.



There is also an incentive on providers to retain their existing pension customers, as overall the estimated levels of expected profitability of standard annuity business sold to existing pension customers is more than the expected profitability of annuity business sold on the open market.



The differences in retention rates (i.e. proportion of pensions annuitising with their pension provider rather than switching) between firms varies widely and some firms have relatively high retention rates and have active retention strategies that may increase customer loyalty and reduce the propensity to shop around.



There are particular groups of consumers where it appears that the market is not working well. There is an apparent lack of choice and ability to switch for those with small pension funds and lower annuity rates available to these consumers generally, which is likely in part to be due to the fixed costs of providing an annuity representing a larger proportion of the customer’s funds.

FCA, Thematic Review of Annuities, TR 14/2 February 2014, p26 Ibid

27

RESEARCH PAPER 14/44 

There is also a lack of access to enhanced annuity rates for some consumers annuitising with their existing pension provider and not shopping around.121

It decided to conduct a competition market study on products for retirement income.122 The terms of reference for this study were revised following the March 2014 Budget. The FCA said: The market study into retirement income will consider products such as annuities and income drawdown. These are products purchased by individuals with their accumulated pension pot that provide an income during retirement. We will also be considering new financial products which might be offered to those approaching retirement. We will examine competition and choice in the context of the various options open to consumers when retiring. As part of this work we will assess the value for money associated with different at-retirement products in the future landscape.123

2.2

Budget 2014

In Budget 2014, the Government announced short-term changes, increasing the size of pension that could be taken as a lump sum and introducing more flexibility into the income drawdown arrangements from 27 March 2014. From April 2015, there would be more radical reforms: 1.164. As a first step towards this reform, the Budget introduces a number of immediate changes, to allow people greater freedom and choice now over how to access their defined contribution pension. From 27 March 2014 the government will:

-

reduce the amount of guaranteed pension income people need in retirement to access their savings flexibly, from £20,000 to £12,000

-

increase the capped drawdown limit from 120% to 150% to allow more flexibility to those who would otherwise buy an annuity

-

increase the size of a single pension pot that can be taken as a lump sum, from £2,000 to £10,000

- increase the number of pension pots of below £10,000 that can be taken as a lump sum, from 2 to 3

- increase the overall size of pension savings that can be taken as a lump sum, from £18,000 to £30,000. 1.165. Under the current tax system, people are charged 55% if they choose to withdraw all of their defined contribution pension savings at the point of retirement. This means the majority of people instead purchase an annuity and receive taxable income over the course of their retirement. Under the new system, an individual will be able to withdraw their savings at a time of their choosing subject to their marginal rate of income tax. The government anticipates that under these circumstances some people will choose to draw down their pension sooner in order to suit their personal situation. This will increase income tax revenue in the short to medium term.124

121

Ibid p29 Ibid p30 123 FCA, Retirement income market study: revised terms of reference, 9 June 2014 124 HM Treasury, Budget 2014, March 2014, HC 1104, para 1.164-5 122

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The Chancellor of the Exchequer said: [..] we will completely change the tax treatment of defined contribution pensions to bring it into line with the modern world. There will be consequential implications for defined benefit pensions upon which we will consult and proceed cautiously, so the changes we announce today will not apply to them. But 13 million people have defined contribution schemes, and the number continues to grow. We have introduced flexibilities, but most people still have little option but to take out an annuity, even though annuity rates have fallen by half over the last 15 years. The tax rules around these pensions are a manifestation of a patronising view that pensioners cannot be trusted with their own pension pots. I reject that. People who have worked hard and saved hard all their lives, and done the right thing, should be trusted with their own finances, and that is precisely what we will now do: trust the people.[…] I am announcing today that we will legislate to remove all remaining tax restrictions on how pensioners have access to their pension pots. Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want: no caps; no draw-down limits. Let me be clear: no one will have to buy an annuity. 125

Further details of the Government’s plans were included in a consultation paper Freedom and choice in pensions (Cm 8835). On 20 May 2014, Pensions Minister Steve Webb made a statement setting the new proposals in the context of the Government’s pension strategy: Having ensured that the vast majority of workers build up a worthwhile pension pot on top of a simplified state pension, we now have a new opportunity to think about the choices people have in retirement. In the past, retirement was often a relatively short period of time, and the priority for most was to turn their pension savings into a regular income for as long as they lived. But in a world where people will routinely live for 25 years in retirement, we need to think more creatively and give people new options about what they will do with their own money. In the past, Governments were concerned that if people had freedom over their pension pots, they would run them down too quickly and then depend on state support in later life. The single-tier pension provides a game-changing opportunity to rethink this model. With people receiving a full single-tier pension already clear of the basic means test, the state need be much less prescriptive about how people use their accumulated pension savings. That is why the Government have announced a plan for radical liberalisation of the retirement savings market with effect from April 2015. Gone will be the detailed rules on how quickly people can turn their pension pot into annual income. Instead, for the first time, we will treat people as adults, giving them the flexibility to choose how best to use their hard-earned savings in the way that suits their personal circumstances. People will still be free to take a tax-free lump sum and turn the balance of their pension pot into an annuity, providing a guaranteed income for life, but they will also be able to withdraw the whole of their pension pot as cash to spend as they see fit, subject only to taxation on the balance in excess of the tax-free lump sum. Or they can decide to allow their money to go on growing, drawing cash as and when they wish, perhaps as part of a phased retirement—something that we have talked about for years and are now delivering. By lifting the rules, we anticipate that industry will respond with new products that meet consumers’ income needs in new and innovative ways.126

125 126

HC Deb 19 March 2014 c793 HC Deb 20 March 2014 c950-1

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Initial responses In his response to the Budget, Shadow Chancellor Ed Balls said his party would study the proposals carefully.127 In the debate on the Budget on 25 March 2014 Shadow Work and Pensions Secretary, Rachel Reeves, said the Opposition would judge the against three tests: First, is there robust advice for people who are saving for their retirement? Secondly, is the system fair to those on middle and lower incomes who want a secure retirement income? Thirdly, are the Government sure that the changes will not result in extra costs to the state, either through social care or by increasing housing benefit bills? We will continue to push for the reform of pensions, but it must be reform that works for people who have saved all their lives, who deserve security and confidence in retirement.128

The flexibility for people to choose their own vehicle to finance their retirement income was welcomed by Sir Edward Garnier, who had sponsored one of the Private Members’ Bills on retirement income funds in the previous Parliament.129 Other Conservative MPs welcomed the increased choice and thought it would act as an incentive to save.130 Crispin Blunt thought financial services companies would innovate in response to the announcement. The challenge was to “ensure the spirit of the reforms develops into a well-governed and safe experience to deliver good customer outcomes.”131 Chair of the Work and Pensions Committee, Dame Anne Begg, asked about the future for annuities: Annuities are an excellent principle—someone saves into a pot and then buys something that lasts them to the end of their life. We do not know how long we will live after reaching pension age, so an annuity provides insurance: we know it will not run out before we reach the end of our life. It insures against old age. All of that is right. However—this is the big but—what if there is no annuity market? What will the many people for whom an annuity is the right choice do then?132

Responding to the Statement on the Government’s pensions strategy, the Shadow Pensions Minister, Gregg McClymont, welcomed the increase in the limits applying to small pots that would take effect from March 2014. Regarding the longer term changes, he asked about the implications for the development of risk-sharing schemes: Finally, the Minister made great play of his defined ambition agenda, which is buried in his statement. How can one develop the collective pensions to which he subscribes when they depend on intergenerational risk-sharing? As we understand it, intergenerational risk-sharing becomes extremely difficult, if not impossible, if people exit the system at the age of 55.133

In debate on 2 July 2014, Mr McClymont further questioned the basis for the policy, given the rationale for auto-enrolment and evidence on customer experience of the annuities market: […] the Pensions Minister, has developed a whole pensions policy based on the notion that inertia has to be harnessed for the public good, meaning that, as a rule, people are 127

HC Deb 20 March 2014 c961 HC Deb 25 March 2014 c177 129 HC Deb 24 March 2014 c84; see Library Note SN 712 Pensions: income drawdown (May 2014) 130 E.g; HC Deb 25 March 2014 c 185 [Margot James; Charlie Elphicke]; HC Deb 24 March 2014 c96 [Caroline Nokes] 131 HC Deb 25 March 2014 c197 132 Ibid c237 133 HC Deb 20 March 2014 c953 128

30


not aware of the complexities of pensions and there therefore needs to be a system in place so that those who do not exercise a choice still get a good outcome. Is the hon. Gentleman really that confident that we will very quickly reach a situation in which there will be informed consumers across the board who can make the kinds of investment decisions to which he is referring? […] Would he care to comment on why the existing annuities market was not working? My understanding of the analysis is that the default position of individuals was simply to accept what they were offered and not to get involved in the type of process to which he refers. If that means that the annuities market was a failure because people were not getting value for money as a result of not shopping around, what confidence does he have that there will be an overnight revolution in people’s engagement with the type of guidance he suggests? 134

Outside Parliament, responses to the proposal were also mixed. Pensions expert Ros Altmann said the message of the Budget was that the Government “does believe in the value of saving and wants to trust people who have put money into pensions to manage their money for themselves in retirement, with far fewer rules and restrictions.” She said the beauty of the additional freedoms was that, as well as being popular with the public, they would bring in extra tax revenue in the near term.135 Michelle Cracknell of the Pensions Advisory Service (TPAS) welcomed the fact that individuals would have greater choice, although they would need help in making decisions: This budget will be remembered for introducing "grown up" pensions where individuals have more flexibility. This is good news and reflects that the people who we talk to whose retirement plans are more fluid; people do not just stop working and draw a pension these days. Greater choice can however make decisions more complicated. We know that from the volumes of calls we take on retirement decisions. We look forward to providing this help to more people going forward in order to help them make pension decisions that suits their retirement plans. 136

Others, such as the Low Income Tax Reform Group, welcomed the fact that the reforms “should force providers to be more competitive in what they are prepared to offer pension savers.”137 The ABI said the insurance industry looked forward to playing a key role in ensuring the reforms delivered better outcomes for customers, but that they represented a “significant challenge for everyone involved in helping people secure their retirement income.” In particular, it was crucial to ensure that customers had the information they needed to make the right choice for their circumstances.138 Other reactions were more sceptical. The Institute for Fiscal Studies issued a note of caution and said there were number of reasons why compulsory annuitisation might be a good thing. It could: -

reduce moral hazard (i.e. the risk that individuals exhaust their pension pots knowing they could receive means-tested benefits in retirement); help to prevent individuals exhausting their savings prematurely, for example, because they underestimate how long they are going to live;and

134

HC Deb 2 July 2014 c916-7 Ros Altmann, ‘UK Budget 2014: A watershed moment for pensions and savings’, Financial Times,19 March 2014 (£) 136 The Pensions Advisory Service, Budget 2014, 19 March 2014 137 LITRG, Pensioners put in greater control over their own cash, 20 March 2014; See also, ‘A brave new work for Britain’s savers, Financial Times, 21 March 2014 (£) 138 ‘Budget 2014: ABI comments on changes to pensions, 19 March 2014 135

31


-

reduce the risk of ‘adverse selection’, whereby there is an increase in the price of annuities because those still wanting to purchase one are disproportionately those who expect to live a long time.139

The NAPF was concerned that increased choice would bring a significant burden of responsibility for individuals to understand the choices they were making: Automatic Enrolment, one of the largest and most successful reforms of workplace pensions ever seen, was introduced to encourage people to make good financial decisions about their retirement, because experience tells us that people are often illinformed and make poor decisions about financial planning for old age. On the one hand the idea that savers can take their pension as a lump sum, albeit subject to tax, may be an incentive to save. However, this choice brings with it a significant burden of responsibility for individuals to understand the choices they are making. We know this is not always the case as people often underestimate how long they will live and overestimate how long their pot will last. There is a recognised problem with the lack of financial literacy in the UK and there is a distinct lack of detail in today’s announcement on how the Government will ensure people have access to good impartial advice so they make the right decisions about their income for retirement.140

The TUC feared that the reforms would not deliver a decent income in retirement: […] the main thrust of the Chancellor’s policy goes against what most people want from the pension system – a decent income in retirement. As no-one can know how long they will live, this is best achieved by sharing risk in collectively organised pension schemes. [..] Annuities are a broken product, but we are throwing the risk-sharing baby out with the broken market bathwater.141

The Financial Times said the changes upheld the important principle that individuals did not need the state to tell them what is best for their future. However, the Government must be ready to manage the risks its revolution entailed: The market for retirement products will be radically transformed. Annuities as we know them may well disappear. Since those with a health problem may not want to buy one, providers could find it harder to pool risks, pushing rates higher. But this will push the industry to innovate, offering products that are better tailored to the health conditions and life expectancy of an individual.[…]Financial watchdogs will also have to monitor the market closely: getting rid of the compulsion to buy annuities does not eliminate the possibility of mis-selling. In fact, given the probably proliferation of new products, it is likely to increase the risk of fraud.142

Former Labour adviser John McTernan described the reforms as “the privatisation and personalisation of massive risk with huge unknowns.”143 EEF welcomed the principles of the new regime but was concerned that the reforms were being rushed:

139

IFS, Budget 2014: pensions and savings policies, 20 March 2014 NAPF comments on 2014 budget, 19 March 2014 141 TUC Pension changes go in wrong direction 20 March 2014 142 ‘A brave new work for Britain’s savers, Financial Times, 21 March 2014 (£) 143 ‘This pension reform is no liberation – and Labour must explain why’, Comment is free, The Guardian, 24 March 2014 140

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They are of momentous importance and risk undermining the consensus that has been carefully crafted over the last decade or so as a means of encouraging private pension saving and raising incomes in retirement. 144

