intouch PENSIONS NEWS AND INFORMATION FROM THE EXPERTS
GMP equalisation rears its head The Government consults on draft regulations The Department for Work and Pensions intends to amend current legislation to explicitly provide that if any provision of an occupational pension scheme is less favourable to one sex as a result of the GMP rules, then it is modified so as not to be less favourable.
Effects of unequal Guaranteed Minimum Pensions (GMPs)
For a man and a woman born on the same date and with the same service and earnings history, the effect of unequal GMPs on the overall occupational scheme pension manifests itself in a number of ways: ■
GMP payment dates – As noted above, the age at which the GMP has to come into payment varies between men and women.
Deferred pensions – Whilst the scheme pension at the date of leaving will be identical, the accrued GMP will be higher for the woman. The detailed GMP ‘anti-franking’ rules and the effect of different rates of revaluation to the GMP
and to the balance of the deferred pension typically results in a higher initial pension at retirement for the woman.
Pensions in payment – Even if pensions at the point of retirement are identical, the effect of different rates of pension increase applied to the GMP element and the balance of the pension will mean that the pensions will diverge over time. If the percentage increase to the pension in excess of any GMP is greater than the statutory increase on the GMP, the overall pension increase will be greater for the man, due to his smaller GMP component.
A look back in time The landmark Barber case established that pensions are ’pay’ under EU law. As a consequence, benefits under occupational pension schemes have to accrue equally for men and women for service on and after 17 May 1990, in order to comply with the legal principle of equal pay for equal work. This has been reflected within overriding domestic legislation since 1996, which requires schemes to be treated as having an equal treatment rule. Whilst benefit design has changed in the years since the Barber decision – typically resulting
GMPs are the prescribed minimum pensions that a defined benefit occupational pension scheme had to provide for it to be used for contracting-out of the State Earnings-Related Pension Scheme (SERPS) between 6 April 1978 and 5 April 1997. SERPS (now called the State Second Pension) provides pensions that are unequal between men and women and this is reflected in the GMP legislation. Payment of a GMP must commence at age 60 in the case of a woman (except where employment is continuing), whereas for males the earliest payment age is 65. In addition,
the GMP accrues at a faster – and therefore more generous – rate for females, reflecting their shorter working lifetime to their GMP retirement age.
Miscellaneous recent developments Page 3
Important deadlines Page 6
Adequate, safe and sustainable pensions Page 7
A review Page 8
lump sum of £500 at 65, the DWP solution to equalisation would be to pay both £1,000 – namely £500 at 60 and another £500 at 65; this seems to go overboard on the meaning of equal treatment (as a more obvious approach would simply be to pay both men and women £500 at age 60)! Needless to say, the GMP rules are far more complex. The Government’s illustrative method is likely to be the most expensive approach, both in terms of increases in scheme liabilities and – perhaps of greater importance – administration costs. A possible alternative might be to make use of the ability to ‘convert’ GMPs into main scheme benefits of equivalent actuarial value, followed by a one-off equalisation exercise. To date we are not aware of any schemes that have done this since the Government introduced this option in 2009. However, this may be the easiest option. in a common normal retirement age of 65 for men and women for future service – very few defined benefit contracted-out schemes have to date directly adjusted scheme benefits to remove the inequalities arising from the GMP rules. This has been due to legal uncertainty of what, precisely, is required. For instance, is the GMP element ‘pay’? If so, then the GMP itself must be equalised under European law. On the other hand, if it is not ‘pay’, then the GMP is purely a calculation factor that provides an underpin to the level of pension provided by the scheme. EU case law also provides that it is possible to objectively justify unequal pay in certain circumstances. For instance, the Birds Eye Walls v Roberts case from 1993 held that a bridging pension payable to men between the ages of 60 and 65, but not to women, was objectively justified in that it compensated for the fact that the Basic State Pension for men does not begin to be paid until age 65. Would a court accept arguments that differences in pensions due to GMPs are objectively justified, given that they mirror the corresponding reductions from the State Pension?
