In Sight. a quarterly pensions publication. UK votes to leave the EU. This quarter s round-up

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1 Aon Hewitt In Sight a quarterly pensions publication August 2016 This quarter s round-up Page 1 UK votes to leave the EU 2 A new directive for pension schemes 2 EU general data protection regulation 3 Delay for Finance Act Help for schemes in distress? 3 Inquiry into pensions regulation 4 Money purchase governance 5 New Bill to protect savers 5 Accessing money purchase flexibilities 6 Regulator's annual funding statement 7 News round-up Regular features 6 On the horizon 8 Training and events UK votes to leave the EU The UK's vote to leave the European Union (EU) on 23 June will have wide implications for pension schemes. In the immediate future, the actions are likely to be scheme-specific. For example: The impact on employer covenant will be highly dependent on the employer's business sector. There are likely to be winners and losers. Trustees of defined benefit (DB) schemes will need to assess the impact on their scheme's employer. A review of the scheme's investment strategy should be considered for both DB and defined contribution (DC) schemes in light of the changed financial outlook. This should include interest rate, inflation and currency hedging positions. The impact of market movements on the scheme's funding position should be assessed and actively monitored going forward. DB trustees should consider what would be required to get their funding position back on track and if any actions are required before the next scheduled valuation. In addition to these actions, which focus on integrated risk management, other specific steps might be appropriate for some schemes. For example, a review of the assumptions adopted for transfer values, commutation and other factors might be appropriate. The longer term consequences will depend on what replaces EU membership. Once the UK has formally notified the EU Council of its decision to leave, there will be a period of up to two years over which the UK will negotiate the terms of its withdrawal, a process which is bound to be complex. The UK will remain a member state until the negotiations are concluded and there will be no immediate change to the legal and regulatory provisions that currently affect UK pension schemes. Many of the EU requirements that are most significant for pensions have been incorporated into UK legislation. Continued on next page Risk. Reinsurance. Human Resources.

2 Of course, over time, there is likely to be some divergence: the revised pensions directive is expected to be implemented in the near future (see next column). Whether or not the UK will need to implement the provisions may depend on the timing and terms of the UK's exit and, crucially, whether the UK remains in the European Economic Area (EEA) whilst outside the EU (like Iceland and Norway). However the Brexit vote may mean that the UK does not implement the revised directive. There are a number of specific areas which could be affected by the referendum result in due course: The UK may no longer be bound by ECJ judgments. Cross-Border schemes may be impacted, although (if the UK did not join the EEA) this may simply require them to set up a non-eea section. The risk of an EU institution deciding that the Pension Protection Fund provides inadequate protection should be removed. The prospect of a requirement to equalise for unequal guaranteed minimum pensions may become less likely (although the arguments that have been put forward to justify such equalisation may rely on UK legislation rather than EU interpretation). There will be potentially complex implications for data security. The direction of any future pension reforms, for example the review of pensions taxation that was reported to have been put on hold in the run up to the referendum, might depend on the outcome of the political reshuffle that has followed the referendum result. Action Employers and trustees should liaise closely with their consultant and scheme actuary to assess the potential impact of Brexit and consider what steps might be needed to mitigate risks. They also need to decide whether and how much to communicate with both DB and DC members. A new directive for pension schemes In June, the final text of the revised pensions directive was published. The directive still has to be formally approved by the European Parliament and the implementation process is likely to be completed late in Member states are then expected to have 24 months to incorporate the requirements into their own legislation. The implications for UK schemes are uncertain, as discussed in the previous article. The amendments focus on governance and disclosure. The governance provisions include requirements for a risk management system and own risk assessment, both of which include several specific prescribed areas. An internal audit function, independent of other key functions, is also required to evaluate internal controls and the system of governance. The disclosure changes include requirements for prescribed information to be provided on annual pension benefit statements and at certain trigger points to members and prospective members - this includes some items that might not typically be provided currently - such as five years of investment performance for defined contribution members. Some changes are also proposed in respect of cross-border activities. Although the amendments make reference to the adoption of a proportionate approach, there are several provisions that would impose new requirements on UK schemes. The additional costs resulting from the proposed requirements are likely to be particularly significant for smaller