Expected impact The Government expects the reforms to result in increased income tax receipts in each year until 2030. After that, a small ongoing reduction in tax receipts of around £300 million a year is expected. Its assumption is that around 30% of people in DC schemes would decide to drawdown their pensions at a faster rate than via an annuity.145 Most recently, the Government has said that it expects around 130,000 a year to access their pension flexibly.146 However, the extent of behavioural change was difficult to predict.147 It hopes the changes will stimulate innovation and new competition in the market: […] with providers creating new products to satisfy individual consumer needs and meet new social challenges such as funding care later in life […]. It will also expand the market to allow further development of existing products, such as deferred annuities. 148

Evidence to the Treasury Committee’s inquiry into Budget 2014 suggested it was too early to predict the impact of the changes on the market. The Committee concluded that: 16. The market is likely to adapt, offering a new range of financial products for those approaching retirement. It is crucial that these products are not defective. Were they to be so, the reputation of the financial services industry, which has suffered severe damage in recent years from large scale mis-selling, would be further tarnished. (Paragraph 144) 17. The FCA has now been given new powers to intervene early, in advance of detriment occurring. In practice, this will be extremely difficult to accomplish without creating other forms of consumer detriment. In particular, it will be essential to avoid stifling market innovation. The use of these new powers will be a major test of judgement based regulation. (Paragraph 145) 18. The impact of these reforms on the annuity market will only be known after a number of years. Increased flexibility and choice in retirement will only benefit consumers if an active and innovative market offers a range of products, which should include annuities, to suit individual requirements. (Paragraph 152).149

Shadow Pensions Minister Gregg McClymont asked via a freedom of information request for the analysis underpinning the reforms, but this was refused. He said: The government needs to come clean on how they predicted savers’ behaviour would change under these reforms as this formed the basis of their estimates.[…] This has been such a radical change to the retirement income policy and usually with change of this sort would be published with a more detailed impact assessment.150

144

EEF response to Freedom and Choice in pensions consultation, June 2014 HM Treasury, Policy costings, March 2014, p11 146 HMRC, Tax Information and Impact Note - Pension Flexibility 2015, 8 August 2014 147 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 6.14 148 Ibid, para 3.19 149 Treasury Committee, Budget 2014, HC 1189, Budget 2014, Conclusions and recommendations 150 Josephine Cumno, Treasury refuses to reveal pension reform analysis, Financial Times, May 2014 (£);HC Deb 2 July 2014 c903 145

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2.3

The guidance guarantee

Consultation The Budget announcements will increase the options available to people. This is because the current system strongly encourages the purchase of an annuity unless the individual has savings below a certain amount (in which case they may be able to take it as a lump sum) or above a certain amount (in which case they may be eligible for flexible drawdown). A summary of the options available before 27 March 2014 (the date from which Budget 2014 introduced more flexibility was introduced to the lump sum and drawdown rules) can be found in Freedom and choice in pensions - Box 3A. The Government’s intention is that from April 2015, individuals aged 55 and over will be able to access their defined contribution pension savings as they wish, subject to their marginal rate of income tax.151 Their options will include: 

Taking their pension savings as cash, and/or



Buying an annuity (or other income generating guaranteed products that may emerge, and/or



Using drawdown but without any limits applies.152

The Government says that for many people “purchasing an annuity will remain the best way to secure an income, at least at some point.” However, it expects the new system to open up many more options for people. For example: 

those with more than one source of income, such as a defined benefit pension combined with a defined contribution pot, may prefer to keep their defined contribution pension invested and use their defined benefit pension to provide an income



those wishing to carry on working part-time through the early years of retirement may benefit from using their savings more flexibly, for example by accessing their tax-free lump sum only, before securing a retirement income through purchasing an annuity when they fully retire



those in good health who expect to live longer may prefer to purchase a drawdown product for the early years, and an annuity solely to cover their later retirement, at the point at which the longevity insurance it provides is more cost effective



for some individuals, it may make sense to use some of their pension fund to pay down their mortgage or other debts, or to find other sources of income, for example by investing in a business 153

Recognising that it will be important for people to make informed decisions, it has made a commitment to introduce a ‘guidance guarantee’: […] a new guarantee that all individuals with a defined contribution pension in the UK approaching retirement will be offered guidance at the point of retirement that: 

is impartial and of consistently good quality

151

HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014, Executive Summary 152 FCA, Retirement reforms and the Guidance Guarantee, CP14/11 21 July 153 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 4.6

34


covers the individual’s range of options to help them make sound decisions and equip them to take action, whether that is seeking further advice or purchasing a product



is free to the consumer



is offered face to face

4.12 To deliver this, the government will introduce a new duty that, from April 2015, pension providers and trust-based schemes must offer to each of their defined contribution customers a ‘guidance guarantee’ at the point of retirement.154

It said that people would need help navigating expanding choices, particularly in the light of experience with the annuities market: 4.7 The government recognises that, in expanding the range of choices available, there is a corresponding need to help consumers navigate those choices, so that they can make good decisions which suit their needs and circumstances. An informed, active customer base is critical to ensuring an effective market. 4.8 Although people may already seek information or advice before purchasing an annuity, the majority of people do not shop around. Those who do try to shop around often fail to find the help they need to secure the best deal for their individual circumstances and may find the options confusing. Consequently, over half of those reaching retirement simply purchase an annuity from their pension provider regardless of whether it is the best rate for them, or whether an annuity is right for them at all. 4.9 The FCA’s thematic review (set out in Chapter 2) concluded that the annuities market is not working properly for consumers. It found that consumers miss out on benefits available from shopping around and switching due to their lack of engagement in pensions and annuities. Consumers find the trade-offs they face confusing and the impact of inertia means that people often fail to make choices which would get them the most value out of their pension savings.155

Outside commentators have stressed the importance of people being able to make informed decisions. Age UK said: Giving people a real choice about how and when to use their pension savings is the right approach, but it must be an informed choice so the advice available to them when they make this crucial decision needs to be first rate. Making this a reality will be central to the success of the reforms and we look forward to working with the Government and the financial services industry to make sure this happens.156

The Treasury Committee said some consumers would require substantial guidance: Creating greater freedom and choice in retirement will require individual consumers to consider the range of circumstances they may face, in particular relating to longevity. They will need to make informed decisions based on their personal needs and likely circumstances. For some consumers, these choices will require substantial guidance.157

154

Ibid Ibid 156 Age UK, welcome help for savers but no gains for the poorest pensioners, 19 March 2014; ABI, Budget 2014: 11 thoughts on George Osborne’s pension plan, 20 March 2014 157 Treasury Select Committee, Budget 2014, 13th report 2013-14, HC 1189, May 2014 155

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TUC questioned whether the guidance would be sufficient: Independent guidance is clearly better than that provided by company sales teams, but half an hour of the best possible advice will not equip people for what could be thirty years of managing their pension pot. […] Expecting the market to deliver retirement income solutions that work for the great majority is unrealistic. The annuities market was broken, but what we need is the same careful consideration of policy, consumer preference and evidence that led to pensions auto-enrolment.158

The NAPF had previously argued that the same principles around inertia and defaulting being used in the accumulation stage by means of the policy of automatic enrolment, should be extended to the decumulation stage, to ensure that “in the event that the DC saver did nothing, they would still be guided through a process that led to a good outcome.”159 It said that the successful implementation of the Government’s proposals would depend on factors including: •

the development of appropriate and good value retirement income solutions and defaults;

•

the emergence of Guidance services that support people making retirement decisions.160

The Government’s consultation document Freedom and choice in pensions asked for views on questions including whether guidance should be delivered by an independent third party (rather than pension providers), whether the requirements to offer guidance should be different for trust-based and contact-based schemes and what more could be done to ensure guidance was available a key decision points during retirement.161 In July 2014, it announced a number of further policy decisions in relation to the guarantee: 

providers of guidance must be genuinely impartial; they must not have any actual, or potential, conflict of interest



the FCA will have an important role in setting and maintaining standards for guidance, and monitoring compliance with these standards. The FCA is consulting on proposed high-level standards in its parallel paper



the guidance service is intended to equip and empower people to make confident and informed choices on how they put their pension savings to best use; it will help people to ask the right questions, but will not itself make specific recommendations. As part of its standards-setting role, the FCA is consulting on the scope and content of guidance



the Treasury will hold overall responsibility for the service design and implementation until the guidance service reaches maturity, and will work with a range of organisations, including the Pensions Advisory Service (TPAS) and the Money Advice Service (MAS) to deliver the guidance service



individuals will be able to access and use the service in a range of ways, including face-to-face, online and over the phone, according to their needs and preferences

158

TUC press release, 21 July 2014 NAPF, Supporting DC savers at retirement, June 2013 160 HM Treasury consultation on ‘Freedom and choice in pensions’, an NAPF response 161 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, p47 159

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the government will legislate to require pension providers and schemes to signpost individuals to the guidance service as they approach retirement. The FCA will be responsible for setting and enforcing the detailed requirements for contract-based schemes and is consulting on proposed rules. The government will place equivalent legislative requirements on the trustees of trust-based schemes



the government will legislate to establish a levy on regulated financial services firms to fund the cost of the guidance service 162

Intensive design work would continue, with legislation following in the autumn via amendments to this Bill during its Parliamentary stages. Further the FCA would publish a Policy Statement later in the autumn.163 Legislation would be needed to: […] establish a new, separate FCA standards regime and to give the FCA, as the expert conduct regulator, the appropriate duties and powers to set standards and monitor compliance. […] place a statutory obligation on the FCA to make rules to require contract-based pension scheme providers to signpost their customers to the impartial guidance service, and […] introduce an equivalent requirement on trustees of trust-based schemes (by amending existing disclosure requirements on occupational pension schemes) to do the same for their members. […] establish a new levy on regulated financial services firms.164

Issues ‘Guidance’ not ‘advice’ Although in his Budget Statement, the Chancellor had referred to ‘advice’, the consultation document made clear that this was a guarantee of ‘guidance’: We will introduce a new duty on pension providers and schemes to deliver this ‘guidance guarantee’ by April 2015. We have asked the Financial Conduct Authority to make sure this guidance meets robust standards, working closely with consumer groups. And we will make available a £20 million development fund to get the initiative up and running.165

There are important differences between advice and guidance. Independent financial advisers must be registered with the Financial Conduct Authority (FCA) and have certain qualifications. They must carry out a ‘fact find’ where they ask detailed questions about the individual’s circumstances, goals and how they feel about taking risks with their money. They may recommend specific products. Advice comes with a series of guarantees and consumer protections. If an individual ends up with an unsuitable product after getting advice, they may have a case for ‘mis-selling’. There is generally a fee for advice which must be paid by the recipient. However, set against this cost would be any improvement in outcome as a result of the individual choosing a more suitable product than they would have found for themselves.166

162

HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014, p19 163 Cm 8901, para 3.28-9 164 Cm 8901, para 3.13, 3.15 and 3.21 165 Ibid page 3 166 Money Advice Service website – Do you need a financial adviser; Financial Conduct Authority website – Assessing customer needs

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For the purposes of the Government’s guarantee, guidance will differ from advice in important ways. It will be free to the consumer at the point of delivery and will aim to inform people about options available. It is not intended to stray into areas such as specific product or provider recommendations, which should be handled by an authorised financial adviser. Ultimately, consumers will be responsible for the decisions they make.167 In evidence to the Work and Pensions Committee on 30 April 2014, Pensions Minister, Steve Webb said that guidance would be about “getting people up to the starting gate”: The thing that we are talking about is free to the consumer. There is no charge for it. It is what we call “guidance”, rather than independent financial advice, so it is not formal, detailed, or product-specific; you can go and buy that if you want to, but this is familiarising people with the options they have and some of the concepts, even. Most people do not even know what an annuity is. 168

The FCA explains that the objective is to “empower consumers to make informed and confident decisions on how they use their pension savings in retirement”: 2.10 The objective of the Guidance Guarantee is to empower consumers to make informed and confident decisions on how they use their pension savings in retirement. To be effective the guidance will need to be tailored, providing consumers with sufficient personalised information. 2.11 Therefore, the guidance will inform, educate and help empower pension savers. It will equip consumers with information about their options when accessing their pension savings. The guidance will give consumers key facts and information about the consequences of the relevant options, for example taxation. It will also set out other issues the consumer should consider based on the information the consumer puts into the discussion; for example, the needs of the family where a consumer has a spouse or dependants. It will provide clear next steps and appropriate signposting to further sources of information or advice. The consumer will receive a record of the session for future reference and continuation of their retirement journey. 169

In his evidence to the Work and Pensions Committee, the Minister explained why the Government’s guarantee was for guidance rather than advice: The challenge is that for modest annuities, the cost of proper independent financial advice—surveying the market and so on—would be very significant relative to the size of the pot. […] I think forced advice would be a real challenge. At the moment, people use different figures for the typical pot, but £25,000 to £30,000 is not unusual. If you spent £500 to £1,000 on advice, or that kind of figure, that is a big chunk out of a small pot. […] I do not disagree for a second that we need people to be making informed choices. […] On the other hand, we just put a charge cap on pensions at 0.75%. Any levy on the industry, ultimately, will probably come out of consumers’ pensions, and so we have to be a bit careful about buying advice for everyone when there is probably a set of people who do not really need it and a set of people who will freely choose to buy it anyway.170

167

Financial Conduct Authority, Retirement reforms and the Guidance Guarantee, CP14/11 21 July 2014, para 2.12; HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 4.11 168 HC 1248, 30 April 2014, Q23 and 30 and 41 169 FCA, Retirement reforms and the Guidance Guarantee, CP 14/11, July 2014 170 HC 1248, 30 April 2014, Q39 and Q78; For information on the costs of advice and guidance, see National Association of Pension Funds, Supporting DC savers at retirement: an analysis of the advice and brokerage market, June 2013, para 31