The Government’s stance The Government believes that, whilst schemes do not have to equalise the GMP, they do have to equalise overall scheme benefits accruing from 17 May 1990 and this includes any inequality arising from the GMP legislation. The purpose of the currently proposed amendment to UK legislation is, in the Government’s view, simply to remove the need for an actual comparator of the opposite sex in relation to any genderbased inequalities arising out of the GMP rules. It believes this change is required in
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order to comply with EU law requirements in circumstances where sex inequality arises directly from state legislation. The calculation of GMPs is of course prescribed by law and mirrors the historic inequalities in the earnings-related State Pension. However, by explicitly requiring schemes to rectify any unfavourable terms arising as a result of the GMP rules, there is a risk that the Government may be going beyond what EU law requires. The Government has taken legal advice on this but is unwilling to make it publicly available.
Equalisation The Government is not planning to stipulate how equalisation should be achieved in practice. However, it has published as part of its consultation ‘A possible method for equalising pensions for the effect of the Guaranteed Minimum Pension’ which it thinks “would be useful” to private sector schemes. This is based on an ‘opposite sex notional comparator’. It compares what a member would be paid under the scheme at all ages from age 60 with the payments had the member been of the opposite sex. The benefits would then be levelled up as appropriate. This would necessitate a comparison at age 60 and at least yearly thereafter – if increases to pensions in payment are made other than on 6 April, more frequent checks would be needed post-retirement. This approach would often result in men getting uplifts in their pensions at certain times, and women getting uplifts at other times. Both sexes could therefore gain. As a very simplified example of the concept, if a scheme’s benefit structure provided for a female to be paid a lump sum of £500 at 60 and a male a
Practicalities Unfortunately the Government is completely silent on a number of issues. For instance, will calculations have to be revisited for all those with GMPs who have retired, died, transferred to other schemes, divorced with a pension sharing order or been bought out with insurers since 17 May 1990? Can trustees ignore underpayments to pensioners made more than six years ago, by relying on the limitations in section 134 of the Equality Act 2010? Would interest be needed on underpayments? What would be the tax treatment? There is also the issue of whether historic scheme data will be sufficient. Clearly, the amount of administration work would be huge, with perhaps only marginal benefit uplifts for many members. For the pension movement as a whole, costs totalling billions have been cited. In light of this, it is difficult to see why the Government is reluctant to seek the opinion of the European Court as to whether ‘GMP equalisation’ is really needed.
So what should schemes do? In the first instance, scheme trustees should discuss this with their pension lawyers and the sponsoring employer. For ongoing schemes this may lead to a ‘wait and see’ approach, with no precipitous actions being taken. Schemes that are winding-up will however need to consider how to handle ‘GMP equalisation’. Once tentative options are agreed, the administrative aspects will need to be considered, with the scheme actuary providing input on the effect on scheme liabilities. ■
Some updates... We cover below a number of miscellaneous developments over the past few months If after taking some of the steps outlined above trustees are concerned, they may of course decide that a formal covenant review is appropriate. Where trustees provide the required certification for such a ‘Type A’ contingent asset, this does not mean that it will automatically be accepted. Rather, the PPF will perform its own analysis of the guarantor’s strength and may ask the trustees to supply the information they used to come to their conclusions. For the 2012/13 year the PPF intend giving schemes “the benefit of the doubt” provided that, in the PPF’s view, the guarantee provides a substantial benefit even if this is not at the level implied by the levy. Trustees should not, however, rely upon any particular lower threshold of guarantor strength as satisfying the PPF Board’s requirements! In future years it is intended that ‘Type A’ guarantees will be wholly rejected by the PPF if, in its view, the guarantors are unable to meet the value of their guarantee in full, even where the contingent asset may be considered to have some value.
The CPI issue PPF and ‘Type A’ contingent assets The Pension Protection Fund (PPF) has expressed concerns that it has come across circumstances where a guarantor, with little or no trading history (such as service companies) but with a favourable failure score, in reality did not have sufficient assets to meet the cost of the guarantee if called upon to do so.
Clearly this will be a recurring feature of future PPF levy determinations too.
■ A review of the guarantor’s most recent accounts, together with a consideration of any known post-balance sheet events, to assess the net asset position or profitability of the business. ■ The ability of the guarantor to borrow money. ■ Making enquiries of the guarantor’s financial director to obtain an assurance as to the strength of the guarantor compared to what is being guaranteed.