schemes. Companies with European operations may find some of the requirements more challenging in other member states, particularly in smaller pensions markets. EU general data protection regulation The General Data Protection Regulation (GDPR) was published in the official journal of the EU on 4 May 2016 and applies from 25 May Unlike EU directives, this regulation has direct effect, with no need for national legislation to implement it. Many of the main concepts and principles of the GDPR are similar to those in the current Data Protection Act (DPA), but it does make some significant changes. In particular, it sets out tighter requirements for obtaining consent to process personal data. It also places greater emphasis on the documentation that data controllers must keep to demonstrate their accountability, and imposes stronger sanctions for breaches. The Information Commissioner's Office (ICO) has published a statement confirming that following the UK's decision to leave the EU, the GDPR will not directly apply to the UK but if the UK wants to trade with the Single Market on equal terms, it would have to prove "adequacy" by May This could mean either adopting the GDPR into UK law, or another measure like the amendment of the DPA to make sure it is adequate to protect the personal data of European citizens. It is too early to say what form the UK's adequacy might take, but the ICO has been clear throughout the referendum process that businesses should continue to make arrangements to comply with the GDPR, even in the event of a Brexit. Businesses will have to await further communications from the ICO as to the extent this will still be necessary. We understand that many firms are continuing with arrangements to comply with the GDPR by May In Sight August 2016

3 Delay for Finance Act 2016 Since draft clauses were originally published in December 2015, the Bill that will become Finance Act 2016 has slowly been making its way through Parliament. HMRC has said that Royal Assent will be later this year, rather than in July as expected. There is not a timetable for when the Bill is likely to be passed as an Act, but we understand this is likely to take place in September or October. As reported in the May edition of In Sight, the key changes relating to pensions include a reduction in the lifetime allowance to 1 million and transitional protections relating to this reduction. There are some other technical provisions, mainly relating to the pension flexibilities. The reduction in the lifetime allowance and new protections are already in force, backdated to 6 April 2016 (and are not affected by the delay in Royal Assent). HMRC has confirmed that the online service for scheme members to apply for protection from the lifetime allowance charge will still be available from the end of July 2016 as anticipated. Help for schemes in distress? The government is considering options to help the British Steel Pension Scheme (BSPS). Some of the proposals may lead to changes that could apply to other schemes. Inquiry into pensions regulation The Work and Pensions Committee has launched an inquiry into defined benefit pension scheme regulation and the Pension Protection Fund (PPF), looking at lessons learned from recent cases, including BHS. The Committee will consider the following: The adequacy of defined benefit pension scheme regulation and regulatory powers, in general and specifically in relation to the pension schemes of complex and multi-national companies. Use of these powers by the Pensions Regulator in recent cases, including BHS. Resourcing and prioritisation of the Regulator s supervisory work. Implications of the regulatory approach for employer behaviour, including whether it mitigates or incentivises moral hazard. The sustainability of the PPF. The fairness of the PPF levy system and its impact on businesses and scheme members. The BSPS is in a similar position to a number of other schemes. In particular, funding existing pension obligations can lead to an employer facing insolvency. Forcing the employer into insolvency and the pension scheme into the Pension Protection Fund (PPF), with reduced benefits for members, may not be the optimum solution for the employer, the employees or the other scheme members. The employer may have a viable long term business if the pension liabilities could be reduced perhaps to a level which still exceeded the benefits available in the PPF. The Department for Work and Pensions has been consulting on various options: Finding a solution within existing legislative provisions a Regulated Apportionment Arrangement could provide a mechanism to reduce benefits with Regulator approval. Amending legislation to allow BSPS to reduce pension increases and deferred revaluation to statutory minimum levels within the scheme. Amending legislation to allow transfers of benefits to a new scheme, with lower increases, without explicit member consent for large schemes satisfying certain conditions. Although the consultation focuses on BSPS, responses have highlighted the fact that there are other schemes with similar issues and that any change to legislation should apply to all schemes meeting the defined conditions. The Committee is working jointly with the Business Innovation and Skills Committee which is carrying out a parallel inquiry looking at BHS in terms of the regulatory framework governing mergers and acquisitions. The inquiry has heard evidence from representatives of the PPF, the Regulator, Sir Philip Green (the former owner of BHS) and various parties involved in the takeover and pensions issues of BHS. It is not clear when the outcome will be published or how any wider regulatory issues will be considered. Aon Hewitt 3