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The Government is exploring the extent to which regulated advice might be made more affordable: 4.16 The entitlement to high quality, impartial, tailored financial guidance is a critical first step for consumers at the point of retirement. They will be able to talk through the available options and explore which ones might best suit their personal circumstances. 4.17 Many consumers will want to seek further assistance or advice following their guidance session, in particular to help them purchase a product: this may be regulated investment advice (if the individual is considering a drawdown product) or an annuity brokerage service. Some may want to purchase a product without seeking advice (known as ‘execution only’) and may want to use a comparison site to find the best deal. The government will consider ways to ensure that individuals are equipped with the skills and information to choose the adviser, broker or comparison site that suits their needs and that they understand the nature of the advice or service they will be getting. 4.18 Greater flexibility will mean that more consumers may opt for investment products and therefore will want to access regulated investment advice to help them gauge their risk appetite and consider their wider financial circumstances. The government will work with the FCA to explore the extent to which regulated advice can be made more affordable through more cost effective delivery, such as through the development of online delivery channels. The FCA has already begun a project that aims to help firms providing advisory services to understand better the boundary between regulated investment advice and non-advised services and to look at the issues which may be inhibiting firms providing regulated advice from delivering a streamlined advice service. The project will use the findings of FCA thematic work, consumer research and industry input to identify the issues and provide guidance to support firms in relation to wider investment advice as well as advice in relation to income in retirement. 4.19 Additionally, as more people elect to make use of the new, more flexible options open to them they will need continuing access to support to help them make financial decisions later in their retirement – for example, as the issue of social care becomes increasingly important. The government welcomes views on what may be needed to improve access to the right guidance throughout retirement.171

How and when people will access guidance Pension schemes and providers would be required to signpost their customers to the guidance shortly before their retirement date: 3.15 The majority of respondents supported the government’s proposal that pension providers and schemes should bear responsibility for ensuring that their customers and members are offered guidance at the point of retirement. The government will place a statutory obligation on the FCA to make rules to require contract-based pension scheme providers to signpost their customers to the impartial guidance service, and will introduce an equivalent requirement on trustees of trust-based schemes (by amending existing disclosure requirements on occupational pension schemes) to do the same for their members. The FCA, in its parallel consultation paper, has proposed rules to require signposts to be included in literature sent to customers and members four to six months before their intended retirement date, as well as when an individual contacts their provider or scheme indicating that they wish to access their pension funds. 172

171 172

HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014 Ibid

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In the first instance, the service would be principally targeted at those likely actively to be planning to retire: 3.18 Many respondents agreed that, with the new flexibilities taking effect in April, guidance should at the outset be focused on supporting decision-making at the point of retirement. The government has decided that the guidance service will be principally targeted at those who are likely actively to be planning to retire. The government will give further consideration to how individuals can receive subsequent support should their circumstances change or if they have needs that otherwise extend beyond what the guidance is intended to deliver. 173

Most respondents to the consultation signalled that a “one-off guidance session at the point of retirement would be unlikely to cover the full spectrum of decision points during retirement.”174 In the Budget the Government said that people would be offered face-to-face guidance.175 In its response to the consultation, it said some individuals would want to access guidance through a mix of channels. It was considering how to ensure people could access it in the way they wanted: 3.21 Consumers will want to use the service in a way that they find convenient and engaging. The government is committed to ensuring that those consumers who want or need face-to-face guidance will be able to access it. It agrees with the views put forward by respondents that, for many consumers, other means of engaging with the service – such as online or telephone support – will better suit their needs and preferences. 3.22 Some individuals will want to be able to access guidance through a mix of channels. A saver may, for example, wish to use a web-based tool in their own home, but also value being able to talk to someone on the phone when things get more complex. 3.23 As part of the service design work currently underway, the government is considering how to ensure consumers can access their guidance in the way they want, and will draw on behavioural insights and extensive user research to provide a service that works for its users.176

Standards The Government intends to legislate to establish a standards regime for guidance, separate to the authorisation and regulation arrangements that apply to advice, with the FCA responsible for setting standards and monitoring compliance: 3.13 The government does not believe it would be appropriate for the organisations which will deliver the guidance to be subject to FCA authorisation and regulation in respect of this activity. However, to ensure the conduct of these organisations is subject to appropriate standards, the government will bring forward legislation to establish a new, separate FCA standards regime, and to give the FCA, as the expert conduct regulator, the appropriate duties and powers to set standards

173

Ibid HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014, p36 175 HM Treasury, Budget 2014, HC 1104, March 2014, para 1.160; See also, HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 4.11 176 HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014, para 3.21-3 174

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and monitor compliance. The Treasury will be responsible for designating the guidance delivery partners that will be subject to the standards regime, and will ultimately be responsible for ensuring that remedial action is undertaken on the basis of any recommendations about their conduct from the FCA. The government will also bring forward legislation to clarify that the delivery partners designated by the Treasury as official providers of the guidance, and subject to the standards, will not need to be authorised in respect of this activity. This approach will help prevent unscrupulous firms passing themselves off as providers of guaranteed guidance. 177

The FCA published a consultation on Retirement reforms and the Guidance Guarantee on 21 July, with responses requested by 22 September 2014. It said: 1.22 We are proposing a suite of principles-based standards, which the delivery partners delivering the Guidance Guarantee will need to comply with. 1.23 The proposed standards cover the following areas: • Ensuring the guidance is free at point of delivery • Consistency and quality of the delivery of the guidance • Professional standards • Communications • Systems and controls • Complaint management • The information the delivery partners will use in giving the guidance • Content of the guidance session • Helping the consumer to take the next step • Providing a record of the guidance178

These standards would be of relevance to trustees and members of trust-based schemes as well as the pension and retirement product providers it regulated.179 They would require those delivering guidance to meet certain requirements. For example: 2.7 The delivery partner should set factual financial and personal information that would be helpful for the individual to gather before the guidance session. While consumers cannot be required to divulge personal information, the delivery partner should encourage the consumer to provide this information on the basis that it will make the session more meaningful and helpful to them. 2.8 The delivery partner must discuss with the consumer their relevant options and provide key facts and information on the consequences of each of those options. Based on the information provided by the consumer, the delivery partner must set out other issues for the consumer to consider. 2.9 The delivery partner must also ensure that the consumer receives a record of their guidance session.180

In addition to discussing the options available, guidance should alert consumers to areas they may not have considered: […] for example longevity and the danger of running out of money during retirement, the possible impact of state benefits and possible long-term care needs.181

177

Ibid FCA, Retirement reforms and the Guidance Guarantee, CP 14/11, July 2014 179 Ibid, para 2.3 180 Ibid 178

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Delivery by independent third parties The Government sought views on whether guidance could be delivered by pension providers without compromising impartiality: On the one hand, robust standards and monitoring should help to mitigate the risks. On the other hand, ‘in house’ guidance may not be perceived as genuinely impartial, meaning that, to be successful, guidance needs to be provided by a third party that is independent of the provider.182

In July 2014, the Government said it had decided guidance would be delivered by independent third parties, building on capability in existing organisations: 3.5 Almost every respondent agreed with the government’s central policy goal that guidance must be trusted by consumers. The vast majority, including most financial services industry respondents, said that consumers would not trust guidance given by a person or organisation with a vested interest in selling a financial product or service. The government has therefore decided that the guidance guarantee will be provided by organisations which are independent and have no actual (or potential) conflict of interest. […] 3.8 As noted by many respondents, the government has set a challenging timetable for delivering guidance by next April. It agrees that a clear strategy and forward plan which sets out clear roles and responsibilities is vital to ensure the service is up and running effectively in good time. The government has therefore decided that, until the service has reached maturity, overall responsibility for service design and implementation will remain within the Treasury, which will work with a range of organisations (including TPAS and MAS) to deliver guidance to individuals. .183

The Money Advice Service was set up under the Financial Services and Markets Act 2010. Its statutory remit is ‘consumer financial education’ – equipping individuals to manage their own affairs and enabling them to get a good deal from the financial services marketplace. It is funded by a levy on authorised financial services firms, payment service providers and electronic money issuers. It is currently the subject of an independent review, the purpose of which is to consider the role played by MAS in meeting changing consumer needs for information, education and advice on financial matters and to make recommendations to improve the efficiency and effectiveness of current arrangements. The Pensions Advisory Service is non-departmental public body which provides information and guidance to members of the public on pension issues and helps with complaints and disputes with occupational or private pension arrangements. It is funded by a grant from DWP, which is recovered from a general levy on schemes. (DWP, Triennial Review of Pension Bodies, 2014).

181

Ibid para 2.27 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 4.15 183 HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014 182

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The ABI said that the approach being taken would help ensure the guarantee was delivered in the short term. However, it said that the role of providers should be kept under review.184 The NAPF was concerned that the ‘clock was ticking’: Up to 500,000 people will need guidance next year. Workplace pension schemes want to help their members make good decisions. To do that, they need to know how to adapt their own communications to signpost and complement the guaranteed service. They will also want to be confident that the new service is fully-tested and ready to deliver from day one. With less than 200 working days to go, the clock is ticking .185

Funding In Budget 2014, the Government said it would make available £20 million over the following two years to develop the guidance guarantee.186 In July 2014, it announced that the guidance service would be funded by a levy on regulated financial services firms: 3.24 The government has given careful consideration to the most appropriate way of funding the guidance service, and the consultation responses received. It believes those firms that are likely to benefit from consumers who are better informed about their needs and the choices available to them – and more engaged with and confident about the decisions they are making – should help to fund the delivery of the service. The government therefore intends to legislate to establish a new levy on regulated financial services firms. 3.25 The government will determine the size of the overall levy needed to fund the guidance. Given its existing relationships with the firms who will pay the levy, the FCA will collect the levy and consult on its detailed design (including how it is apportioned across different firms), which must be approved by the Treasury. The FCA is consulting on high level proposals for the levy in its parallel consultation paper, with more detailed proposals to follow in the autumn. The FCA has proposed that the levy should be targeted on those firms which are likely to derive most benefit as a result of the guidance, and that the levy should be proportionate, meaning that some firms will pay a minimal amount or nothing at all.187

The FCA is consulting on how this should work, Specifically: 3.1 The Government consultation response sets out the role for us in collecting the levy to fund the provision of retirement guidance. This includes the design of the levy so that it is raised from the population of firms that will potentially benefit from the retirement guidance service in terms of more engaged and empowered consumers, making better-informed decisions about how to use their pension pots in retirement. 3.2 The Treasury will set the overall amount of the levy. We will need to seek agreement with the Treasury over the design detail we include in our consultation on draft levy rules and before making final levy rules. 3.3 In this chapter we are seeking views on our provisional proposals for: • using the existing FCA ‘A’ fee-block framework for collecting the levy to fund the retirement guidance

184

ABI press release, 21 July 2014 NAPF press release, 21 July 2014 186 HM Treasury, Budget 2014, HC 1104, March 2014, para 1.160 187 HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014 185

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RESEARCH PAPER 14/44 • identifying which firms should contribute to the retirement guidance levy • how the overall levy should be allocated across the identified firms 3.4 These views will inform our consultation on draft levy rules in our annual fees policy consultation paper in October 2014.188

For more detail, see Library Note SN 6891 Flexibility for DC pension savers from April 2015.

3

The Bill

The Queen’s Speech on 3 June 2014 included a Private Pensions Bill to: Provide wider choice, with Defined Ambition pensions encouraging greater risk sharing between parties and allowing savers to have greater certainty about their retirement savings. The main benefits of the Bill would be to: 

Introduce new definitions in into the current legislative framework.



Encourage new forms of pension schemes that provide more certainty for individual members about their pension than current Defined Contribution schemes, which currently dominate the market, while limiting costs for employers to realistic levels.



Enable ‘collective schemes’ that pool risk between members and potentially allow for more stability around pensions outcomes in retirement.

The main elements of the Bill are: General changes to Pensions Legislation The Bill would make provisions for a new legislative framework in relation to the different categories of pension schemes. It would establish three mutually exclusive definitions for scheme type based on degree of certainty in the benefits that schemes offer to members. The Bill would define schemes in terms of the type of ‘pensions promise’ they offer to the individual as they are paying in. A scheme would be categorised as a Defined Benefit scheme, a Defined Ambition (shared risk pension) scheme or a Defined Contribution scheme, corresponding to the different types of promise – full promise about retirement income, a promise on part of the pot or income, or offering no promise at all. Collective Benefits 

Enabling ‘collective schemes’ that pool risk between members and potentially allow for greater stability around pension outcomes. It would also contain a number of measures relating to the valuation and reporting requirement for collective schemes.

Rationale

188

Financial Conduct Authority, Retirement reforms and the Guidance Guarantee, CP14/11 21 July

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Defined Contribution pensions – where individual scheme members bear the risks of longevity, inflation and investment returns – currently dominate the UK pensions market.



Defined Benefit pensions – where the employer bears the risks by promising a pension usually related to salary – are in decline.



Defined Contribution pensions can be the right product for many savers, but outcomes will be less certain and more volatile than those with Defined Benefit Pensions.