As expected, the Pensions Act 2011 completed the process of giving the Government the power to use the CPI, rather than the RPI, as the inflation measure underlying the statutory revaluation and indexation of DB pensions (and PPF compensation). As has been well documented, CPI inflation is generally below RPI inflation. However, the legal position is still not 100% clear! This is due to a challenge that has been rumbling through the Courts. Back in October last year, various public service unions and interest groups challenged through the High Court the Government’s decision to use the CPI as the index for determining public sector pension increases.
Accordingly, as part of its levy policy statement and final determination for the 2012/13 levy year, the PPF now require trustees to certify, via Exchange (the online system for providing scheme information to the Pensions Regulator), that they have “no reason to believe that each certified guarantor, as at the date of the certificate, could not meet its full commitment under the contingent asset as certified”. In this regard, the PPF expect trustees to take “proportionate and reasonable steps to reassure themselves as to whether the guarantor has sufficient value as a business”.
The PPF does not necessarily expect trustees to undertake a covenant review to assess the strength of a potential guarantor. However, it has suggested a non-exhaustive list of areas that trustees should consider, including:
■ Obtaining confirmation from the directors of the guarantor to supplement publicly available information. ■ Considering the liquidity of the guarantor’s assets.
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employers, provided certain criteria are met. This would avoid a ‘section 75’ employer debt falling on the departing employer. The Government has listened to the pensions movement by extending this new facility to schemes where all benefit accrual has ceased. The Government expects that ‘flexible apportionment arrangements’ will become the norm going forward; because of this it has decided not to deal with some of the existing inconsistencies in the legislation relating to ‘scheme apportionment arrangements’.
The change was challenged on four grounds: 1. Whether the adoption of CPI was consistent with the Government’s statutory obligation – The unions argued that the CPI was more a measure of the cost of living and not an index that measured the general level of prices, which is what the Secretary of State has to use. 2. Whether in making its decision, the Government took into account irrelevant considerations or acted for an improper purpose – The complainants argued that the CPI was chosen to save money, rather than as the best estimate of price changes. 3. Whether there was a legitimate expectation that RPI would continue to be used indefinitely – The argument here was that explanatory literature, negotiations with unions and past practice had created a legitimate expectation that RPI would continue to be used for future up-rating, so that it would be unfair or an abuse of power to go back on that general understanding. 4. Whether the change breached public sector sex equality duties – It was argued that the Government had not fully assessed the adverse effect the use of CPI would have on females, it being submitted that women would be disadvantaged more than men. In a ruling delivered in December, the High Court rejected the challenge unanimously in relation to grounds (1), (3) and (4), and by a majority of two-to-one on (2). The High Court however granted leave to appeal on the first two grounds above and a hearing before the Court of Appeal took place in February. In its ruling on 20 March 2012 the Court of Appeal unanimously dismissed the appeal. Regarding (1) above, it held that the CPI was a perfectly proper index to use for up-rating
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public service pensions.Turning to (2), the Appeal Court judges considered that, where there were two different indices (the CPI and the RPI), either of which could legitimately be used, it was permissible for the Government to take into account the effect on the national economy when choosing between them, at least if the effect was significant and there was a need to benefit the economy. In any event, even if the effect on the national economy was not a legitimate factor, the Court of Appeal considered that the Government would have used the CPI anyway, based on the evidence before it that the CPI was a more appropriate index for up-rating pensions than the RPI. The Court of Appeal refused to grant permission for a further appeal to the UK’s Supreme Court. However it is open to the applicants to ask the Supreme Court for such permission. At the time of writing, we do not know whether this will happen. Were there to be a referral to the Supreme Court there is a risk – perhaps small – that it could take a different view to the two lower courts, with the Government being forced to retain RPI-based indexation for public sector pensions. If so, it is difficult to see how it could avoid having to do the same with regards to the statutory revaluation and indexation of private sector DB pensions.
