In Sight. This quarter s round-up. Regular features. 02 Takeover Code gives trustees a say. 02 More on directors disclosures. 06 Pensions tax issues

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1 In Sight August 2013 a quarterly pensions publication This quarter s round-up 02 Takeover Code gives trustees a say New requirements are set to make the impact on pension schemes a debating point during takeover bids. 02 More on directors disclosures The Government has revised its draft regulations. 03 An update on scheme funding The Pensions Regulator encourages a more flexible approach to scheme funding. 03 European developments Although the revised Pensions Directive will contain new rules on governance and disclosure, the solvency capital requirements have been dropped. 04 Making a success of automatic enrolment The Government investigates standards of DC schemes, outlines plans for automatic transfers of small pots; and commits to lifting NEST restrictions and banning member-borne consultancy charges for auto-enrolment schemes. 05 Good practice for DC schemes Revised codes of practice have been laid before parliament. 06 Case law round up The Supreme Court tackles the issue of trustee decision-making and an employment tribunal looks at the justification of a mandatory retirement age. 06 Pensions tax issues The Finance Act 2013 (which confirms reductions in the thresholds for pension savings) receives royal assent, while HM Revenue & Customs consults on a new protection regime and proposes additional disclosure requirements for schemes. 07 The Pensions Regulator The Regulator sets out its strategic approach and looks at current standards of governance. 07 Pension Protection Fund The levy cap is set to increase and there are doubts over PPF entry for overseas schemes. 08 Goodbye FSA The new face of financial services regulation in the UK. Regular features 05 On the horizon 08 Seminar and teleconference dates

2 Takeover Code gives trustees a say The City Code on Takeovers and Mergers has been extended to give the trustees of defined benefit pension schemes a chance to express their views during takeover bids. The Code is designed principally to ensure that shareholders are treated fairly and are not denied an opportunity to decide on the merits of a takeover. The intention of the changes, which took effect from 20 May 2013, is to make the impact on the pension scheme a debating point during this process. Disclosures required by company making an offer If the target company provides a defined benefit pension scheme, the company making the offer must disclose its intentions in a number of areas: Employer contributions, including the current arrangements for funding any scheme deficits (although there is no requirement to make any statement about its future ability to meet any funding obligations to the scheme) The accrual of benefits for existing members The admission of new members. These statements of intention would normally be considered as binding for 12 months from the end of the offer period. The company making the offer will also need to provide the trustees with the same documents that it must make available to employee representatives: The announcement that commences the offer period The announcement of a firm intention to make any offer The offer document (and any revised offer document) The target company s formal response (the board circular) to the offer document (and any response to a revised offer). Opportunities for trustees Trustees have the right to make known their views on the effects of the offer (and any revised offer) on the scheme, although they are not obliged to do so. This could include comment on the company s intentions for the scheme as well as the ability of the target company to make contributions to the pension scheme if the takeover goes ahead. The target company must include the trustees opinion with the board s response circular (or publish it on a website if they receive it too late to include it with the circular). However, the target company does not have to express its view on the effect of the offer on the pension scheme. There is no requirement for the parties to reach a definitive position on the future funding of the pension scheme. However, if the trustees and the company making the offer do reach such an agreement, the Code requires this information to be disclosed in the same way as other agreements connected with the takeover. More on directors disclosures The Government has published a new set of draft regulations specifying how directors pension benefits should be disclosed in remuneration reports. In the May edition of In Sight, we reported that the Government was proposing to revise the directors disclosure requirements and that new regulations were due to take effect from 1 October Under the proposals, announced last year by the Department for Business, Innovation and Skills, there will be a single total figure of remuneration for each director that includes the pension benefits built up over the relevant period. Companies will also need to show details of the pension rights at the end of the year, plus a description of any additional benefit that would be paid on early retirement. As part of the previous consultation process, the pension industry raised concerns about the way that pension benefits would be valued. The new draft regulations address these concerns and confirm that pension benefits will be valued using a modified version of the annual allowance provisions, but measured over the financial year, and with director contributions deducted. For defined benefits a factor of 20:1 will be used instead of the 16:1 used for the annual allowance, and it will be assumed that the director left service at the financial year end (which removes the anomaly that exists for some schemes with the annual allowance method). Directors remuneration information will be contained in a two-part report that companies will have to provide. The two sections will be: a report that explains the remuneration policy that is in place for the company s directors and how the remuneration policy is set. This will include a note of how the company takes employees pay and employment conditions into account. a report that explains how the policy was implemented. This will set out the payments the company made to its directors, and links company performance and pay. It is this part of the report that will include the single remuneration figure, along with details of the member s pension benefits. The latest draft regulations are subject to parliamentary approval, but we do not expect the Government to make any more changes. 2 In Sight Aon Hewitt Quarterly Pensions Publication August 2013