The Bill is needed to encourage new Defined Ambition pensions, in the middle space between Defined Contribution and Defined Benefit pensions that share more of the risk between parties.189

The Pension Schemes Bill 2014/15 was published on 26 June 2014. It is scheduled to have its Second Reading on 2 September 2014. The Bill, Explanatory Notes and an Impact Assessment can be found on the dedicated Bill page of the Parliament website. In its response to the Freedom and Choice in pensions consultation on 21 July 2014, the Government said it would bring forward amendments to the Bill in the autumn to introduce the guidance guarantee.190 The Bill contains a number of regulation-making powers. Under clause 41 they are subject to the negative resolution procedure in Parliament (which means they become law without a debate or vote but may be annulled by a resolution of either House of Parliament). The exception is regulations under clause 40 to amend primary legislation, which would be subject to the affirmative resolution procedure (which means that both Houses of Parliament must expressly approve them).191 The Department has produced a Delegated Powers Memorandum explaining the provisions for delegated legislation in the Bill.192 Clause 43 provides that the main provisions in the Bill (Parts 1 to 3) apply to England, Wales and Scotland. Part 4 (miscellaneous and general) extends to Northern Ireland, except for clauses 38 (payments into the Remploy pension scheme) and 39 (references to pensions legislation amendments to include this Act). 3.1

The legislative approach to ‘defined ambition’

In November 2013, the Government said it proposed to create a specific DA space in legislation. It would also define DB schemes in their own right. It hoped that the new definitions would enable greater clarity about the requirements applying to the different types of scheme: 3. Historically, pensions legislation has broadly classified schemes as either money purchase or non-money purchase, with a money purchase scheme being one which only offers money purchase benefits. Although money purchase schemes are commonly referred to as DC, they are not defined as such in legislation. 4. With the introduction of DA there is the opportunity to recast the legislation, distinguishing between DB and DA schemes in the non-money purchase space. We therefore propose to create a specific DA space in the legislation, taking the Gov.UK, Queen’s Speech 2014 – what it means for you - Private Pensions Bill, 4 June 2014 HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014, para 5.3 191 UK Parliament website – Statutory instruments. For more detail, see Library Note SN 6509 Statutory instruments (December 2012). 192 DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911 189 190

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opportunity to move away from the polarity created by the existing definitions and giving explicit recognition in legislation to the potential for innovation in risk sharing in the middle ground. 5. At the same time, we propose to define DB schemes in their own right. With the creation of new definitions of DA and DB schemes, distinct from each other and from money purchase schemes, we can more easily provide clear and proportionate regulation according to scheme type, giving clarity and reassurance to employers and providers. 6. To enable schemes to evolve and change, we do not propose to create entirely new and separate legislative regimes for the different types of schemes, but instead will use the new definitions to help make clear the distinct requirements that apply to each type of scheme. We see ease of transition as vital to make DA attractive to employers. 7. The aim would be to create a conceptual linkage for the different types of pension scheme that would fall within the DA space and set out the common requirements that recognise their characteristics as distinct from DB and money purchase schemes. 8. It would represent a shift in the legislation, setting out an approach based on the scheme as a whole. This could encourage innovation and act as a greater incentive for schemes to offer a mix of benefits. It would also provide a very clear space for us to set out the characteristics of being a DA scheme, and make it easier for existing schemes to change shape in relation to future accruals. 193

A change in the status of schemes would result in schemes becoming subject to different requirements.194 It said that for DA schemes issues such as governance, member communications and funding would need special attention: […] We believe that the areas of governance, member communications and funding will need special attention, because in DA schemes where some benefits may be discretionary or where the outcome for the member is less certain than in DB schemes but more complex than in money purchase schemes, there will be new responsibilities for the trustees or those running the schemes, and a need to explain to members clearly what the benefits and risks of the schemes are, and what any guarantee means.195

In terms of governance, it said: […] there could be a case for introducing requirements to ensure that where there is discretion in a scheme, trustees or scheme managers give proper and regular consideration to the exercise of that discretion. 35. In addition, given the extra responsibilities on those running such schemes, there is a strong case for imposing different requirements to reflect the greater emphasis on discretion and risk sharing – for example in relation to the levels of knowledge and understanding required and internal controls and processes. There may also be a need to make clearer the expectations about how trustees should manage DA schemes as

193

DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p50 Ibid, p55-6, para 43-6 195 Ibid, p54 para 33 194

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RESEARCH PAPER 14/44 long-term propositions – with appropriate mechanisms for allowing schemes to evolve.196

For communications, it said that the nature of DA schemes might mean there was a clear case for a specific set of information requirements. This was because they offered a degree of guarantee but not absolute certainty, so the “nature of the pension promise may be harder to understand and more complex to communicate without being misleading.”197 As regards funding requirements, the element of guarantee inherent in DA meant there would inevitably be some degree of overlap with DB schemes in relation to scheme funding requirements. However, the requirements would depend on the extent of any promise or guarantee and who stood behind it: 41. Schemes which make a promise in relation to the benefit will need to be funded to be able to meet that promise, but funding requirements should only apply to the extent of the promise or guarantee, and the nature of the funding obligation will depend on who is standing behind the promise. • An employer-sponsored occupational pension scheme which offers a salaryrelated pension with discretionary indexation would need to be funded in accordance with the current scheme funding requirements which apply to occupational pension schemes, equal to the technical provisions – but only to the levels needed to cover the basic pension liability. • A Regulatory Own Fund vehicle offering deferred annuities and discretionary benefits would need to be funded to the level required to meet the discounted capital value of the liabilities (technical provisions) plus an appropriate buffer. 42. Where the employer stands behind the promise in an occupational pension scheme, Pension Protection Fund protection and employer debt obligations would continue to apply as now. These provisions will however need amendment to reflect the different structures of DA schemes and to take account of altered employer obligations. While Pension Protection Fund levies would continue to apply, they would need to be calibrated to reflect the liability accruing as a result of the given promise. 198

The Government also set out its thinking in relation to ongoing initiatives in relation to DC scheme quality, automatic transfers and auto-enrolment: […] the Government is keen to ensure that there are appropriate minimum standards for workplace DC schemes – particularly as they will be heavily used for automatic enrolment. 52. However, requirements that might be applied to money purchase schemes, such as bans or caps on certain types of charge currently being consulted on will not necessarily be appropriate for DA schemes in the same way. This reflects the fact that a partial guarantee offers a degree of protection over pot erosion and that DA schemes may be more complex (and hence involve additional cost). 53. In a similar vein, and given the potential variety of DA schemes, we anticipate we would not necessarily propose to impose the same quality standards on DA schemes as those on which the Government issued its call for evidence in July, especially since some aspects (such as governance) will be covered under specific DA requirements.

196

Ibid p55, para 34 Ibid p55, para 37 198 Ibid p55 197

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54. It is also our current intention that DA schemes would be outside any system of automatic transfer (pot follows member) since this would involve transfers of incommensurable benefits. 55. We will however, need to ensure that DA schemes are able to be qualifying schemes for automatic enrolment purposes, which may require amendments to the automatic enrolment legislation, certification guidance and regulations.199

In June 2014, it said it had made some changes to its proposed approach: We will continue, as intended, to establish mutually exclusive definitions for scheme type based on degrees of certainty for members. We will also ensure proportionate regulation by applying requirements to certain features – where there is a promise, for example, ensuring it is funded – while still maintaining transparency in the law so that employers are clear on the extent of their obligations. We are committed to avoiding legislation that is overly prescriptive; instead, we want to allow schemes to evolve and innovate. Where we have deviated from the ideas set out in the consultation, we have put additional safeguards in place to ensure the new schemes work to their full potential. We are introducing a new definition of collective benefit, which could be offered under DA or defined contribution (DC) schemes. We will refine the definition of DB scheme to take account of certain discretionary features which already exist in some DB schemes and broaden the definition of DC to cater for self-annuitising and CDC schemes (that do not provide a promise or guarantee during the accrual phase). Money purchase schemes will fall within the DC scheme definition. 200

The Bill creates a new category of “shared risk scheme (sometimes known as ‘defined ambition’). 3.2

Part 1 – definitions

Historically, legislation has broadly classified pension schemes as either money purchase, or non-money purchase.201 The definition in the Pensions Schemes Act 1993, as amended by the Pensions Act 2011 provides that: In order for a benefit to qualify as a money purchase benefit, the amount or rate of the benefit must be calculated only by reference to assets which must necessarily suffice to provide the benefit. If any other factor such as a guaranteed investment return or other guarantee of the amount where used at any time to calculate the benefit, it is not a money purchase benefit.202

The Government said amendment was needed following the decision of the Supreme Court in Houldsworth vs Bridge Trustees. The Supreme Court had decided that that certain benefits should be treated as “money purchase benefits” even though it was possible for them to develop funding deficits.203 The Government said that the decision had created uncertainty about the types of benefits that fell within the money purchase definition and that amendment was needed in order to ensure scheme members were protected

199

Ibid p57. For more detail, see Library Note SN 6956 Improving outcomes for DC pension savers DWP, Reshaping workplace pensions for future generations: government response to the consultation, Cm 8883, 25 June 2014 201 DWP, Reshaping workplace pensions for future generations, November 2013, Cm 8710 202 Pensions Act 2011 – Explanatory Note, para 157 203 The Supreme Court produced a press summary of the decision 200

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appropriately.204 Following consultation, the details were provided for in two statutory instruments.205 Part 1 of the Bill define three mutually exclusive definitions of pension. The definitions are based on the type of promise the scheme offers members during the accumulation phase about the retirement benefit (retirement income or a retirement lump sum provided to members).206 Briefly: -

A defined benefits scheme is one that provides a pre-determined retirement income to all members, beginning at pension age and continuing for life. There must be a ‘full pensions promise’ to members, which means that the level of benefit is determined wholly by reference to that promise in all circumstances;

-

A shared risk scheme is one that offers a ‘pension promise’ but not a full pension promise, to all members at some point during the accumulation phase in relation to at least some of the retirement benefit that members might receive; and

-

A defined contributions scheme is one that gives no promise during the accumulation phase in relation to any of the retirement benefits that may be provided to members.

These are discussed in more detail below. The new definitions apply only where the legislation expressly states that they should. They do not apply in any public service pensions legislation (clause 1 (2)). The new definitions do not require employers to offer DA models or to bear more risk. There may be some costs for current schemes, arising from the need to assess how the new definitions apply to them and identify themselves under the current framework.207 Defined benefits In June 2014, the Government said it would “refine the definition of DB scheme to take account of certain discretionary features which already exist in some DB schemes”.208 Clause 2 provides that a defined benefits (DB) scheme is one that provides a predetermined retirement income to all members: This type of scheme provides a pre-determined retirement income to all members, beginning at the scheme’s normal pension age or decumulation point and continuing for life. This income is pre-determined insofar as it is set at a rate that is calculated according to promised factors as stipulated in the scheme rules or other scheme documentation. This is expressed as a ‘full pensions promise’ to members. The normal pension age or earliest occasion for accessing the full benefits is fixed – that is, the only way the age or period of accumulation can change is by change to the scheme

Pensions Bill 2011 – factsheet 2 – Government amendments to the definition of “money purchase benefits”, 17 October 2011; HC Deb 13 October 2011 c46-8WS; SI 2014/1954 Explanatory Memorandum 205 The Pensions Act 2011 (Transitional, Consequential and Supplementary Provisions) Regulations 2014 (SI 2014/1954); The Pensions Act 2011 (Transitional, Consequential and Supplementary Provisions) Regulations 2014 (SI 2014/1711) 206 Bill 12 EN, para 31 207 DWP, Pension Schemes Bill Impact Assessment. Summary of Impacts, June 2014, DEP2014-0911, p15-6, para 23 and 31 208 DWP, Reshaping workplace pensions for future generations: government response to the consultation, Cm 8883, 25 June 2014, p40 204

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rules. Schemes where the normal pension age changes in line with state pension age, without requiring a change to the scheme rules, are thus excluded. Also excluded are schemes which apply a longevity factor to the benefit entitlement. 209

Clause 5 (1) provides that: […] there is a full ‘pensions promise’ provided to members, if, at all times before the benefit comes into payment, there is a promise about the level of benefit that will be received and the level of benefit is determined wholly by reference to that promise in all circumstances. The promise refers to a member’s retirement income, but may also include the ability to withdraw a retirement lump sum at an amount that is set out within the scheme.210

An example of a DB scheme is a salary-related scheme, providing benefits based on a proportion of salary (whether final or career average) and length of service: A salary-related pension scheme where the retirement income to be paid out is determined according to a formula based on salary: for example, 1/80 x average salary x years in pensionable service. The age or point at which this income can start to be paid in full to members can only be changed by a change to the scheme rules. 211

Key to the definition is the fact that there is a full pension promise i.e. that the member is given complete certainty about the level of benefit they will receive in retirement. This means that a scheme may be DB “regardless of its status as an occupational or personal pension scheme and regardless of who stands behind the promise made by the scheme.”212 Clause 5 (6) provides that a benefit does not fail the test (of providing benefits determined wholly by reference to the promise in all circumstances) just because the scheme confers discretion to vary the benefit for reasons related to a member’s individual circumstances. One example would be provision for early payment of a full pension on ill-health grounds - a common feature of current DB schemes.213 There is regulation-making power to enable DWP to further examine and consult on those discretions which should not impact on whether a benefit is considered as having a full pensions promise. This is because: Where a discretion is capable of being used only in relation to individual circumstances, subsection 6 (a) provides for it to be disregarded so that this would not affect the categorisation of a defined benefits scheme because there is still a full pensions promise –for example, providing for benefits on grounds of ill health before the normal pension age. However, there are also some wider discretions in some schemes which could potentially affect whether a benefit meets the requirement under subsection (1) (b).214

Shared risk Clause 3 provides that a shared risk scheme is one that offers a ‘pension promise’, but not a full one, in relation to at least some of the retirement benefit that members might receive. 215

209

Bill 12 EN, para 32 Ibid para 39 211 Ibid para 36 212 DWP, Reshaping workplace pensions for future generations: government response to the consultation, Cm 8883, 25 June 2014, p38 213 Ibid para 43 214 Clause 5 (6) (b); DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911 215 Bill 12 EN, para 32 210

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Clause 5 (2) provides that for the purpose of shared risk and defined contribution schemes, a pension promise is provided if: […] there is a promise to members during the accumulation phase, in relation to a retirement benefit, about the level of benefit that will be received. The level is the rate of the income or the amount of the lump sum (see clause 7). The promise must be expressed at a time before the benefit comes into payment, but unlike under a defined benefits scheme, does not need to be expressed at all times before payment, i.e. throughout the accrual phase.216

The Explanatory Notes explain that a shared risk scheme is one where some contributions are used to purchase a deferred annuity or otherwise secure a promise about part of the income that will be received in retirement: A pension scheme into which the employer and employee pay contributions. These contributions are then invested, and so the retirement benefit in part depends on how those investments perform, but some contributions are used to purchase a deferred annuity or otherwise secure a promise about part of the income that will be received in retirement. The retirement benefit is a combination of that promise and the funds accumulated via contributions and investment returns.217