Employer debt regulations Somewhat belatedly, the Government finally amended the ‘employer debt’ regulations in relation to multi-employer defined benefit (DB) schemes on 27 January. The welcome changes, which had first been proposed last summer, introduce the concept of a ‘flexible apportionment arrangement’. Under such an arrangement, where an employer leaves a multi-employer scheme it will be possible for its scheme liabilities to be re-attributed to one or more of the remaining
The revised regulations also now give an employer, which temporarily ceases to employ at least one active member of a continuing multi-employer DB scheme, a two-month period to notify the trustees that it wishes to operate a ‘period of grace’. This enables the employer to avoid an ‘employment-cessation event’ being triggered with a consequential employer debt assessment, provided the employer does again employ at least one active scheme member within 12 months. Previously such a notice had to be given within one month. In addition, scheme trustees now have the power to extend the one-year period of grace by up to a further two years – this was prompted by employers in the charitable and voluntary sectors, who would not otherwise be assisted by many of the easements available for dealing with an employer debt. One area on which some commentators had sought clarification from the DWP was the meaning of the term ‘active member’. For example, would this include individuals for whom pensionable service is no longer accruing but who retain a final salary link whilst remaining in employment? Rather than amending the definition to provide clarification, the Government’s view is that the best way forward is for schemes and employers to take their own legal advice!
Money purchase benefits As reported in our September 2011 edition, the UK’s Supreme Court ruled against the Government by deciding that a defined contribution arrangement is a money purchase benefit even if there is a pre-retirement guaranteed investment return or the pension is paid directly by the scheme instead of an annuity being purchased from an insurer. This caused some concern for the Government as schemes providing such benefits would be outside the statutory protections afforded to defined benefit arrangements, despite members being at risk due to a potential mismatch between assets and liabilities. This would potentially have placed the Government in breach of EC requirements relating to the protection of pension benefits.
The Government has therefore used the Pensions Act 2011 to amend the definition of a money purchase benefit under DWP pensions legislation such that this will only apply where “its rate or amount is calculated solely by reference to assets which (because of the nature of the calculation) must necessarily suffice for the purposes of its provision to or in respect of the member”. Where this is not the case the scheme will not be a money purchase scheme under the various Pensions Acts. As a consequence, these ‘non-money purchase schemes’ will become subject to DB legislation across such areas as:
This leaves the current position as follows: Date of Birth
State Pension Age Men
Before 6 April 1950
6 April 1950 to 5 December 1953
Between 60 and 65
Between 65 and 66
Between 65 and 66
6 April 1968 to 5 April 1969
Between 66 and 67
Between 66 and 67
6 April 1969 to 5 April 1977
6 April 1977 to 5 April 1978
Between 67 and 68
Between 67 and 68
6 December 1953 to 5 October 1954 6 October 1954 to 5 April 1968
6 April 1978 or later
■ Scheme funding, with triennial actuarial valuations ■ Transfer values ■ PPF levies ■ Revaluation and indexation of benefits ■ Priority in wind-up Whilst the commencement date of the revised definition has still to be finalised, the Act provides that the amendments are to be treated as having come into force on 1 January 1997. There will, however, be transitional provisions – to be set out in Regulations – in recognition that past trustee decisions may not readily be revisited: for example, where a scheme has been wound up in the meantime. At the present time we do not have any details on what precisely the Regulations will say; however, we understand that the DWP will carry out a consultation later this year.
The Government has announced that a further phased increase in SPA to age 67 will be brought in over a two-year transitional period between April 2026 and April 2028. This has still to be agreed by Parliament. (Legislation currently provides that such an increase would occur between April 2034 and April 2036, with a further increase to age 68 phased-in between April 2044 and April 2046.) With ever-improving longevity, a regular uplift in SPA is only to be expected if State Pension provision is to remain affordable and this has been confirmed by the Chancellor’s 2012 Budget speech. This is accentuated by the fact that it is funded on a ‘pay-as-you-go’ basis. Recent figures from the Office for National Statistics show that in 2010 there were 3.2 people of working age in the UK for each person of SPA or over. Even with the increases
to SPA currently taking place this support ratio is projected to fall to 2.9 by 2051. Without the increases to SPA it would drop much further, to 2.0, necessitating significant increases in National Insurance Contributions. Nevertheless, increasing SPA does raise serious social, and therefore political, issues. Life expectancy varies by socio-economic groupings so that a higher SPA may be considered ‘unfair’ for a sizeable proportion of the population. For those in the poorer and more economically deprived parts of the country there is also the issue that meaningful paid employment may be difficult to come by once individuals are in their mid-60s, notwithstanding the abolition of the default retirement age last year. Will greater independence for Scotland see different SPAs north and south of the border? ■
The current uncertainty is, obviously, unhelpful. If your scheme is affected you will need to take legal and actuarial advice on where you stand.
