Pension Schemes Bill

Written evidence submitted by the Association of Consulting Actuaries (ACA) (PS 07)

1. Introduction

 

1.1 The Association of Consulting Actuaries (ACA) welcomes the main aim of the Pension Schemes Bill, which is to establish a new legislative framework for shared risk (defined ambition) schemes. Whilst we are disappointed that the Government has decided not to proceed with ‘flexible defined benefit’ options in the immediate future, we are pleased that the Government is proceeding with the other proposed models for defined ambition schemes. We believe that such schemes have the potential to provide employees with some measure of certainty, whilst also restricting the level of risk being faced by employers. Over time, we expect that a number of new scheme models will be established in the space being created between traditional defined benefit and defined contribution schemes.

1.2 We also welcome the Treasury’s proposals for enabling increased flexibility in drawing benefits from defined contribution schemes (the consequences of which for DWP legislation will need to be contained in this Bill and which we understand are likely to be introduced at Committee stage).

1.3 The ACA’s 1,750 members provide advice to thousands of sponsors of UK pension schemes, including most of the country's largest schemes. ACA members are also scheme actuaries to schemes covering the majority of members of private sector defined benefit pension schemes. Increasingly, actuaries are involved in advising on defined contribution schemes and would expect to advise on the design and implementation of shared risk schemes.

2. Executive Summary

2.1 Whilst we are fully supportive of the aim of this legislation, we have concerns as to the drafting of Part 1 of the Pension Schemes Bill, in particular because of the potential impact on existing schemes and the interaction with existing definitions of benefit types. Whilst pensions professionals will undoubtedly adapt to the new terminology, we are concerned that there is a possibility for confusion amongst members, particularly if they are told that their scheme (which they thought they understood) now has a new description (when in fact there has been no actual change).

2.2 We are also supportive of the concept of ‘collective benefits’, but note that the legislation is unclear as to the roles of ‘actuary’ and ‘scheme actuary’.

2.3 We support the extension of the statutory right of a transfer from DC schemes to continue for as long as benefits are uncrystallised, and would argue for further extensions to the statutory right to a transfer (and the associated statutory discharge) to enable full transfers from DB schemes up to normal pension age as well as a statutory discharge where partial DB transfers are allowed by a DB scheme.

3. Categories of Pension Scheme

 

Part 1

3.1 Part 1 of the Pension Schemes Bill sets out to divide all pension schemes (both existing and future) into three mutually exclusive categories: ‘defined benefits’, ‘defined contributions’ and ‘shared risk’ (‘defined ambition’). This entails the creation of brand new definitions for each of these categories. Whilst we are fully supportive of the aim of this legislation (to create a regulatory space for shared risk schemes), we have concerns as to the drafting of this part. We would also note that this legislation is for the most part enabling and it will be useful to understand better the policy intent underlying the various delegated powers.

Recategorisation of schemes

3.2 In principle, it would seem appropriate that this legislation should cause the minimum disruption (and hence minimal additional cost) to existing schemes. It is therefore desirable that trustees who currently think of their scheme as defined benefit should continue to think of it as ‘defined benefits’ and so on. However, this is not possible as the legislation is currently framed.

3.3 It seems inevitable that some types of schemes will find themselves effectively reclassified under one of these new definitions. For example, cash balance schemes or defined benefit schemes under which normal pension age can vary will now find themselves classified as ‘shared risk’ rather than ‘defined benefits’. Some moderate level of reclassification is appropriate and meets one of the objectives of the overall policy, i.e. to inform members about the risks they face in their pension scheme.

3.4 However, it is important that such reclassifications are kept to a minimum to reduce advice and communication costs. For example, an existing defined benefit scheme that also offers members benefits on a defined contribution basis (for example, through an AVC or top-up fund) would be classified as ‘shared risk’ under the Pension Schemes Bill since it offers a ‘pensions promise’ in relation to at least some of the retirement benefits of each member, but does not meet the test of a pure ‘defined benefit’ scheme. At present, most defined benefit schemes offer an AVC facility (because of a legal requirement to do so before 2006) so, as it stands, the Pension Schemes Bill would reclassify most defined benefit schemes as ‘shared risk’. We understand that the regulation-making power under clause 6(2) will be used to split defined benefit schemes with AVCs into ‘defined benefits’ and ‘defined contributions’ schemes. Clearly, it will be helpful to have this confirmed during the passage of the Bill through the House. However, this does expose a flaw with the approach taken to the drafting: it ought not to be necessary to utilise secondary legislation to correct for misclassifications that follow from applying the primary legislation.

3.5 We also understand that the regulation-making power under clause 6(1) will need to be used so that a scheme that has within it defined benefit and defined contribution sections, only one of which is still open to members, is regarded as two separate schemes. Whilst we can appreciate the logic of this in the abstract, we are concerned with the potential confusion introduced as the scheme is not split in reality. Moreover, other legislation sponsored by the Department for Work and Pensions will continue to regard the scheme as not being split.