3 An update on scheme funding When it comes to maintaining an appropriate funding plan for a defined benefit (DB) pension scheme, trustees should consider the flexibility they have in certain areas and the need for the employer to remain strong. These are the key themes in the Pensions Regulator s second annual statement on scheme funding, which is primarily aimed at DB schemes that have valuations with effective dates in the year to 21 September Trustees can be flexible when setting the discount rate (the assumption that is typically most significant when it comes to calculating the technical provisions) and agreeing any recovery plan. For example, legislation requires trustees to choose a prudent discount rate that reflects either the expected returns on their scheme s assets and/or the yields on high quality bonds. They should adopt an approach that best suits their scheme and the employer. The Regulator highlights that the assumptions made for different asset classes may change from previous valuations to reflect changes in market conditions. This represents a significant change in emphasis from last year s statement. The recovery plan can be tailored to the scheme and to the employer s circumstances. As a starting point trustees should consider whether the employer can maintain the current level of contributions. Affordability considerations may lead to movement from this, but trustees should ensure they document the reasons for any change to the level or period of contributions, and indicate that they have had due consideration of the risks. The statement notes that the best support for a scheme is a strong and ongoing employer alongside an appropriate funding plan. Where there is tension between the need for scheme contributions and for investment in the employer s business, it is important that the solution neither damages the employer covenant nor benefits other stakeholders, taking account of their priority ranking, at the expense of the scheme. Trustees should seek an open dialogue with the employer. An integrated approach The Regulator says that trustees should take an integrated approach to addressing covenant, investment and funding risks, and should be able to provide evidence to show how they have achieved this. Trustees should also understand the risks facing their scheme and make sure they have plans in place to mitigate these. What s next? The Pensions Bill, which is expected to come into force in 2014, includes an additional statutory objective for the Regulator to minimise any adverse impact on the sustainable growth of an employer. In the autumn, the Regulator will consult on revisions to the scheme funding code of practice and on its approach to the regulation of DB schemes. The new code and regulatory approach, which is due to be published early in 2014, will reflect the development of the new regulatory objective. The consultation will also include further discussion about integrated risk management, which appears likely to form a key part of the Regulator s strategy. The Regulator is also developing a suite of risk indicators relating to recovery plans, investment strategies and employer covenant. The Regulator will use these to identify schemes that are out of line with its principles. It will continue to focus on schemes where it may have the greatest impact. Where the Regulator engages with schemes, it will pay particular attention to the link between the strength of the covenant, the scheme s investment strategy, and the prudence in the discount rates compared to expected investment returns. European developments The European Commission has confirmed that it will not address solvency capital requirements (a pillar of its insurance directive Solvency II ) for occupational pension funds in its revised pensions directive, which it intends to present in the autumn. The Commission will focus on governance and disclosure, the other two pillars of Solvency II. There remains significant uncertainty over the details and how onerous they might be, but the revised directive may include requirements for: Schemes to regularly conduct an own risk and solvency assessment, including consideration of overall solvency needs, specific risk profile, approved risk tolerance limits and business strategy. Schemes to set up an internal audit function, to evaluate internal controls and other elements of the governance system, including outsourced functions. Those who run schemes or have key functions to be fit and proper, which EIOPA (the body advising the Commission) states should not unduly prevent member participation but this may depend on the details. The introduction of a pre-enrolment key information document, with specific requirements for defined contribution schemes. 3