State Pension Age The Coalition Government had originally intended that State Pension Age (SPA) would be equalised for the sexes by November 2018, initially at age 65, with the unisex SPA increased incrementally thereafter until it reached age 66 in April 2020. However, following representations that this would have resulted in a significant tranche of females seeing a two-year uplift in their SPA, the Government eventually decided to phase in the transition to age 66 more slowly. Whilst a common SPA will still apply from November 2018, the Pensions Act 2011 provides that the phased increase to age 66 will not now be completed until October 2020. The increase in SPA beyond age 65 will only affect those born on or after 6 December 1953.
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...and some timely reminders Important deadlines are fast approaching! PPF Levies The following table summarises the various reporting deadlines for the supply of information by defined benefit (DB) schemes for the purposes of the 2012/13 Pension Protection Fund levy. Item
Submission of scheme return on Exchange
By 5pm on 30 March 2012
Certification of any contingent assets
By 5pm on 30 March 2012
Certification of any deficit-reduction contributions
By 5pm on 10 April 2012
Certification of any full block transfers
By 5pm on 29 June 2012
Trustees of DB schemes should ensure their scheme return gives a full breakdown of their plan asset split – including pooled funds. This is because a scheme’s investment strategy will now be taken into account in determining its PPF risk-based levy.
Lifetime Allowance and ‘Fixed Protection’ The Standard Lifetime Allowance for pension savings will be reducing from £1.8m to £1.5m from 6 April 2012. Individuals wishing to retain a Lifetime Allowance of £1.8m, by applying for Fixed Protection, will need to ensure they submit form APSS 227 to Her Majesty’s Revenue and Customs (HMRC) by no later than 5 April 2012. Those applying for Fixed Protection will also need to advise their employer and pension scheme of this, as Fixed Protection will be lost if there is any relevant benefit accrual after 5 April. For money purchase pension provision, it will be necessary to ensure that no contributions are paid beyond that date; in particular, any employer contribution in respect of March will need to be received by the pension scheme by 5 April. Where an employee has obtained Fixed Protection, this will also be lost if a new ‘arrangement’ under a registered pension scheme is made on or after 6 April 2012. If a special arrangement is to apply for the continuation of death benefits, then if this is provided under a registered pension scheme it will be necessary to ensure it is in place by 5 April. Those applying for Fixed Protection will also need to ensure that it is not inadvertently lost in future through auto-enrolment into a workplace pension arrangement. To maintain Fixed Protection once auto-enrolled, it will be necessary for the individual to formally opt-out within the prescribed time scale. This would need to be repeated every three years following automatic re-enrolment!
Money purchase contracting-out Contracting-out on a money purchase basis will cease with effect from 6 April. For employers operating a contracted-out money purchase (COMP) scheme, this will mean increased National Insurance Contributions (NICs) from that date; scheme members will also see an increase in their NICs. It will be important that employers – and scheme trustees – review the rules of any COMP scheme to ensure they are aware of the required levels of contributions to be paid from 6 April 2012. Will these automatically reduce as a result of the scheme no longer being a COMP? If not, a rule change would be required if contributions are to be reduced to avoid an overall increase in costs for employers and/or employees. Any proposed scheme rule change to reduce employer contributions would require at least a 60-day advance consultation with affected employees. Unless they have already done so in the 12 months prior to 6 April 2012, COMP scheme trustees will need to notify affected members by, at the latest, 5 May 2012 that the scheme is no longer a money purchase contracted-out scheme.
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Trustees of DB schemes should ensure their scheme return gives a full breakdown of their plan asset split – including pooled funds.