A cash-balance scheme would also fall within this definition. This is because: A cash-balance scheme gives its members ‘some form of guarantee but not complete certainty on the level of income’, because: 

the sum accrues on a defined basis;



the actual amount of income that the member will receive in retirement is unknown because it will depend on market factors at the time the sum is used to purchase an annuity. 218

A money purchase scheme with an element of guarantee would also be defined as a shared risk scheme.219 Defined contributions In June 2014, the Government said it would: […] broaden the definition of DC to cater for self-annuitising and CDC schemes (that do not provide a promise of a guarantee during the accrual phase). Money purchase schemes will fall within the DC scheme definition. 220

Clause 4 provides that a scheme is a defined contributions (DC) scheme if there is no pensions promise in relation to any of the retirement benefits that may be provided to member. For example: A pension scheme into which the employer and employee pay contributions, which are then invested. The retirement benefit depends wholly on the money contributed to the scheme and the investment return, and potentially any pooling of risk between 216

Ibid para 40 Ibid para 36 218 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p51 219 Bill 12 EN para 43 220 DWP, Reshaping workplace pensions for future generations: government response to the consultation, Cm 8883, 25 June 2014, p40 217

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members, and so the employee is given no certainty at all during the accumulation phase.221

Meaning of pension promise Clause 5 explains what is meant by a pension promise. For example, Clause 5 (3) provides that a pensions promise would include a promise about the factors used to calculate the level of retirement benefit but not a promise to pay benefits by reference to what a pension pot or pool of assets can provide: 41. Any promise about a level of retirement benefit includes a promise about the factors that will be used to calculate the level of a retirement benefit (subsection (3) (a). These factors, may, for example, include the length of pensionable service, or be linked to the member’s salary but do not include longevity factors. A promise that the level of retirement benefit will be calculated by reference to what the pot of contributions or investment returns can provide does not constitute a ‘pensions promise’ for the purposes of defining a defined benefits or shared risk scheme (subsection (3) (b). Neither is it a promise where a scheme specifies the factors that will be used to distribute the assets between members and establish the value of a collective benefit (subsection (3) (c)).222

Clause 5 (4) provides that a promise is provided if the scheme sets out the promise, or requires it to be obtained from a third party. This “enables a pension scheme to be defined on the basis of a pensions promise regardless of whether it comes from the scheme itself, the employer or a third party.”223 Under clause 5 (5) there is a promise if the scheme offers it as an option. This means that: […] the scheme categorisation depends on what the scheme offers to members, not the offer that individual members take up. Should a scheme offer a money purchase pension with the option for members to purchase a guarantee, because there is the potential promise to be given, this scheme would be defined as a shared risk scheme.224

Clause 5 (7) provides that when working out whether there is a particular kind of promise in relation to benefits, account can be taken of benefits that may be provided only after a period of time: […] for example where members start in a scheme with money purchase benefits and no promise but then after a certain number of years or a certain age start accruing benefits to which a promise attaches.225

Treatment of a scheme as two or more separate schemes Clause 6 provides for a scheme to be treated as two or more separate schemes. The Explanatory Notes say: 47. This clause requires regulations to be made for a pension scheme that does not fit within any of the categories set out in the clauses above (it is not a defined benefits, defined contributions or shared risk scheme) to be treated as if it were two or more

221

Bill 12 EN para 36 Ibid para 41 223 Ibid para 42 224 Ibid para 43 225 Ibid para 46 222

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separate schemes, each then fitting within a category, for the purposes of these definitions and other specified legislation. 48. An example of such a scenario would be where an existing scheme has a defined benefits section which is not open to new members, and a defined contributions section for new members. This type of scheme would not be defined as a shared risk scheme, since, though there are some elements of a pensions promise, the promise is not available to all members. Instead, regulations must be made providing for the scheme to be treated as if it were two schemes for the purpose of the categorisation – in the example given above, it is likely that the power would be used to treat the scheme as if it were a defined benefits scheme and a defined contributions scheme. 226

The Government expects this to ensure that “all schemes fit into the categories set out in Part 1.”227 Interpretation of Part 1 Clause 7 defines some of the terms in Part 1, in particular, the terms retirement benefit, retirement income and retirement lump, which are important in defining the pension promise. For example, under clause 5 (1), there is a full pension promise in relation to a retirement benefit if there is a promise about the level of benefit that will be received, which is determined wholly by reference to that promise in all circumstances. Clause 7 provides that ‘level’ of retirement benefit means: (a) in the case of retirement income, the rate of that income, and (b) in the case of a retirement lump sum, the amount of that lump sum;

Furthermore, that: “retirement income”, in relation to a member of a pension scheme, means pension or annuity payable to the member on reaching normal pension age; “retirement lump sum”, in relation to a member of a pension scheme, means a lump sum payable to the member on reaching normal pension age or available for the provision of other retirement benefits for the member on or after reaching normal pension age.

Normal pension age in relation to retirement benefits refers to: […] the earliest age at which, or occasion on which, the pension scheme member is entitled to receive benefits from the scheme without adjustment for taking benefits early or late. If there is no such age or occasion, ‘normal pension age’ will be normal minimum pension age as defined by section 279(1) of the Finance Act 2004 – that is, before 6th April 2010, 50, and on or after that date, 55. A ‘fixed’ normal pension age means a pension age (or other decumulation occasion) that cannot be changed except by an amendment to the scheme rules.228

Amendments to do with Part 1 Clause 8 and Schedule 1 makes consequential amendments to existing pensions legislation to take account of these new categories. It also replaces some references to money purchase schemes with references to a scheme under which all the benefits that may be

226

Ibid DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911, para 18 228 Bill 12 EN para 51 227

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provided are money purchase benefits.229 The Explanatory Notes set out where the effect of the amended legislation is changed. In particular:

3.3



Section 124 of the Pension Schemes Act 1993 places a duty on the Secretary of State to pay unpaid contributions to schemes in the event of employer insolvency and consequent default on employer contributions. The Schedule amends the wording to replace ‘money purchase scheme’ with ‘defined contribution scheme, or a shared risk scheme under which all of the benefits that may be provided are money purchase benefits.’ In conjunction with an amendment included in Part 3 of Schedule 4, this updates the provision to ensure that it applies in the right way to schemes that offer collective benefits, as well as ensuring that “all schemes which are shared risk and have only money purchase and collective benefits, and schemes which are defined contributions and provide a guaranteed income after the point of retirement, are captured.”230



Section 51 and 51A of the Pensions Act 1995 require pensions in payment to be increased in line with inflation capped at 5% for rights accrued between 1997 and 2005 and at 2.5% for rights accrued from 6 April 2005. The requirements have not applied to money purchase schemes since April 2005. These provisions are amended to ensure that all defined contributions schemes, including money purchase schemes, schemes offering collective benefits and those defined as self-annuitising, are exempt from the indexation requirements.231



Sections 20 to 28 of the Pensions Act 2008 set out the requirements that a pension scheme must meet if it is to be a ‘qualifying scheme’ for automatic enrolment purposes. The provisions are amended to reflect the new definitions in Part 1. The quality requirements are on the whole unchanged (except where stated).232 Part 2 – general changes to pensions legislation

Promise obtained from a third party Clause 9 relates to the possibility of a promise being obtained from a third party as set out in clause 5 of the Bill. The Explanatory Notes say: […] It contains a power to enable the Secretary of State to make regulations to require that trustees or managers of a scheme must not obtain any such promise from a third party unless conditions set out in the regulations are met. Regulations may also provide for a prescribed person to enforce compliance with this requirement, and allow civil penalties to apply to a person who fails to comply with them. This clause also makes changes to section 34(7) of the Pensions Act 1995 to add this clause to the list of provisions that section 34, which makes its own provisions in relation to trustees’ power of investment, cannot override.233

The intention is to enable additional member protections: 22. We intend regulations under this provision to enable additional member protections where the scheme itself is not liable for the guarantee, and where there may not be a direct contractual relationship between the member and the provider of the third party guarantee in new styles of shared risk and defined benefits schemes, and where the Pension Protection Fund and the Financial Services Compensation Fund may not 229

Ibid para 54 Ibid para 58 231 Ibid para 60 232 Ibid para 67 233 Ibid para 68 230

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apply. The conditions would be intended to ensure that the risk being taken with such an arrangement was proportionate.234

Disclosure of information The Pension Schemes Act 1993 (section 113) provides for the Secretary of State to make regulations requiring pension schemes to keep certain persons informed of various matters including the scheme’s constitution, its administration and finances and the rights and obligations that may arise under the scheme. Following consultation, the requirements for occupational and personal pension schemes were consolidated and are now in the Occupational and Personal Pension Schemes (Disclosure of Information) Regulations 2013 (SI 2013/2734).235 Clause 10 would amend section 113 of the 1993 Act to remove the ‘non-exhaustive’ list of those people to keep informed. This list would in future be in secondary legislation. The Government said this would “enable the Department to take account of the new categories of scheme and members in terms that are meaningful.” Clause 10 (4) would require schemes to have regard to guidance prepared by the Secretary of State when complying with disclosure requirements. 236 The Government has consulted on whether it would have guidance addressing areas of good practice. Some respondents said this would helpful on specific areas such as lifestyling or electronic communications. 237 The Government has indicated an intention to bring forward a specific set of information requirements relating to DA schemes: 37. The nature of DA schemes may mean there is a clear case for a common set of information requirements distinct from those for DB and money purchase schemes. The fact that DA provision will offer members some degree of guarantee but not absolute certainty about their pensions means that the nature of the pension promise may be harder to understand and more complex to communicate without being misleading. As a result, we would consider the need to set out specific disclosure and information requirements for DA schemes ensuring that members receive clear and consistent explanations of their pension rights in the scheme. 38. We would look to ensure the approach to what we require is consistent with the principles behind the new harmonised disclosure regulations which comes into force in April next year. We expect that many of the elements of disclosure required for DB and money purchase schemes may also be applicable and will ensure it is clear and easy to identify what disclosure is required for DA. 238

Regulations under section 113 are subject to the negative resolution procedure.239 Extension of preservation of benefit under occupational schemes Before the Pensions Act 2014, legislation required occupational pension schemes to offer a refund of contributions, or a cash transfer to a member leaving a scheme after three months and before two years of service, who had not accrued any right to future benefits under the

234

DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP 2014-0911 Details of the consultation are on the Gov.UK website – Occupational and Personal Pensions (Disclosure of Information Regulations) 236 DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911, para 25-6 237 DWP, The Occupational and Personal Pension Schemes (Disclosure of Information) Regulations 2013. Government response to the consultation, July 2013 238 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, page 55, para 37 239 DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP 2014-0911, para 28 235

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scheme.240 The refund applied to the member contribution only, the employer contribution remained in the scheme and could be used to cover future employer contributions, scheme administration costs or one-off scheme costs. There was no equivalent rule for workplace personal pensions. In January 2011, DWP said it was concerned that this difference could act as an incentive for employers to set up occupational pension schemes specifically to take advantage of the short service refund rules. It was therefore examining the role short service refund rules could play following the introduction of automatic enrolment.241 In December 2011, it said it had decided to abolish the use of short-service refunds for occupational DC schemes.242 Section 36 of the 2014 Act therefore introduced a requirement that, where all members are money purchase benefit, a preserved benefit must be provided after 30 days’ service. The right to a refund of contributions was removed.243 Clause 11 would extend this to apply to all cases where the pension benefit is not salaryrelated: 75. The clause states that schemes must provide a short service benefit where leavers have at least 30 days’ qualifying service and all the pension benefit is a non-salary related one (that is, not calculated either by rate or amount with reference to the member’s salary). If any of the pension benefit is salary related, the two year rule still applies. 76. Where a benefit may be calculated on a salary related basis in some circumstances and a non-salary related basis in others (e.g. an underpin benefit which pays the higher of the two calculations), it will be treated as salary-related for these purposes. 77. If a member’s pensionable service began before the amendments came into force, the previous requirements for preservation of benefits will continue to apply. 244

Early leavers: revaluation of accrued benefits Clause 12 would make provision for the way in which the deferred benefits of early leavers are revalued. Given the aim of encouraging personal pension schemes to provide benefits other than money purchase benefits, the purpose is to ensure that revaluation methods currently not available to personal pension schemes could be made suitable: 30. Following the changes made by this Bill, personal pension schemes will be encouraged to provide benefits other than money purchase benefits. The power will enable regulations to amend Chapter 2 in order to modify the current revaluation provisions to ensure that the revaluation methods that are currently not available to personal pension schemes are made suitable for those schemes. This will enable those schemes to appropriately revalue deferred benefits for early leavers if new personal pension schemes evolve so that the average salary or final salary method is considered more appropriate. The power is restricted so that the revaluation method used for a benefit to which a right has already accrued may not be changed (see new section 85A(2)(b). This power will be subject to the negative resolution procedure. Although it is a power to amend primary legislation, any regulations will be limited to

240

Pensions Schemes Act 1993, section 101 DWP, Preparing for automatic enrolment: Regulatory differences between occupational and workplace personal pensions. A call for evidence. January 2011 242 DWP, Meeting future workplace pension challenges: improving transfers and dealing with small pension pots, Cm 8184, December 2011 243 Pensions Act 2014 – Explanatory Notes, para 154-5 244 Bill 12 EN 241

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technical changes which build on existing requirements, and will be responsive to new benefit structures. The negative procedure was therefore considered appropriate. 245

Early leavers: transfer values Clause 13 and Schedule 3 would make amendments relating to transfer values to reflect the new scheme categories defined in Part 1 of the Bill. The Explanatory Notes say: 87. Schedule 3 amends Chapter 4 of Part 4 of the Pension Schemes Act 1993, which sets out provisions governing how members of an occupational or personal pension scheme may apply for, take and use the cash equivalent value of their rights in the scheme, and how that transfer value is to be calculated. 88. The existing provisions provide for two ways to calculate and give effect to transfer rights. If the rights are to money purchase benefits, the transfer value is the realisable value of the member’s rights in the scheme on any given date, which is relatively straightforward to calculate. For salary related benefits the situation is more complex as trustees have to convert a promised benefit into a cash equivalent. As there is no direct correlation between the member’s benefits and the money available to pay them, trustees are required to give the member a guaranteed cash equivalent that is valid for a prescribed period of time. 89. This Schedule amends Chapter 4 to reflect the new scheme categories defined in Part 1 of the Bill. Under the changes there will still be the same two methods to offer a transfer value – members of defined benefits schemes, members of shared risk schemes and members of defined contributions schemes that provide benefits other than money purchase benefits will get a guaranteed cash equivalent, and members of defined contributions schemes providing money purchase benefits will get the realisable value of their assets. 90. As now, the details about how trustees and managers calculate a cash equivalent will be described in regulations. 246

Transfers from public service schemes Clause 14 would give the Secretary of State power to make regulations to prevent members from transferring out of public service DB pension schemes, except to other DB schemes. DB here has the meaning provided for in section 37 of the Public Service Pensions Act 2013 rather than the meaning in clause 2 of the Bill.247 This relates to the Government’s decision to legislate to prevent members of public service schemes transferring their pension rights to a DC scheme to take advantage of the flexibilities for DC scheme members to be introduced from April 2015. It said: 5.6 Initial government estimates suggest that the net cost of 1% of public service workers transferring out of public service schemes each year would be £200 million. This burden would be borne by the Exchequer, which would need to fund the additional costs by placing the burden onto taxpayers or onto current scheme members by imposing higher contributions. The government believes that continuing to allow people to transfer from a public service defined benefit scheme to a defined contribution scheme to take advantage of the new system would therefore be unfair on both the taxpayer and remaining scheme members.