Consequences of being ‘shared risk’

3.6 It is not clear from the Bill what the consequences are if a scheme does find itself categorised as ‘shared risk’. We understand that the intention is for further disclosure and governance requirements under secondary legislation and it would be helpful to explore what these are, and how onerous they may be. The one specific power granted under the Bill in respect of shared risk schemes is a power to create exemptions from indexation (which we welcome as providing a framework for future schemes incorporating conditional or discretionary indexation, although we understand that there is no immediate intention to commence this provision).

3.7 We also expect that there will be amendments needed to tax legislation in due course to provide appropriate methods for testing benefits from new schemes that are classed as ‘shared risk’ against the annual and lifetime allowances. This is because the current methods may give inappropriate tax outcomes for the new designs that the Bill is intending to facilitate.

Interaction with existing definitions

3.8 These three new definitions of pension scheme operate alongside existing definitions of ‘benefits’. The Finance Act 2004 s152 effectively divides benefits for tax purposes into ‘defined benefits’, ‘cash balance’ (a subset of money purchase) and ‘other money purchase’ (money purchase which is not cash balance) – there is (appropriately) no intention to change these. Existing DWP legislation (the Pension Schemes Act 1993 s181) has its own definition of ‘money purchase benefits’. This was recently amended by the Pensions Act 2011 s29 to make clear that only benefits calculated solely by references to the assets available to the member could be ‘money purchase’ (in other words benefits in respect of which a deficit could never arise). Except in the context of auto-enrolment (Pensions Act 2008 s21), there is no explicit definition of ‘defined benefits scheme’: certain provisions in legislation (such as the funding requirements in the Pensions Act 2004 Part 3) are restricted indirectly to defined benefits schemes (by applying them to occupational schemes other than those providing solely money purchase benefits). Until recently, cash balance benefits were only defined in DWP legislation in the context of indexation in payment. There has been a small extension to the application of cash balance benefits following the DWP’s narrowing of the definition of money purchase benefits, but other than this, cash balance benefits remain in the same ‘not money purchase’ category as defined benefits.

3.9 The new Pension Schemes Bill adds further complexity to already difficult legislation by putting a new layer of definitions at a scheme level on top of the existing level of definitions at a benefit level. This new layer is likely to add further to the legal and other advice costs involved in establishing schemes to ensure that the scheme and the benefits it provide are correctly classified under the various pieces of legislation. It has to be questioned as to why this is necessary when, to date, definitions at the benefit level have proved to be perfectly suitable. We also understand that there is no intention to adjust the benefit level approach in existing DWP legislation, so current obligations will continue to be driven from this level, whilst new obligations or easements may be driven from the scheme level approach.

3.10 We find the choice of the terms ‘defined benefits’ and ‘defined contributions’ in the Pension Schemes Bill unhelpful. These new definitions categorise pension schemes from a completely different perspective to that of all the other definitions used for pension benefits, by way of the promise being provided to scheme members, yet they use terminology that is remarkably similar to terms that are already in common usage amongst both pension experts and pension scheme members. Everyone with any knowledge of pensions will confidently say (using everyday language) that a defined contribution scheme and a money purchase scheme are identical. This identity is fundamentally undermined by the Pension Schemes Bill, since a ‘money purchase scheme’ (i.e. a scheme which solely provides ‘money purchase benefits’) is not the same as a ‘defined contributions scheme’. [1] It appears that all money purchase schemes will be defined contributions schemes, but the converse will not be true: there may be defined contributions schemes under which there is no pension promise in the accumulation phase, but which nevertheless do not provide solely ‘money purchase benefits’ as defined in the Pension Schemes Act 1993. (Examples would be schemes providing solely collective benefits, or schemes in which pensions from defined contribution pots are secured within the pension scheme.) Clearly, pensions professionals will do their best to use the new terminology correctly, but the potential for confusion among members or lay trustees is very great.

3.11 Whilst it may now be too late in the process for a complete rewriting of the Pension Schemes Bill, it is important that the disadvantages of the approach being taken are realised. In particular, any new disclosure requirements should not require members to be told which definition in the Pension Schemes Bill their scheme meets since that could cause confusion, an outcome contrary to the aim of giving members greater certainty over the nature of their benefits.

Drafting issues

3.12 The terminology of ‘pension promise’ is a relatively new one in pensions legislation and we understand that ‘promise’ is not a fully defined term in wider legislation. We expect therefore that legal interpretations as to what does and does not constitute a promise will vary and that case law may be needed to establish the definition properly.

3.13 We find the parenthesis ‘other than longevity’ in clause 5(3) unclear. If a scheme includes a promise about longevity factors, does that prevent it from meeting the definition or not?