Similarly, they will have to provide each such member, as soon as practicable and in any event by 5 August 2012, with: ■ The date the scheme ceased to be a COMP scheme, namely 6 April 2012; ■ A statement that, as a result of no longer being a member of a contracted-out scheme, the member may build up entitlement to an additional State Pension from 6 April 2012; and ■ A statement explaining that the member’s Protected Rights will become ordinary scheme rights under pensions legislation from 6 April 2012 and that where the member is married or has a civil partner there is no longer a statutory requirement for the scheme to provide a survivor’s pension or annuity. (The member notifications will need to be appropriately amended in the small minority of cases where a COMP scheme is intrinsically a defined benefit scheme and is to continue to be used for contracting-out from 6 April 2012 by satisfying the alternative requirements for a contractedout salary related (COSR) scheme.) Contracts of employment may also need to be amended, so should be reviewed by employers. As indicated above, from a purely statutory position the concept of Protected Rights will fall away from 6 April and legislation will no longer require schemes to maintain separate Protected Rights accounts that must be used to secure annuities with an attaching contingent spouse’s (or civil partner’s) pension on the member’s death. Apart from simplifying scheme administration, this will provide greater flexibility for members and their retirement income. However, the rules of some COMP schemes may have built in the Protected Rights requirements rather than simply making reference to the relevant provisions in pensions legislation. In such cases, scheme rule changes would be needed to take advantage of the legislative easements. The Government has recognised that, in some instances, there may not be an appropriate amendment power to simply do this. Accordingly, it has regulated to give trustees the power, by resolution, to remove all or part of a scheme rule which makes special provision relating to Protected Rights and which no longer reflects a statutory provision. Any such resolutions would have to be made by no later than 5 April 2018 but can have retrospective effect. If you have yet to discuss any of these with your usual Xafinity contact, you should do so as a matter of urgency. ■
An agenda for adequate, safe and sustainable pensions The snappy title of a White Paper from the European Commission The European Commission’s White Paper published on 16 February 2012 addresses the challenges of providing for old age. The biggest challenge seen by the Commission is the effect of aging populations; over the next fifty years the life expectancy of males at birth is projected to increase by nearly eight years, with a slightly smaller increase for females. The aging effect is exacerbated by the baby-boomers retiring over the next few years. In 2010 there were four people in the EU aged between 15 and 64 for every person over 65. It only takes forty years for this ‘dependency ratio’ to reduce to two to one. The Commission therefore believe that strategies need to be developed and put in place urgently to adapt to these changes.
The White Paper concentrates on two main areas for reform. These are: balancing the time spent in work and retirement, and developing complementary private retirement savings. Balancing the time spent in work and retirement is politician-speak for raising retirement ages and strengthening incentives to work longer. The Commission recognises the need to raise the pension age and link it to gains in life expectancy, and they believe that there is a need to focus on unwarranted early retirement options. However, they also acknowledge that if people are working longer appropriate health, workplace and employment measures will be needed to support this. It is worth noting, of course, that State Pension Age is already scheduled to increase in the UK to age 66 by 2020, with a proposed further uplift
to 67 by 2028 (some eight years earlier than currently provided). The abolition of the UK’s statutory ‘default retirement age’ last year also enables older people to work longer should they so wish. The Commission notes that improving private retirement savings depends on better access to schemes and their cost effectiveness. So the White Paper sets out an agenda and states that the Commission will: ■ Cooperate with Member States to assess and optimise the efficiency and cost-effectiveness of tax and other incentives for private pension saving. ■ Encourage Member States to provide better information to individuals for their retirement planning and pension saving decisions. ■ Review the IORP directive (see box on the next page). ■ Take initiatives to ensure more effective protection of workers’ occupational pension rights in the event of their employer’s insolvency. ■ Develop initiatives to improve consumer information and protection standards via voluntary codes. ■ Develop a code of good practice for occupational pension schemes. ■ Resume work on a pension portability Directive. ■ Promote the development of pension tracking services, including cross-border tracking. ■ Investigate whether there are any tax obstacles to cross-border mobility. ■ Explore whether there is a need to remove any contract law obstacles regarding life insurance products, to facilitate cross-border distribution of certain private pension products. There are a lot of good ideas and policies in the White Paper and the Commission must be congratulated on raising the profile of pensions on Europe’s political agenda. However this is all overshadowed by the review of the IORP directive. If the ‘Solvency II’-type rules are applied to pensions, it could have the opposite effect in the UK. The dramatic increase in funding required would undoubtedly cause most of the remaining defined benefit schemes to close, and could push many employers into insolvency. ■