245

DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP 2014-0911 Bill 12 EN 247 Ibid para 91 246

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5.7 Having considered these issues carefully, the government intends to introduce legislation to remove the option to transfer from a public service defined benefit scheme to a defined contribution scheme, except in very limited circumstances. In the interest of fairness to members and consistency across schemes, the government’s preferred approach is to treat all public service schemes equally including those which are funded or have funded elements.[…].248

In July 2014, the Government announced that the prohibition on transfers would not apply to funded public service schemes, such as the Local Government Pension Scheme. This was because such schemes held assets, which meant that transfers did not have the same implications for the Exchequer as in the case of unfunded schemes. (Unfunded schemes operate on a pay-as-you-go basis which means that there is no fund of assets from which pensions are paid. Instead contributions are paid to the Exchequer, which meets the cost of pensions in payment, netting of contributions received.) The Government said it would give consideration would be given to the safeguards that should need to be put in place to protect the interests of both individuals and funds in cases of transfers out: 4.33 The costs to the Exchequer of withdrawals from funded public service pension schemes are less direct than from unfunded schemes, given the assets held by funded schemes. However, in some circumstances, for example where a significant number of withdrawals from a fund impact the short-term cash-flow and therefore stability of the fund, there could still be implications for scheme members and the taxpayer. 4.34 The equivalent concern over scheme stability also arises for private sector defined benefit schemes and is addressed by existing powers allowing trustees to ask the Regulator for longer to make transfer payments (if the interests of the members of the scheme generally will be prejudiced by making the payment within the usual period), and to reduce transfer values to reflect scheme funding, measures which could equally apply to public service pension schemes. 4.35 Since funded public service pension schemes hold assets, transfers out have a less direct impact on the Exchequer. As such, and in light of the decision to continue to allow transfers from private sector defined benefit to defined contribution schemes the government has decided to continue to allow transfers from funded public sector defined benefit schemes. Safeguards akin to those in the private sector will be introduced in the public service schemes where they do not already exist. 4.36 This will include the Local Government Pension Scheme (LGPS), which is the largest of the funded public service pension schemes. Unlike the other funded public service pension schemes, the LGPS is not a trust-based scheme. The government will therefore work with the Department for Communities and Local Government and other stakeholders over the summer to ensure appropriate safeguards are introduced to the Scheme which give due consideration to the interests of both scheme members and the taxpayer.249

For members of private sector DB schemes considering a transfer to a DC, the Government intends to introduce a requirement that they take advice: […] for the majority of people, but not all, it will remain in their best interest to stay in their defined benefit scheme. In response to stakeholder feedback, the government will

248

HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014 HM Treasury, Freedom and choice in pensions: the government’s response to consultation, Cm 8901, July 2014 249

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introduce two new safeguards to protect individuals and pension schemes: a new requirement for an individual to take advice, from a professional financial adviser who is independent from the defined benefit scheme and authorised by the FCA, before a transfer can be accepted; and new guidance for trustees on the use of their existing powers to delay transfer payments and take account of scheme funding levels when deciding on transfer values.250

Trade unions representing public service workers expressed differing views of the ban on transfers from unfunded schemes. For example, the NASUWT accepted that it removed the risk to Government finances posed by potential transfers out of public service schemes.251 However, the Fire Brigades Union was opposed.252 Indexation requirements For DB schemes, there is a statutory minimum by which pensions in payment must be increased. Under the Pensions Act 1995 indexation in line with prices, capped at 5%, was required for rights accrued from 1997.253 Under the Pensions Act 2004, the cap was reduced to 2.5% for rights accrued from 2005 onwards.254 Clause 15 would exempt Regulatory Own Funds (ROF) from the indexation requirements in the Pensions Act 1995. The Government has said that the primary option for a CDC scheme providing some form of promise or guarantee, would be a vehicle set up as a ROF. 255 The reason for exempting ROFs from the indexation requirements is presumably that being able to suspend indexation is one of the key levers available to CDCs needing to restore funding levels (see section 3.4 below). Clause 16 would introduce a regulation-making power to exclude other pensions of a prescribed description from the indexation requirements for future accruals. Such regulations would be subject to the affirmative resolution procedure, so need to be approved by both Houses of Parliament before becoming law.256 Removal of requirement to maintain register of independent trustees Clause 17 would remove the statutory requirement for regulations to provide that the Pensions Regulator (TPR) compile and maintain a register of trustees.257 The Explanatory Notes say: Section 23 of the Pensions Act 1995 allows the Pensions Regulator to appoint an independent trustee to a scheme whose employer has suffered an insolvency event. The Regulator can only appoint a trustee from the trustee register, which it must establish and maintain. But the Regulator has another, general power (under section 7 of the Act) to appoint trustees to replace a person found not to be ‘fit and proper’ to be a trustee. In relation to this there is no requirement to appoint from a register of trustees, and the Regulator appoints replacements using flexible procurement panels. This clause removes the requirement to maintain a register of trustees under section

250

Ibid p25 NASUWT Response to Freedom and Choice, June 2014; See also NUT response to Freedom and Choice, June 2014 252 FBU Further response to Freedom and choice in pensions, June 2014 253 Section 51 254 Section 278 255 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, page 53 256 Bill 12 EN, para 96 257 Information about the current independent trustee register is on TPR’s website. 251

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23, in order that the Regulator can instead follow the same procedure as when appointing trustees under section 7.258

The Impact Assessment explains that this removes a regulatory burden on TPR, thus fulfilling a DWP commitment to the ‘Red Tape Challenge’. The alternative procedure for appointing trustees under section 7 of the 1995 Act is considered to be “less burdensome and thus less costly for both the Regulator and the independent trustees than the current requirement.”259 Rules about modification of schemes Section 67 of Pensions Act 1995 sets out the conditions under which the subsisting rights of members of occupational pension schemes can be modified. As originally enacted, it prohibited changes to the rules of a scheme which would reduce a member’s accrued pension rights without the member’s consent. The 2002 Pickering Report on pension simplification argued that this prevented DB schemes from making perfectly sensible changes which would leave the members no worse off overall, and was a contributory factor in many decisions to close down defined benefit schemes.260 Section 67 was substantially amended by the Pensions Act 2004. Under the new rules, only detrimental changes to subsisting rights were covered, and trustees may make changes without consent, so long as each member from whom consent has not been obtained retains benefits that are actuarially equivalent to those he had prior to the change.261 The Pensions Regulator explains the applications of these provisions in Code of practice 10: Modification of subsisting rights (January 2007). In consultation on its proposals for DA, the Government said it did not think DB scheme sponsors should have the power to modify subsisting rights beyond what was allowed under existing legislation. 47. The Government believes that employers should not have the power to transfer or modify accruals built up under previous arrangements into new arrangements, beyond what is allowed under current legislation, otherwise there is a risk that members could lose out on legitimate expectations. 48. This means that deferred and pensioner members, and the past accrued benefits of active members, would not be affected as a consequence of introducing DA pensions. 49. We do, however, want to support employers, scheme trustees and members who, properly advised, wish to alter the shape of past accruals through options that already exist, such as incentive transfer exercises and changes made with member consent. Such options are legitimate ways for employers to manage their risks as long as they are well run in line with best practice. 50. In order to protect members we believe the principles set out in the Incentive Exercises for Pensions: A Code of Good Practice, published in June 2012, should broadly apply in these circumstances. In addition, we are considering whether there should be a requirement to provide independent financial advice in all cases where an

258

Bill 12 EN, para 97-8 DWP, Pension Schemes Bill Impact Assessment. Summary of Impacts, June 2014, DEP2014-0911 260 Alan Pickering, A simpler way to better pensions, July 2002, para 4.26-4.33 261 Pensions Act 2004, section 262; Lewin and Sweeney, Deregulatory Review of Private Pensions, An independent report to the Department for Work and Pensions, July 2007, p14 259

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RESEARCH PAPER 14/44 employer offers to transfer a member’s accrued rights from a traditional DB scheme to a new arrangement.262

Reflecting the new definitions to be introduced by the Bill, clause 18 would provide for the existing protection arrangements in section 67 to apply to a proposal to replace benefits to which a promise is attached, with benefits where there is no promise. The Explanatory Notes say: 99. Section 67 of the Pensions Act 1995 contains provisions to protect members against detrimental modifications to their ‘subsisting rights’ – that is, ‘any right which at that time has accrued to or in respect of [the member] to future benefits under the scheme rules; or any entitlement to the present payment of a pension or other benefit which [the member] has at that time, under the scheme rules’. 100. Some changes can only be made if the member agrees: these are called ‘protected modifications’. Section 67A sets out the circumstances in which a modification to members’ rights is a ‘protected modification’. 101. Currently, section 67A states that a change must be considered as a ‘protected modification’ where money purchase benefits would replace non-money purchase benefits, or where the change would result in a reduction to a pension in payment. This clause amends section 67A to include a proposed modification where a right to benefits that include a pensions promise is to be replaced by a right to benefits where there is no pensions promise.263

Part 2 of Schedule 4 would provide for the protection arrangements also to apply to a proposal to replace non-collective benefits with a right to collective benefits.264 3.4

Part 3 – collective benefits

Approach to legislation In November 2013, the Government set out the approach it would take to legislating for collective schemes. It said: 22. CDC schemes can take different forms. Some could potentially operate within the existing legal framework in the UK; others, where there is no guarantee or promise are more difficult to reconcile with it and may need a new regulatory vehicle.265

Schemes offering some form of promise or guarantee, such as the pensions income builder model, could operate within the proposed DA regulatory framework. The primary option for this would be a vehicle set up as a Regulatory Own Fund (ROF). CDC schemes that provide a promise or guarantee 23. CDC schemes that provide the member with some form of promise or guarantee, such as the pension income builder explored in Chapter 4, could operate within the proposed DA regulatory framework. As with any other scheme containing a promise, they would need to be funded on a technical provisions basis and meet the appropriate solvency requirements.

262

DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p25 Bill 12 EN 264 Ibid, para 127-8 265 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p53; 263

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24. However, the means by which these funding requirements can be satisfied are likely to be different from traditional DB arrangements where a sponsoring employer stands behind the arrangement (and is effectively responsible for any deficit that arises in the scheme). 25. The primary option for a CDC scheme providing some form of promise or guarantee would be a vehicle set up as a Regulatory Own Fund. As a first step, we would need to modernise the current Regulatory Own Funds legislative requirements, not least to bring them into line with the other DA reforms and to ensure they work from a practical perspective. 26. In European terms, such schemes fall within the terms of Article 17 of the Institutions for Occupational Retirement Provision (IORP) Directive. This sets out the requirements for institutions that, themselves – rather than the sponsoring employer – underwrite the liabilities or guarantees investment performance or benefits level. 27. Besides setting out the regulatory vehicle for these schemes we will need to consider whether the framework should include other requirements to enable them to provide the high levels of governance that would be needed to protect member interests. For example, there may be a case for a more formal approval arrangement on set-up, possibly by requiring schemes to obtain a licence from a regulator, as well as being subject to regulatory oversight of their funding levels.