4 Collective benefits

Part 3

4.1 The ACA supports the development of a framework to create new collective defined contribution (CDC) schemes.

4.2 The Pension Schemes Bill proceeds by creating a new category of ‘collective benefits’ (not ‘schemes’) which will typically meet the requirements to be a ‘defined contributions scheme’ under Part 1. It will be confusing to many members that a scheme that enables the sharing of risk between members through the provision of collective benefits will not meet the requirement for a ‘shared risk scheme’ (which requires the provision of a promise). [2] It is not clear that this was the only or best way to draft this legislation, although we note that in practice wholescale redrafting is unlikely to be possible.

General requirements for collective benefits

4.3 In outline, the principles set out in the Bill seem to create a workable and practical framework for collective benefits, although we will need to see the regulations to be sure. We would welcome a full consultation on the details of the secondary legislation.

4.4 The framework requires the setting of targets and the assessment of the probability that the scheme meets those targets. Where that probability is lower than or exceeds a level to be set in regulations, trustees may be required to have a policy for dealing with a surplus or deficit. We would caution against too prescriptive an approach to the required probability in the secondary legislation. It would not be helpful if some of the gains that may be achievable from a collective benefit scheme were to be lost through an over-cautious investment strategy driven by the need to meet the scheme’s target level of benefits with a hard-coded probability.

Role of the actuary

4.5 The Pension Schemes Bill gives a number of roles to ‘an actuary’ (e.g. in clauses 20, 26 and 27). In each of these clauses, the regulations indicate that the trustees may be required to obtain the necessary report or certification from ‘an actuary who has specified qualifications or meets other specified requirements’. Clause 32, however, includes a regulation-making power for the trustees to be required to obtain advice from ‘the scheme actuary’ (the term to have the meaning given in regulations).

4.6 Although the term ‘scheme actuary’ is widely used in common parlance, section 47(1) of the Pensions Act 1995 defines the role simply in terms of ‘the actuary’, and this is the term most commonly used in legislation (although ‘scheme actuary’ is used in the Pensions Act 2008 in the context of certification against the test scheme standard for auto-enrolment purposes). It may be therefore that a reference to ‘the actuary’ throughout would be preferable. It is not clear on the current drafting whether the intention is that ‘the scheme actuary’ would provide advice under clause 32, but that any actuary would be able to provide the certifications and reports required. We would expect a single named actuary (the scheme actuary in common parlance) to be responsible for all the statutory requirements in relation to a scheme providing collective benefits and for the drafting of the legislation to reflect this.

5 DWP consequences of the Treasury’s flexibility proposals

5.1 The Pension Schemes Bill will include legislation consequential on the introduction of greater flexibility for members of occupational pension schemes with money purchase benefits (which we describe here for ease of usage as ‘DC schemes’ – noting however that this is not the same as ‘defined contributions’ schemes as defined by Part 1 of the Pension Schemes Bill). With the exception of clause 14 on the prohibition on transfers from public service schemes (which will need to be amended to reflect the policy intention to allow transfers from funded public service schemes), this legislation is not yet available. Our comments are therefore only on the underlying policy intention.

5.2 The Treasury’s response to its ‘Freedom and choice in pensions’ consultation indicated that it would legislate to extend the statutory right to transfer from a DC scheme up to the scheme’s normal retirement age (it currently only applies until a year before preservation ‘normal pension age’ (NPA) which in some DC schemes could mean (by an accident of drafting) no statutory right to transfer from as early as age 54). This right is enshrined in DWP legislation and will be amended by means of the Pension Schemes Bill. In the current climate of DC flexibility (but noting the Government’s assurance that it will not force schemes to offer flexibility), there is a strong argument that the statutory right should continue as long as the member still has uncrystallised DC benefits in the scheme. There does not seem any reason to draw a line at what is typically an arbitrary scheme ‘normal retirement age’. Alongside this right would naturally come a statutory discharge for trustees on any liability to the member following the transfer.

5.3 We also think that consideration should be given to introducing a statutory discharge for trustees who permit partial transfers from defined benefit (DB) schemes (to allow members to transfer out any DC funds in order to access full flexibility whilst still retaining their DB benefits in the scheme). It may also be considered whether it is appropriate to extend the statutory right to a transfer to include a right to a partial transfer in such cases. (At the moment the DWP legislation only gives rights, and statutory discharges, where a transfer is taken in respect of all the benefit from a scheme.)

5.4 We would also request some extensions to transfer rights/statutory discharge in the DB world. We think the right to transfer should be extended right up to NPA (rather than stop one year before) – together with the statutory discharge; and a statutory discharge (but no imposed right) should be given where the trustees allow a member with DB rights to take a transfer in respect of part of those DB benefits to another scheme. We think this could support an important option that trustees may wish to introduce, allowing members to tailor their retirement provision to suit them, and giving schemes a tool for some de-risking. For example, a member with a £25,000 pa DB pension right and a state pension may well prefer to transfer the value of £10,000 pa of those DB rights for flexible use – if the scheme is willing to allow this.

October 2014