4 Money purchase governance New code of practice and guidance The Pensions Regulator's new code of practice 13, Governance and administration of occupational trust-based schemes providing money purchase benefits, should come into force in July. The code has been renamed to clarify that it applies to all schemes that have two or more members in which some or all of the benefits are money purchase. Building on the charges and governance regulations introduced in April 2015, the revised code of practice sets out the Regulator s view of actions and behaviours expected of trustee boards and which demonstrate compliance with the legal requirements. It is accompanied by six supporting guides that provide practical guidance on how trustees can meet those standards in practice. The guides aim to help trustees implement the code by providing some examples of approaches that could be taken and factors to consider. The Regulator recognises that different approaches to compliance may suit different schemes and the guides are not intended to be prescriptive, although in some instances they show what the Regulator considers to be best practice. Failure to complete governance statement or scheme return The Regulator has issued its first fine over failure to complete a chair s statement and has also warned that it will take action where trustees fail to complete their scheme return. The Regulator is concerned that some trustees are not meeting their basic duties its figures show that defined contribution (DC) scheme return completion rates have fallen for the second year running. In a change from last year, the 2016 DC scheme return requires provision of new information about compliance with the statutory governance requirements. In particular, trustees of occupational schemes providing money purchase benefits need to declare whether or not they have produced a governance statement signed by the chair. Where the governance statement has not been produced within seven months of the end of each scheme year ending on or after 6 July 2015, the trustees face a mandatory fine of between 500 and 2,000. In this case the trustees acted promptly and received the 500 minimum penalty. A checklist for trustees, along with more detailed information about the new scheme return, is available on the Regulator's website. Actions Trustees must ensure that they complete the annual governance statement on time and that they complete the scheme return promptly. Assessing asset security Where a scheme's only money purchase benefits are additional voluntary contributions (AVCs), trustees are expected to take a proportionate approach, having regard to the significance of the value of AVCs relative to members' overall benefits in the scheme. The new code of practice and guides are designed to be read together and are intended to be accessed primarily online, with hyperlinks between the two. They cover six main sections: the trustee board scheme management skills administration investment governance value for members communicating and reporting Actions Trustees of schemes with money purchase benefits should work through the new code and guidance, reviewing their own practices and identifying existing processes that might need to be amended. This should complement work already being undertaken to produce the annual chair's governance statement. In its new code of practice, the Regulator has said that it expects trustees to assess the extent to which, and in what circumstances, any loss of scheme assets might be covered by indemnity insurance or similar arrangements, or a compensation scheme such as the Financial Services Compensation Scheme (FSCS) and to communicate the overall conclusion about the security of assets to members and employers. The FSCS provides compensation to investors in certain circumstances if they hold investments with an authorised financial services firm that defaults and is unable to meet claims against it. The Financial Conduct Authority has recently amended its rules governing the operation of the FSCS. As a result, trustees of occupational pension schemes providing money purchase benefits may now be able to make a claim where they would not previously have been eligible. However, the FSCS rules are complex, so this does not necessarily mean that all money purchase benefits are covered. Trustees may find it helpful to refer to a guide on the security of assets produced by the DC Assets Working Party. 4 In Sight August 2016

5 New Bill to protect savers For some time there have been concerns about the need for stronger legislative standards for master trusts, which are becoming an increasingly popular part of the auto-enrolment regime. Documents accompanying the Queen's speech confirmed the government's intention to bring forward a new Pensions Bill intended to address this. A master trust (broadly, a trust-based multi-employer pension scheme for a group of unrelated employers) will have to demonstrate that it meets strict new criteria before entering the market and accepting contributions from members or employers. Greater powers will be given to the Pensions Regulator to authorise and supervise these schemes and take action where necessary. As well as improving protection for members of master trusts, the Bill will introduce provisions to cap early exit charges in occupational pension schemes (see below). The Bill will also create a single private pensions guidance service as announced in the 2016 Budget, which will combine the Pensions Advisory Service, Pension wise and the pensions aspects of the Money Advice Service (MAS). MAS will then be replaced by a new body responsible for identifying gaps in the financial guidance market and ensuring that individuals have access to high quality guidance