28. While we have identified Regulatory Own Funds as a potentially suitable vehicle there may be other vehicles (which emerge either now or in the future) which could also provide this type of collective arrangement. We are therefore not looking to restrict the types of vehicles that could be used, simply to provide an enabling framework.266 As regards scheme funding requirements, these would apply to the extent of any promise or guarantee: A Regulatory Own Fund vehicle offering deferred annuities and discretionary benefits would need to be funded to the level required to meet the discounted capital value of the liabilities (technical provisions) plus an appropriate buffer.267

A ROF is a scheme which itself, rather than any employer, underwrites liability to cover against biometric risk (linked to death, disability or longevity), or guarantees a given investment performance of a given level of benefits. Article 17 of the European Directive on the Supervision of Institutions for Occupational Retirement Provision (2003/41/EC) requires such schemes to hold additional assets above normal funding levels. The requirements of Article 17 were transposed into UK law by the Occupational Pension Schemes (Regulatory Own Funds) Regulations 2005 (SI 2005/3380). At that time the Government was not aware of any such schemes operating in the UK.268 In June 2014, the Government said it was introducing a new definition of collective benefit, which could fall within the DA or DC definition. Those collective schemes that did not provide a promise or guarantee during the accrual phase would fall within the DC category:

266

DWP, Reshaping workplace pensions for future generations, November 2013, Cm 8710, p53; See also, DWP, Collective Defined Contribution Schemes, December 2009 267 DWP, Reshaping workplace pensions for future generations, November 2013, Cm 8710, p55 268 SI 2005/3380 – Explanatory Memorandum

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Collectives are not currently possible in the UK in practice because they are not catered for in either pensions or tax legislation. The Department for Work and Pensions has had discussions with Her Majesty’s Treasury (HMT) and Her Majesty’s Revenue and Customs (HMRC) to examine this issue. In order to enable collective schemes that are run safely and regulated appropriately, we propose to define benefits provided on a collective basis in primary legislation for the first time.269

Because such schemes were complex and could be opaque, they would need strong standards of communication and governance: We will create a framework that draws on the experiences of other countries where collective schemes operate and places the interests of members firmly at the heart of that design, prioritising clarity and transparency. Collective schemes are complex and can be opaque – because of the indirect relationship between contributions and benefits. This necessitates strong standards of communication and governance. We intend collective schemes to be overseen by experienced fiduciaries acting on behalf of members, taking decisions at scheme level and removing the need for individuals to make difficult choices over fund allocations and retirement income products. We will also introduce a robust regulatory regime in respect of targeting benefits and internal accounting, providing regulators with the appropriate mandate and tools to supervise schemes properly. We believe it is crucial that members fully understand the risks associated with collective arrangements when they join the scheme, and while it is not for the state to determine the benefit design of these schemes, we will ensure that schemes set out clearly (to members) in advance how their rights are defined, what they can expect from the pool, and how positive and negative shocks will impact on their pension benefits. Collective schemes, as with all DC arrangements, do not come without risk, but with proper standards of governance and a suitable regulatory regime, we believe that we can mitigate these appropriately. A definition of collective benefits and associated key requirements will be included in the Pensions Bill while secondary legislation is likely to include more detailed provisions in relation to areas such as benefit targeting, risk management, communications and governance. 270

The necessary changes to tax rules would be addressed separately: The legislative measures we will introduce will not address tax rules; however we will continue to work with HMRC and HMT to consider how collective schemes would operate within the pensions tax regime.271

Part 3 of the Bill defines the concept of collective benefits and makes provision for regulation-making power in relation to them. These include powers to make regulations requiring trustees/managers of such schemes to: -

Set targets in relation to the rate or amount of benefits scheme members can expect, which should be at a level which ensures that the probability of meeting them is equal to or higher than a level of probability set out in regulations.

269

DWP, Government response to the consultation. Reshaping workplace pensions for future generations, Cm 8883, June 2014, p22 270 Ibid 271 Ibid

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-

Request a certificate from an actuary confirming that the scheme has sufficient assets to meet the initial targets, to a degree of probability specified in regulations; Providing a statement of the scheme’s investment strategy, and keeping the strategy under review; Request regular valuation reports to assess the likelihood of the scheme being able to meet the targets it has set relation to benefits; and Have a policy for dealing with circumstances in which the probability of a scheme being able to meet a target in relation to a collective benefit falls above or below a level of probability set out in regulations.

This emphasis on setting targets, communicating with members and keeping the scheme’s ability to meet them under review, would appear to reflect lessons learned from experience in the Netherlands, summarised by DWP as follows: 19. Although historically schemes in the Netherlands have been described as CDC, they were presented to the members as DB, with members developing expectations that pensions were guaranteed, when in practice there was scope within the rules for pensions (including those in payment) to be reduced in the event of under-funding. Employers viewed them as defined contribution, so considered they had more control over their costs than under DB. 20. Whilst the model seemed sustainable during a period of strong economic growth, the downturn and the resulting pressure on scheme funding has led to benefits being reduced and to the structure of the schemes being reviewed, with a new pensions contract being introduced in 2015. As well as being explicit that there are no guarantees, a new funding regime is being introduced. The changes are expected to lead to a significant consolidation in the number of schemes.272

Detailed provisions in relation to areas such as benefit targeting, risk management, communications and governance are to be in secondary legislation.273 In terms of governance, the Government said it intended collective schemes to be “overseen by experienced fiduciaries”: Collective schemes are complex and can be opaque – because of the indirect relationship between contributions and benefits. This necessitates strong standards of communication and governance. We intend collective schemes to be overseen by experienced fiduciaries acting on behalf of members, taking decisions at scheme level and removing the need for individuals to make difficult choices over fund allocations and retirement income products.274

Throughout Part 3, there are references to “the trustees or managers of a pension scheme”, suggesting that there is scope for them to be either trust-based or contract-based. The RSA has argued that collective schemes (CDCs) should be trust-based: Pension provision is notoriously open to conflicts of interest. And these are exacerbated by the fact that individuals have little knowledge of what their pension provider is doing and little leverage over their actions. 272

DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013, p47 DWP, Government response to the consultation. Reshaping workplace pensions for future generations, Cm 8883, June 2014, p22 274 DWP, Government response to the consultation. Reshaping workplace pensions for future generations, Cm 8883, June 2014, p22 273

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We would therefore strongly recommend that: 1. CDC pensions, like DB pensions should only be introduced under trustee management; that is where the governance of the fund owes loyalty only to its beneficiaries. 2. That the primary duty of the trustees is to represent the interest of the members. The trustee body should have amongst its members adequate expertise to manage the investment and benefit issues they will confront. 3. The trustees should make public their investment and benefit policy, and their proposed response to known risks. These should be made available to all beneficiaries. 4. There should be clear rules as to the decisions which can be made by the trustees and those which need the authorisation of the regulator.275

Definition Clause 19 would provide for the definition of collective benefits. The Explanatory Notes say that: 103. Where in all circumstances the rate or amount of the benefit payable to or in respect of a member depends entirely on (a) the amount available to pay that member’s and other members’ benefits and (b) factors used to determine what proportion of that amount is available for the provision of the particular benefit. 276

Clause 19 (3) would provide that a benefit which is a money purchase benefit is not a collective benefit.277 A scheme that provides collective benefits would fall within one of the definitions in Part 1 of the Bill, depending on whether or not it provides a ‘pension promise’. A scheme like the pensions income builder, where a proportion of the contributions paid are used to purchase a deferred annuity each year, would fall within the shared risk definition.278 A scheme that offers no pensions promise would fall within the DC category.279 Targets Clause 20 would provide for regulations to require trustees or managers of schemes offering collective benefits to set targets in relation to the rate or amount of those benefits: In particular, regulations can be made about, amongst other things, the way that targets are expressed, recorded and published. The intention is that members of a scheme with collective benefits should be provided with a reasonable estimate of the benefits that they can expect to receive from the scheme; in the absence of a welldefined pot over which the individual has clear ownership, the target is a way of illustrating for the member what they might receive. 280

It also provides for regulation-making powers to require trustees/managers to obtain a certificate confirming that “the actuary is of the opinion that the probability of the assets being

275

RSA, Collective pensions in the UK II, November 2013, p13 Bill 12-EN, para 103 277 Ibid 278 DWP, Reshaping workplace pensions for future generations, Cm 8710, November 2013 p34 and p51 279 Clause 5 (3) (c); Bill 12-EN, para 41 280 Ibid para 104 276

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sufficient to meet the initial targets is in line with the level set out in the regulations.” 281 In more detail, DWP explains that: 51. The setting of targets in relation to collective benefits is key to ensuring that schemes providing collective benefits operate in as transparent a manner as possible. Whilst the target is unenforceable, it will provide a clear indication of the level of benefits that the scheme is seeking to provide for its members. 52. When a scheme first starts to offer collective benefits, the Department intends to require the trustees or managers to obtain a certificate from an actuary which confirms that the initial targets set by the scheme have been set at an appropriate level. This level will be measured by reference to a level of probability specified by the Secretary of State in regulations (and this level of probability is also relevant to regulation-making powers in subsequent clauses). In other words, at the point that the scheme begins to offer collective benefits, there should be a tenable link between the contributions paid into the scheme, the investments held by it and the target level of benefit to be provided by those investments. 53. This level of probability will need to be set at a level which takes into account a number of different matters. Concerns about scheme transparency and the important of ensuring that members understand the rate or amount of benefit that the schemes is aiming to provide will need to be balanced with the need to ensure that there is sufficient flexibility about the link between assets and target levels to allow schemes to take advantage of risk sharing options that are inherent to schemes that offer collective benefits – for example, the ability to smooth investment across the membership. The Department intends to canvas industry opinion as to the appropriate level of probability before setting on a definite figure […]282

Investment strategy Section 35 and 36 of the Pensions Act 1995 outline the requirements governing investments for trust-based schemes. These include a requirement to produce a Statement of Investment Principles (SIP): “a written statement of the investment principles governing decisions about investment for the purpose of the scheme”.283 The required detail for the SIP is set out in the Occupational Pension Scheme (Investment) Regulations 2005 (SI 2005 No 3378). Scheme investments are covered in the Pensions Regulator’s Trustee guidance. Clause 23 would provide a regulation-making power to require trustees or managers to “produce a statement about the investment strategy to be followed in connection with the provision of ‘collective’ benefits.” The Government has explained that although there are potential similarities with existing legislation applying to trust-based schemes, it would be important to have specific regulation-making powers in relation to the investment strategy for collective benefits: This is not only so that there is consistency in terms of investment requirements and obligations between trust-based and contract-based schemes that offer collective benefits, but also because, given the different nature of collective benefits to other forms of pension benefits as a result of the opportunities associated with risk-sharing between members, it is appropriate to have separate provisions relating to investment strategy and decisions. For example, it may be appropriate for the investment strategy for collective benefits to be revisited on a more regular basis than an investment

281

Ibid DWP, Pension Schemes Bill - Delegated Powers, June 2014, DEP2014-0911 283 Tolley’s Pension Law, E.40; IDS Pension Service, Pension trustees and administration, para 7.10; Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378) 282

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RESEARCH PAPER 14/44 strategy which relates to the provision of other types of benefits – a requirement to review the strategy on an annual, rather than a triennial, basis might be appropriate. 284

Clause 24 would provide a regulation-making power to impose requirements on trustees or managers of schemes in relation to their choice of investments in connection with the provision of collective benefits. This could include specifying criteria to be applied in choosing investments and requiring diversification of investments.285 Clause 25 would provide a regulation-making power to require the trustees or managers of a pension scheme that provides collective benefits to obtain reports about investment performance relating to collective benefits. DWP explains that: This power is necessary to ensure that trustees or managers are actively reviewing the performance of investments so that appropriate steps can be taken as quickly as possible to address any issues with investment choices or strategy. This is important in ensuring that there is transparency in the way that the scheme is run and also for member protection.286

Valuation reports Clause 26 would provide a regulation-making power to require those schemes offering collective benefits to obtain, from an actuary, a ‘valuation report’ which values the assets held by the scheme for the purposes of providing collective benefits and assesses how likely it is that the scheme will be able to meet targets in relation to those benefits.287 It is anticipated that such reports will need to be obtained on an annual basis, in order for the trustees or managers to be able to monitor to what extent the assets held by the scheme are likely to be sufficient to provide the target level of benefits.288 It also provides for regulations to require the actuary to certify whether the probability of the scheme being able to provide the target level of benefits is equal to, higher or lower, than a specified level of probability. This would be “key to the steps that the trustees or managers take to respond to the outcome of the valuation” and links with the policy for dealing with a deficit or surplus required under clause 28.289 Regulations may also require the report to be obtained from an actuary who has specified qualifications or meets other specified requirements. The Government has explained that this is to protect scheme members: […] Again, this comes down to member protection – the actuary will be required to make judgement calls when valuing assets held by the scheme and assessing the likelihood of the scheme meeting any targets in relations to those benefits which potentially impact on the level of benefits the member actually receive from the scene.[…] it is particularly important in the context of collective benefits that the actuary has a sufficient and appropriate level of technical expertise, since the risk in relation to collective benefits lies entirely with the members; the consequence of poor actuarial advice could be lower benefits for members. Unlike under a traditional salary-related pension arrangement where the employer stands behind any promise offered by the scheme and is therefore responsible for meeting any funding shortfall, trustees or managers may not have recourse to additional funds from an employer (or from the

284

DWP, Pension Schemes Bill -Delegated Powers, June 2014, DEP2014-0911, para 66 Ibid, para 68 and 68; clause 41 286 Ibid para 71 287 Bill 12-EN, para 112 288 DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911, para 76 289 Ibid para 74 285

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member) in the context of providing collective benefits. The accuracy of the valuation report and actuarial certification is likely to be of paramount importance. 290

Clause 27 would provide for a regulation-making power to make provision about the methods or assumptions to be used by an actuary valuing assets, assessing the likelihood of a scheme meeting a target in relation to collective benefits and in relation to the methods and assumptions used in preparing a valuation report.291 The Government has explained that this is in regulations rather than primary legislation for a number of reasons: The provisions in this clause will involve a detailed and technical process that is most suitably set out in secondary legislation. Its implementation will require further consideration and consultation with interested parties, such as the actuarial profession. It is also felt to be important to retain a significant degree of flexibility in establishing the details of the process, so that the Department can make a quick and effective response to any concerns raised. As schemes that provide collective benefits do not currently exist within the occupational pension sphere in the UK, the Department will need sufficient flexibility to ensure that the valuation process and the methods or assumptions to be used by an actuary valuing target benefits, are fit for purpose. 292