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IORP Directive Review The European Insurance and Occupational Pensions Authority (EIOPA) is an independent advisory body to the European Parliament and the Council of the European Union. In March 2011 it was asked to advise the European Commission on reviewing the Directive ‘on the activities and supervision of institutions for occupational retirement provision’ (the IORP Directive). The original Directive was adopted in 2003 and Member States had until 22 September 2005 to bring into force the laws, regulations and administrative provisions necessary to comply with most of its provisions. To ensure that obligations to pay retirement benefits can be met, the Directive included a number of prudential rules – in particular, the now familiar concept of ‘technical provisions’ and ‘recovery plans’ for funded defined benefit schemes. The underlying aim of the Directive was to facilitate an internal market for occupational pension schemes by permitting an IORP in one Member State to be sponsored by employers in another Member State. As is often the case, the opposite has occurred. UK schemes have typically excluded employees working in other Member States in order to avoid the onerous requirements of operating cross-border. The Commission now wants to improve the Directive for three main reasons: ■ There are (not surprisingly) only a few IORPs operating across Member States and it wants to encourage more. ■ The recent economic crisis has demonstrated the need for risk-based supervision. ■ There are now many more defined contribution schemes than when the Directive was first adopted. The Commission sought advice on 23 topics, with most questions asking how the Solvency II Directive, which applies to insurers, should be amended to pension schemes. It is not surprising therefore that EIOPA’s advice, published on 15 February this year and running to over 500 pages, did not address the question of whether Solvency II is the correct starting point. However, it did note that many respondents to its consultations believed that Solvency II is the wrong framework for pension schemes. The key Solvency II concept recommended by EIOPA is to review the adequacy of security through a Holistic Balance Sheet. On the asset side, the holistic balance sheet includes contingent assets, the value of the sponsor covenant and pension protection funds in addition to the pension scheme’s physical assets. The
argument for this approach is that it takes account of all resources possibly available to the IORP to meet its liabilities. On the liability side the balance sheet includes a risk margin and an additional Solvency Capital Requirement. EIOPA propose two policy options regarding the discount rate to use to value the liabilities. The first is to only use a risk-free rate (i.e. that based on gilt yields). The second is to introduce two levels within the best estimate of liabilities – one calculated on a risk-free rate and one calculated on the expected return on assets (or on a fixed basis prescribed by the relevant Member State). EIOPA also propose two options for the risk margin. The first is simply a margin for adverse deviation from assumptions. The second, more draconian, option is for the margin to be the additional amount required to buy out the liabilities with an insurance company. The Solvency Capital Requirement is the additional amount of assets required to have a high degree of confidence that the IORP could meet its liabilities through the next 12 months. EIOPA states that the degree of confidence is a political decision, but the Solvency II requirement for insurers is a 99.5% probability. EIOPA’s advice also contains proposals to enhance governance and risk-management, and again these are based on Solvency II type rules. The third tranche of recommendations is to improve disclosure to members, mainly through a standard pan-European Key Information document. EIOPA stresses the need for a Quantitative Impact Study (QIS) to assess the possible impact of their advice on the financial requirements for pension funds. Nevertheless, it is disappointing that EIOPA is tacitly accepting Solvency II type rules. If adopted, the new rules would lead to significantly higher funding targets and shorter deficit recovery periods. EIOPA’s advice has been roundly criticised by most UK observers. Steve Webb, the Pensions Minister, said in parliament “We are gravely concerned about these proposals. The UK Government does not accept the need for new solvency arrangements for defined-benefit schemes based on Solvency II, which would have potentially serious effects for UK defined-benefit pension schemes. We are especially concerned about any proposals that would increase costs for employers, at a time when we are looking to keep costs down, or that might affect the vital role pension funds play as investors in the UK. We will oppose these proposals”. ■
As always, your Xafinity consultant will be happy to provide guidance and should be contacted if you have any queries. Alternatively, for more information please contact Lyndon Jones on 020 7469 1811 or firstname.lastname@example.org. The information contained in this Intouch should not be relied upon for detailed advice or taken as an authoritative statement of the law. Any decisions should be taken on the advice of an appropriately qualified professional adviser.
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Latest pension news update from Xafinity. This issue covers: • GMP equalisations • PPF and ‘Type A’ contingent assets • The CPI issue • Empl...