CMS Cameron McKenna response to Government Consultation Paper: Simplicity Security and Choice

This response has been prepared following consultations and discussions with a number of our clients representing employers and trustees from a broad section of occupational pension schemes.

All paragraph references in this paper are to paragraphs in the Department of Work and Pensions Technical Paper, unless otherwise specified.

1. Minimum Funding Requirement

1.1

Giving trustees a power to trigger a winding-up of the scheme in the event that the employer does not make contributions in accordance with the Schedule of Contributions (at paragraph A15) is not helpful. It provides the trustees with a power that it will almost never be in members’ best interests to use, as it would result in termination of ongoing pension provision. Therefore it gives trustees and members the illusion that the trustees are in a strong position, without them actually having any real powers at all.

1.2

In general, the idea of a scheme specific solvency standard is potentially problematic. Under the current regime, whilst the MFR may be flawed, at least schemes can be certain that they have complied with it. The scheme specific standard runs the risk that in the future some schemes (particulary smaller ones) will not know what they need to do to comply or that there is a compliance issue at all. However, the general intention to allow employers more flexibility is worthy in principle and should work for larger schemes.

1.3

As a general point, employers are currently extremely focused on compliance with the accounting standard FRS 17 and therefore changes to the MFR basis may not have the affect on employers which the Government anticipates.

2. Section 67 Pensions Act 1995 – scheme amendments

2.1

The proposals at paragraph C5 that schemes could be allowed to make changes “providing the actuarial value of the change does not exceed a certain percentage limit of a member's total accrued rights - say five per cent (the de minimis approach)” seem to be more complex and potentially difficult to operate than the existing provisions in section 67.

2.2

In practice, problems have arisen with section 67 where, for example, a future service amendment has not been properly documented at the time the change was made because of an administrative oversight. The new proposals would not address this.

2.3

Concern has been expressed that an “equivalent value” test along the lines suggested by Alan Pickering would allow the conversion of defined benefit rights to defined contribution rights. In practice, we cannot envisage that an actuary would ever certify an amendment on this basis.

3. Member-nominated trustees and directors (MNTs)

3.1

The view was expressed to us that future requirements in relation to MNTs should ensure that the provisions that many schemes have in place allowing nomination and/or selection by trade unions should be allowed to remain in place.

3.2

The new proposals will create problems in relation to existing trustee arrangements which include independent trustee companies. Often such arrangements are structured as one trustee company with employer and member representatives and a separate independent trustee company. In addition, you should also be aware that exoneration provisions in scheme documentation are often limited in their application to independent trustees (and the Law Commission proposes that such trustees should not be able to rely on exoneration clauses at all). Under the new proposals, it seems likely that an independent trustee would need to become a director of a trustee company and would, as a result, potentially be less exposed to any liability for wrong doing and negligence. This is because liability would usually be the trustee company’s not the individual director’s and limitations on the scheme exoneration provisions would not apply to the trustee company.

4. Immediate vesting

4.1

• We found no clients with whom this was a popular suggestion. Some of the reasons for opposition to the proposal are as follows:
• The reason that there are still any final salary schemes at all is in part inertia. However, if the costs associated with such schemes were to increase (as would be the case with immediate vesting), it may overcome this inertia and we may see more final salary scheme closures;
• It would not significantly benefit members as many employers would simply introduce longer waiting periods – which would actually mean that the employees who stay beyond 2 years have lost some element of benefit accrual. It seems likely that such waiting periods would be in the region of 12 months to dovetail with the requirements in relation to designating stakeholder arrangements;
• It would not necessarily encourage more people to join occupational pension schemes as anecdotal evidence was that many members viewed refunds of contributions as a positive thing.

4.2

Many schemes are structured to automatically include employees as members unless they choose to opt-out. In practice, this probably results in more people being members of employer pension schemes than would otherwise be the case. However, if immediate vesting was introduced, some schemes have indicated that they would consider changing this practice to require members to opt-in in order to avoid being left with very small benefits in relation to members who choose to opt out after only a few weeks membership. Therefore, this proposal could result in fewer people joining occupational pension schemes in the future.