Regulations under clause 27 will be subject to the negative resolution procedure.293 Policy for dealing with a deficit or surplus Clause 28 contains a regulation-making power to require trustees/managers of schemes offering collective benefits to have a policy for dealing with circumstances where the probability of meeting a target falls above or below a level of probability set out in regulations: 115. Under clause 28, regulations may provide that trustees or managers of schemes offering collective benefits are required to have a policy for dealing with circumstances where the probability of a scheme meeting a target in relation to a collective benefit falls above or below a level of probability set out in regulations - termed in the Bill as ‘deficit’ or ‘surplus’ in relation to the target. 116. The clause also sets out powers to require the policy to contain provision for a deficit or surplus to be dealt with in one or more of a range of ways, to contain an explanation of the possible effect of the policy on members in different circumstances and to be drawn up with a view to achieving certain results within a specified period of time.294

DWP explains that the main objective behind this clause is to ensure that schemes offering collective benefits operate in a “transparent and accountable manner” as the policy would set out how benefit levels might change for members under different economic scenarios.295 Clause 28 (3) provides for regulations to require trustees/managers to consult about this policy, make provision for the content of the policy and about how it is reviewed or revised. The requirement to consult (clause 28 (3) (a)) is important because a change to the surplus/deficit policy in a collective scheme could potentially involve a redistribution of assets amongst the membership.296 The power to make provision about reviewing and revising the

290

Ibid para 75 Bill 12-EN, para 114 292 DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911, para 80 293 Ibid para 81 294 Bill 12-EN 295 DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911, para 84 296 Ibid, para 87 291

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policy may be used to require reviews on a regular basis - possibly on an annual basis to tie in with valuation reports.297 While the intention is to allow trustees/managers flexibility as to how they deal with any deficit or surplus, there may be some restrictions on this: […] Whilst the intention is to use the powers to make provision about what information the policy should contain (including the types of scenarios that the policy should address), there should also be a degree of flexibility available to trustees and managers as to the way that any deficit or surplus should be dealt with. The appropriate action might, for example, differ depending on scheme design. This is why subsection 4 (b) contains a power to require the policy to contain provision for a deficit or surplus to be dealt with in one or more of a “range of ways.” However, it is important that some safeguards are put in place in relation to acceptable ways or time periods for dealing with a deficit or surplus; this is why a power has been included at subsection 4 (a) to require the policy to be formulated with a view to achieving results described in the regulations within a period or periods described in the regulations. 298Clause 29 provides for a regulation-making power to allow an amount to be treated as a debt due from an employer to a scheme offering collective benefits in situations where a deficit in relation to a target benefit has resulted from a specified offence or the imposition of a specified levy.299

Other provisions Clause 30 contains a regulation-making power to require trustees/managers of schemes offering collective benefits to have, and to follow a policy for the calculation and verification of collective benefits.300 DWP explains: 96. This clause also contains powers to make other provision about the content of the policy, the review and revision of the policy, and may require trustees or managers to consult about the policy. This policy will be a key scheme document and it is important that, as schemes providing collective benefits develop, there is an opportunity to adjust the detail as to the content of the policy to take account of the way that a variety of schemes operate in practice.301

Clause 31 provides for regulations to be made regarding the winding-up of collective schemes. It: […] provides for regulations to modify the application of sections 73, 73A, 73B and 74 of the Pensions Act 1995, which concern the winding up of occupational pension schemes, in relation to collective benefits. 121. The clause also provides for regulation-making powers to be used to make provision in relation to collective benefits corresponding or similar to any provision made by sections 73, 73A, 73B and 74 of the Pensions Act 1995.302

DWP explains: 99. The rules setting out the winding up of a pension scheme are important in providing protection and transparency for members in the event of the scheme being wound-up. 297

Ibid Ibid, para 85 299 Bill 12-EN, para 117 300 Ibid, para 118 301 DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911 302 Bill 12-EN 298

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Rules governing the winding up of existing occupational pension schemes (other than money purchase schemes and other exempted schemes) are set out in the 1995 Pensions Act. However, the winding up provisions were not drafted with collective benefits in mind, and it is likely that collective benefits will not be compatible with these provisions as currently drafted. We envisage that collective benefits may therefore need to be taken out of the existing wind-up rules and a more appropriate set of rules put in place governing their wind-up. It is likely that the Regulations will need to include a greater degree of technical detail than would be suitable for inclusion in primary legislation.303

Clauses 32 includes a regulation-making power to require trustees or managers to consult a scheme actuary before taking action or decisions in relation to the provisions in Part 3 of the Bill. This is important to ensure that scheme decision-making incorporates expert advice.304 In addition, regulations may provide the scheme actuary to have regard to guidance when advising on these matters. The Government explains: There is precedent within pensions legislation for including provisions which require the actuary to have regard to prescribed guidance, for example under section 230(3) (matters on which advice of actuary must be obtained) of the Pensions Act 2004. The provision in clause 32(2) is a technical requirement to ensure that scheme actuaries can be required to have recourse to the most recent and appropriate professional guidance when advising those with responsibilities in schemes offering collective benefits.305

Clause 34 provides a power to impose requirements in regulations about the publication of scheme documents described in clauses 21-28 (regarding the processes for contributions, investment and valuation in collective schemes). Regulations may also specify to whom such documents should be sent.306 Clause 35 provides a power to make regulations regarding enforcement: […] conferring functions on a specified person to enforce regulations relevant to this Part of the Bill, and a power for civil penalties to apply of the relevant requirements in the regulations are not complied with.307

The Government has explained: 104. Clause 35 allows regulations made under Part 3 of the Bill to confer functions on a specified person in connection with enforcement of those regulations. In addition, clause 35 allows those regulations to provide for Section 10 of the Pensions Act 1995 to apply where there is non-compliance. 105. The Pensions Regulator has an existing enforcement power under section 10 of the Pensions Act 1995. This prescribes that, where the Regulator is satisfied that by reason of any act or omission this section applies to any person, they may by notice in writing require that person to pay, within a prescribed period, a civil penalty in respect of that act or omission not exceeding the maximum amount. The maximum amount of any penalty under Section 10 of the Pensions Act 1995 is £5,000 in the case of an

303

DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911 Ibid para 101 305 Ibid para 102 306 Ibid para 103 307 Bill 12-EN 304

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individual or £50,000 in the case of a company, or such lower amount as might otherwise be prescribed.308

Clause 37 and Schedule 4 would make amendments to other legislation to reflect the introduction of collective benefits. These include the provisions in the Pensions Act 1995 to protect members against detrimental modifications to their subsisting rights. The Explanatory Notes say: 127. As noted for clause 18 above, section 67 of the Pensions Act 1995 contains provisions to protect members against detrimental modifications to their ‘subsisting rights’. 128. Currently, section 67A states that a change must be considered as a ‘protected modification’ where money purchase benefits would replace non-money purchase benefits, or where the change would result in a reduction to a pension in payment. This clause adds a further case to that list so that if a right to non-collective benefits would be replaced by a right to collective benefits under the scheme rules, this is a protected modification. Part 2 also modifies the 1995 Act to exclude collective benefits from the existing framework of subsisting rights provision. 309

In addition, Schedule 4 would provide for:

4

-

Collective benefits to be exempt from the employer debt provisions in section 75 of the Pensions Act 1995 which apply where a DB scheme in wind-up is in deficit.310

-

Occupational schemes offering only collective benefits (or only money purchase benefits and collective benefits) will not be eligible for the Pension Protection Fund (set up under the Pensions Act 2004 to provide compensation to members of defined benefit pension schemes winding up underfunded on the insolvency of the sponsoring employer).311

-

Schemes providing collective benefits are to be exempt from the scheme funding requirements in the Pensions Act 2004 (which currently apply to occupational pension schemes but not to money purchase schemes or schemes of a prescribed description).312

-

Provisions requiring trustees or managers of occupational money purchase schemes to prepare schedules of payments for scheme members are to be amended so that it applies to all DC or shared risk schemes under which either all of the benefits to be provided are money purchase benefits or money purchase benefits and collective benefits.313

. Part 4 – Miscellaneous and general

Clause 38 would allow the Secretary of State to make payments into the occupational pension scheme for Remploy. The Explanatory Notes say:

308

DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911 Bill 12-EN 310 Ibid para 131 and 132 311 For detail, see the website of the Pension Protection Fund. For more on the background to the scheme, see Library Note SN 3917 Pension Protection Fund (July 2012) 312 For more detail, see Library Note SN 4877 Pension scheme funding requirements (March 2013) 313 Bill 12-EN, para 137 309

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139. This clause allows for the Secretary of State to make payments into the Remploy Limited Pension and Assurance Scheme, the occupational pension scheme for the organisation Remploy. 140. Remploy is a non-departmental public body that provides employment services for disabled people and those with barriers to work. Its pension scheme is currently funded by Remploy via monies received from the Department for Work and Pensions. The proposed legislation will enable the Department for Work and Pensions to fund the scheme directly.314

Remploy is a Non-Departmental Public Body and a public corporation. It operates as a commercial company and is funded through revenue generated from its commercial activities and grant-in-aid from government.315 The Remploy Pension Scheme is a trust-based occupational pension scheme. It has a Crown guarantee in the event of the insolvency of the sponsoring employer.316 On 22 July 2014, Minister for Employment, Esther McVey, announced that she was launching a commercial process for Remploy, which would allow an investor or partner to take on a “significant stake in Remploy Employment Services and invest in its continued growth and development.” As regards the pension scheme, she said: We will ensure that the Remploy Pension scheme continues to be funded and that the accrued benefits of members are protected.317

Clause 39 would make amendments to bring the Pension Schemes Bill within the scope of existing references to pensions legislation in the Pensions Act 2004. These include section 13 of the Act, which allows the Pensions Regulator (TPR) to issue an improvement notice to a person who has contravened pensions legislation and to section 90 and schedule 18 which allow TPR to issue ‘codes of practice’ in relation to the discharge of duties under pensions legislation.318 Clause 40 contains a regulation-making power to make consequential amendments to existing legislation to accommodate the new definitions in Part 1 and the concept of collective benefits in Part 3. The Government said the Bill itself made a number of changes to existing legislation to enable property scrutiny. However, other changes would need to be made in future to enable the proper operation of provisions in the Bill: 107. Many consequential changes to existing legislation are being made by other provisions of this Bill. This clause inserts a regulation-making power to make further consequential changes, i.e. to bring existing legislation into line with the new definitions and types of benefit that are established in this Act. The provision includes a Henry VIII power to allow amendments consequential on this Bill to be made to primary or secondary legislation, whenever passed or made. We have prioritised for inclusion in the Bill certain key consequential amendments that relate to fundamental elements of the current legislative structure. The main provisions in the Bill are to establish a new framework - which of itself does not directly place any new requirements on schemes. The key consequential amendments in the Bill relate to the nature of benefit rights and entitlements of members at key points in the pension saving lifecycle in order to enable proper scrutiny and give sufficient clarity.

314

Ibid For more detail, see Library Note SN 698 Remploy (August 2014) 316 The Pensions Regulator FOI reference 2010-11-18 – A list of pension schemes with a crown guarantee. 317 HC Deb 22 July 2014 c126WS 318 Ibid. The powers of the Pensions Regulator are discussed in more detail on its website. See also, Library Note SN 4368 The Pensions Regulator: Powers to protect pension benefits (March 2013) 315

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108. However, this power has also been taken in order to deal with other amendments which will be needed subsequently for the proper operation of the provisions in the Bill and their interaction with other requirements in private pension and wider legislation, including legislation of other government departments. The changes made by this Bill constitute significant change to the pensions legislative structure, and are therefore likely to take some time to bed in. There will be detailed implications which will need to be worked through during the implementation stages, including consideration of virtually all of the current stock of pensions secondary legislation and the powers under which it is made. Even if an attempt is made in future legislation to take account of the effect of the Bill there is a clear risk that unintended consequences will slip through unnoticed, which could cause implementation problems. The power to amend future legislation therefore acts as a useful safety net. 319

319

DWP, Pension Schemes Bill Delegated Powers, June 2014, DEP2014-0911

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Appendix 1 – Glossary Annuity – a lifetime annuity is a contract with an insurer to provide a series of payments over the lifetime of the individual (or, in the case of a joint-life annuity over the remaining lifetime of the longest survivor). Contract-based scheme - In a contract-based scheme an employer appoints a pension provider, often an insurance company, to run the scheme. The scheme members will sign a contract with the provider who will make the majority of decisions about the way the scheme is run. Cash balance scheme – a scheme in which a guaranteed cash sum is built up on the basis of a known formula which is related to the employee’s pensionable earnings in each year of membership. The resulting “cash balance” can be used to buy an annuity or to make other arrangements. Cash equivalent transfer value – the value which a pension scheme member may require to be paid as a transfer payment to another registered pension arrangement. Contracting out - The system by which individuals can opt out of State Second Pension and use a proportion of their National Insurance Contribution to build up a funded pension. It is to be abolished when the single-tier State Pension is introduced from 6 April 2016. Income drawdown - whereby an individual can draw an income from their fund while leaving the rest of it invested. However, under current rules there are limits on the amount of income that can be drawn down each year except where the individual can show they have other pension income over a certain amount. Public service pension schemes – an occupational pension scheme providing benefits for public service workers. Most of the main public service schemes (those for civil servants, teachers, the NHS, police and firefighters) are unfunded and operate on a pay-as-you-go basis. This means there is no fund of assets from which pension benefits are paid. Instead, employee and employer contributions are paid to the sponsoring government department, which pays benefits to pensioner members, netting off the contributions received. Of the main public service schemes, only the Local Government Pension Scheme is funded. This means that contributions are paid to a fund, which is invested, and from which the cost of benefits is met. Regulatory Own Fund (ROF) – a scheme where the scheme itself, and no employer in relation to that scheme, underwrites liability to cover against biometric risk (linked to death, disability or longevity), or guarantees a given investment performance of a given level of benefits. Article 17 of the European Directive on the Supervision of Institutions for Occupational Retirement Provision (2003/41/EC) requires such schemes to hold additional assets above normal funding levels. Trust-based scheme – A schemes that is sponsored by the employer but managed by a board of trustees. The trustees have full responsibility for the management, administration and investment of the plan. The trustee’s fiduciary duty is to act in the interests of members.

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