on money and debt. There will also be a Lifetime Savings Bill that will enable the creation of the Lifetime ISA outlined in the 2016 Budget. Accessing money purchase flexibilities There are a number of initiatives designed to ensure that the money purchase pension flexibilities introduced in April 2015 operate as intended. Consultations on capping early exit charges Consultations from the Department for Work and Pensions (DWP) and the Financial Conduct Authority (FCA) are taking forward the government's plans to introduce a cap on early exit charges by the end of March As reported in the May edition of In Sight, early exit charges have been identified as a possible barrier for some members who want to take advantage of the pension flexibilities. The cap will therefore apply only to schemes from which a member can take flexible benefits (broadly money purchase or cash balance benefits). The proposals have been aligned where possible, so that the cap will apply in a similar way across occupational and contract-based schemes (such as group personal pensions). The cap will be 1% of the member's fund value for existing schemes and 0% for new schemes. Market Value Adjustments (MVAs) in 'with profits' policies are not regarded as exit charges and hence will be excluded from the cap. In summary, early exit charges are charges borne by members: when taking, converting or transferring flexible benefits on or after normal minimum pension age (currently age 55) but before the member s selected retirement date. For contract-based schemes, the primary duty to comply will rest with service providers. For occupational schemes, it will fall on either the trustees or service providers, depending on who imposes the charge in practice. The DWP believes that service providers are the source of most exit charges that are applied to the funds of occupational pension scheme members but is hoping to clarify this as part of the consultation process. It has also acknowledged that it is not always clear which components may make up an early exit charge. Creating a secondary annuity market The Treasury, HMRC and the Financial Conduct Authority have each published consultations on the secondary market for annuities, which is intended to come into operation in April As reported in the February edition of In Sight, the government intends to extend the pension flexibilities to existing pensioners who have already purchased annuities. The consultation documents set out further aspects of the proposed tax regime and the market for the sale of annuity income streams. Subject to certain conditions, the new tax regime will allow individuals to assign or surrender annuities and deferred annuities held in their names in return for a cash sum (either paid net of tax to the individual or paid into a drawdown arrangement). The annuities could originate from money purchase or defined benefit arrangements, and it is intended that trustees will be able to assign annuities held in their name to individuals, which would enable those members to enter the secondary annuity market. Firms will be required to provide risk warnings and recommend that advice be taken in all cases; annuitants will be required to take appropriate advice where the value of annuity income is above a certain threshold. Pension Wise will be extended to cover the new market. Consultation on simplifying pensions language The Association of British Insurers (ABI) has been consulting on a draft guide that aims to simplify language relating to the new retirement choices. The intention is for pensions language to be simple, clear and consistent and avoid technical terms where possible, in order to help individuals better understand their options at retirement. The initiative is supported by the pensions industry, government, regulators and consumer groups and it is hoped that the guide and language will eventually be applied consistently across the sector. FCA confirms rule changes Following consultation, the Financial Conduct Authority updated its rules and guidance in April 2016 to reflect the pension flexibilities. The changes are mainly designed to ensure that the pensions market works well for consumers, including new requirements intended to help consumers shop around, and ensure that they have the information to make informed decisions. There are additional rules and guidance for firms on how they should communicate with customers. Aon Hewitt 5

6 Regulator's annual funding statement The Pensions Regulator s annual funding statement, published in May, is primarily aimed at defined benefit schemes with valuation dates between 22 September 2015 and 21 September The recent market volatility will have impacted on funding positions for these schemes and the Regulator expects most to reduce investment return assumptions. Additional deficit contributions or longer recovery periods may be required. The Regulator s analysis suggests that, for most schemes, employers will be able to increase their contributions to maintain the existing recovery plan end date. It expects trustees to seek higher contributions where these are affordable to the employer without a material impact on sustainable growth plans. The general messages focus on integrated risk management (IRM), employer covenant, and collaboration between trustees and the employer. Under the IRM approach, trustees should seek to understand the scheme s exposure to risk across employer covenant, investment and funding, and to put in place a funding and risk management strategy that is integrated across these areas. The Regulator reiterates that a vital part of this process is a focus on the ability of the employer to provide financial support to the scheme both now and in the future. In