4.3

If immediate vesting was introduced, some clients have indicated to us that they think that it would only work if a materiality threshold was introduced – so only benefits over a certain level vested.

5. Transfers and safe harbours

5.1

Simplification and removal of duplication in the existing transfer regime (paragraphs D4-6) would be generally welcomed.

5.2

The proposals in part K of the Technical Paper in relation to transfers of de minimis amounts to a stakeholder arrangement without consent “where members left the schemes more than six months previously, providing the members do not object, were aware of the proposal to do so at the time they ceased to participate in the scheme, and do not ask for the rights to be transferred elsewhere” are generally to be welcomed.

5.3

There are practical difficulties as stakeholder arrangements require the individual’s consent to be established (this has also been a problem in relation to finding vehicles for pension credits where the former spouse has not indicated a destination).

6. Divorce

6.1

The abolition of safeguarded rights suggested at paragraph F17 is to be welcomed. Pension sharing has proved unnecessarily complex to operate and any simplification is to be welcomed.

6.2

The option for schemes to transfer out pension credits where the former spouse has not indicated a destination for the transfer, should not be removed. For many schemes this is the most practical solution for dealing with such benefits. However, thought should be given as to increasing the available destinations for such transfers to include stakeholder schemes (see paragraph 5.3 above). Alternatively, the consent of the former spouse to a transfer to a stakeholder, in default of selecting his/her own vehicle could be made a condition of implementing a pension sharing order.

6.3

Earmarking should continue to be an alternative to pension sharing. Earmarking orders are used with reasonable frequency as many people find them easier to understand than the existing pension sharing regime. There are also some people for whom an earmarking order is a better alternative than a pension sharing order – for example it can give the former spouse rights in relation to a lump sum death in service benefits.

7. Compulsory membership

7.1

This proposal has not been met with approval from any of the clients we have discussed the issue with.

7.2

There is a danger that because of means tested stated benefits and the benefit structures in some occupational pension schemes, it would not be in the interest of certain lower paid employees to join their employer’s pension arrangements.

7.3

If an employee does not have an option whether or not to join the scheme, there could be problems if that scheme eventually winds up in deficit and not all of the benefits are able to be secured. The employee would not have had the option to save for his/her retirement elsewhere and may therefore feel they have some basis for a claim against the employer who forced him/her into the scheme.

8. Winding-up

8.1

Changes do need to be made to the existing regime to ensure greater fairness between different classes of member.

8.2

The suggestion of capping the benefits of senior employees in paragraphs G8-10 is a good one and would address a problem found in small companies where the executives responsible for the insolvency of the company take early retirement before the pension scheme is wound up.

8.3

Where a scheme winds up with a solvent employer, the full buy-out basis suggested at paragraph G33 would hasten the closure of many schemes to prevent potential costs increasing. However, such schemes might not then be wound up as the employer could not afford the cost, but run for as long as possible as closed schemes.

8.4

The suggestion in paragraph G17 that a new category of creditor should be introduced would be of little practical benefit. This would doubtless cause difficulties with other categories of creditor, banks may refuse to lend and companies’ credit ratings may be adversely affected.

9. Indexation

9.1

Paragraph B17 provides that the Government will not make any changes to the indexation requirements unless they “had good reason to believe that the coverage of and contributions to occupational pensions would be higher than would otherwise be the case.”. This is not the correct test for deciding whether changes should be made to the existing LPI requirements. No one factor of itself can be said to be responsible for deterring employers from setting up occupational pension arrangements, however, this along with many other things may be a contributing factor.

A better alternative might be to look at the extent to which the existing LPI requirements are responsible for additional costs which deter employers from continuing existing pension provision.

9.2

The provision of LPI is optional in personal pension schemes and it is hard to justify why similar flexibility should not apply in an occupational pension scheme. This is particularly the case as final salary schemes are increasingly not balance of cost schemes where the employer meets the rising scheme costs – more and more costs are being transferred to the members in the form of increased member contributions. Therefore, it is potentially in members’ interests that LPI should just be an option as part of the overall benefit design.

For further information please contact Mark Atkinson at [email protected] or on +44 (0)20 7367 2184.