particular, trustees need to understand the sensitivity of the scheme s assets and liabilities to different future economic scenarios, and consider their view of the employer's ability to support the scheme in each scenario, and the impact this would have on plans for sustainable growth. On the horizon Here are some key future developments likely to affect pensions. April 2017 March 2017 Deadline for applying for individual protection 2014 (IP 2014) Proposed introduction of secondary annuity market NEST contribution limit and bulk transfer restrictions to be removed May 2018 New EU General Data Protection Regulation expected to apply April 2019 End of automatic enrolment transitional periods for money purchase schemes Cap on early exit charges introduced Late 2018 Expected deadline for EU member states to implement pensions directive 6 In Sight August 2016

7 News round-up Guidance on covenant assessment The Employer Covenant Working Group (ECWG) was established in May 2012 to provide an industry-wide forum for employer covenant advisors. The group was set up to discuss matters related to employer covenant, promote relevant issues with the Regulator and Pension Protection Fund, and to raise the profile and standards of employer covenant advice. The group was publicly launched in April 2016 and published its first guidance document at the same time. Principles of covenant assessment for scheme valuations A practical guide for advisors, trustees and sponsors provides guidance on principles that should underpin independent covenant assessments undertaken for the purposes of scheme funding valuations. It will help trustees and others identify the issues that should be included in any covenant assessment they commission. New online pension tracing service A new website has been launched by the Pension Tracing Service to help people find their lost pension savings. According to the Department for Work and Pensions (DWP), there is currently an estimated 400 million in unclaimed pension savings in the UK. Its new website is intended to provide a free and immediate way of tracing details of pension providers. Individuals have to enter their former employers details and are given contact details for pension schemes that may hold benefits for them. The database holds more than 320,000 pension scheme contact details. This augments an existing DWP pension tracing service answering requests by phone or post. The ECWG intends to release further guidance covering other situations in which covenant assessment is a key consideration. Compensation for loss of pension A working group of employment judges has proposed a significant overhaul of the guidance and actuarial tables used by employment tribunals to assess the compensation for loss of pension rights upon a finding of unfair dismissal. The working group has been consulting on a new approach to how compensation is assessed to reflect recent changes in pension law and practice. It proposes replacing the current guidelines with a new approach. A new simple category would include all defined contribution and the majority of defined benefit schemes, usually assessing loss on the basis of employer contributions. There would also be a complex category for rare, high-value defined benefit cases with different approaches available for the assessment. Creating a pensions dashboard In Budget 2016 the government tasked the pensions industry with ensuring that by 2019 it had designed, funded and launched a pensions dashboard, a free to consumer online resource that will allow people to find their retirement savings and view them all (including their state pension) in one place. The idea of a dashboard has been around for some time, but it is not clear what it should look like and how it should be built. In May 2016, the Pension Finder working group, a collaboration of 14 organisations led by the Money Advice Service, published a white paper setting out recommendations based on its findings so far and next steps for the project. The Association of British Insurers has said it plans to take forward this work, announcing a plan to lead the development of a prototype. Aon Hewitt 7

8 Training and events Dates scheduled for our pensions training seminars are set out below. Unless stated otherwise, all courses and events take place in central London. For further information, or to make a reservation, please pensionstraining.enquiries@aonhewitt.com or telephone the Pensions Training team on: +44 (0) You can also book online at aon.com/pensionstraining Pensions training courses Defined Benefit part 1 (one day) Defined Benefit part 2 (one day) Defined Contribution (one day) PMI Award in Pension Trusteeship (two days) Dates September (Leeds), 19 October, 6 December January, 21 February (Leeds) November (Manchester), 13 December March November March to 13 October (Surrey) to 16 March (Surrey) Other events London trustee seminars, 5.30pm These regular events help trustees to keep abreast of current pensions matters and developments in the industry, and to understand the practical issues they should be considering. Participation is free of charge. Details of the topics to be covered will be sent out nearer the time. Dates September, 16 November Contacts If you have any questions on In Sight, please speak to your usual Aon Hewitt consultant or contact: Helen-Mary Finney +44 (0) helen-mary.finney@aonhewitt.com About Aon Aon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 72,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit: Aon plc All rights reserved. The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. Aon Hewitt Limited is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales. Registered No: Risk. Reinsurance. Human Resources.