4 Making a success of automatic enrolment With the roll-out of automatic enrolment, the Government is committed to ensuring that workplace pension schemes deliver good outcomes for their members. A number of initiatives have been announced, which aim to help people keep track of their pension savings and build up a larger retirement fund. Quality standards in DC schemes The Department for Work and Pensions is seeking views on the quality standards in defined contribution (DC) pension schemes, with a view to setting out minimum legislative standards to protect members. A call for evidence focuses on key areas that can influence DC outcomes: scheme governance investment and default options administration and record keeping scale The intention is to complement the Pensions Regulator s work on DC governance by considering additional requirements that should apply to both occupational and personal pension schemes. Clampdown on consultancy charges The Government has announced that it plans to help protect employees from what it considers can be high and inappropriate charges in auto-enrolment pension schemes. The Pensions Bill 2013 includes measures intended to enable limits to be put on consultancy charges in qualifying schemes, because the Government is concerned that excessive charges could lead to negative impacts on investment returns and increased opt-outs. This will be subject to consultation. Draft regulations have also been released under provisions contained in the Pensions Act These would prevent a scheme being used for automatic enrolment if it allows the deduction of charges from contributions to be made to a third party. (Trustees and providers are not third parties for this purpose.) Agreements that were in place before May 10, when the Government announced its plans for a ban, will not be affected. The intention is that the ban comes into force as soon as possible. Separately, the Department for Work and Pensions will consult in the autumn on proposals to cap default fund charges in defined contribution schemes. Automatic transfers and the abolition of short service refunds The Department for Work and Pensions has outlined plans that are designed to help individuals with small DC pots to consolidate their pension savings in order to better plan for retirement. The plans would apply to DC pots set up after a certain date and valued at less than 10,000. In these cases, a member s pot would be transferred automatically into a new employer s DC arrangement if they changed jobs, unless they actively chose to leave it in their previous employer s scheme. The member would retain the option to transfer out to another pension arrangement at some point in the future. The pot size limit of 10,000 would be reviewed every five years and revised if appropriate. This system of automatic transfers would also help to avoid the situation where schemes have a large number of stranded automatic enrolment pots, which would be expensive to administer. In terms of the transfer process itself, there are two possibilities. One suggestion is for the creation of an IT system to match pots to members. The alternative is member-driven and would see the worker passing the appropriate information from the former employer to the new employer. The broad legal framework for the automatic transfer system is set out in the Pensions Bill, but most of the details will be contained in regulations. We may need to wait until next year to determine how the system will work in practice, because a formal consultation on draft regulations is not expected until after the Bill receives royal assent in The Pensions Bill also provides for the abolition of short service refunds from DC schemes, which is expected to occur shortly after royal assent in Removal of NEST restrictions The Government intends to lift restrictions on contribution limits and on transfers to and from the National Employment Savings Trust (NEST) in The pensions minister has announced that the annual contribution limit, currently 4,500 a year, will be removed from The announcement states that the restrictions on individual transfers in and out of NEST are also being lifted, to coincide with the start of the automatic transfer regime. However, the ban on bulk transfers will remain in place until the end of the main roll out period for automatic enrolment in April The Government will legislate for these changes as soon as possible. 4 In Sight Aon Hewitt Quarterly Pensions Publication August 2013

5 Good practice for DC schemes Revised codes of practice for defined contribution (DC) pension schemes are expected to come into force in the autumn. Following consultation last year, the Pensions Regulator has laid before Parliament revised drafts of two codes of practice (numbers 5 and 6) which cover late payments to occupational DC schemes and personal pension schemes respectively. The codes set out how trustees of occupational schemes and providers of personal pension arrangements should meet their legal obligations. They cover monitoring the payment of contributions, provision of information to members and reporting material payment failures to both the Regulator and scheme members. The Regulator has also added supporting guidance to these revised codes to provide practical help and examples. The revised codes make it clear that trustees and providers must do more than simply check that contributions have been paid on time. They must also have in place monitoring procedures that will allow them to assess the amounts paid. Rather than a requirement to systematically duplicate the employer s payroll calculations, the Regulator expects trustees and providers to set up and operate processes that are appropriate for the scheme. They may take a risk-based approach to determine the level of intervention required. The review of the codes coincided with the introduction of automatic enrolment. As the Regulator believes that the vast majority of schemes used for auto-enrolment will be DC, it did not include code of practice number 3, which covers contributions to defined benefit schemes. In 2014 the Regulator intends to introduce an online system for reporting material payment failures and expects that all users will be reporting against the codes via this system by March A revised draft of code of practice 13 on the governance and administration of occupational trust-based DC schemes has also been laid before parliament. This new code provides practical guidance to help trustees meet the legislative requirements for running DC schemes. Back in January, the Regulator consulted on a package of measures intended to help DC schemes to achieve good member outcomes, which included a draft of the code of practice. While the thrust of the final code is largely unchanged, the drafting has been revised with the intention of giving more clarity and drawing out the key messages. Further regulatory guidance will be published in the autumn, when the code comes into force. This will contain practical guidance for trustees. Here are some key dates for expected legislative developments impacting occupational pension schemes. Spring 2014 Summer 2013 News on defined ambition Proposal for revised pensions directive Autumn 2013 Consultation on revisions to scheme funding code of practice Abolition of short service refunds from occupational DC schemes Consultation on automatic transfers of small pots 6 April 2014 Reduction in annual and lifetime allowances 2016 Singletier state pension and end of contractingout 2015 FRS 102 replaces FRS 17 October 2013 Revised disclosure of information regulations (earliest date) 1 October 2013 Revised requirements for directors disclosures 5

6 Case law round up Setting aside trustee decisions The Supreme Court has handed down a judgment over the so-called rule in Hastings-Bass, which centres on the failure of trustees to properly perform their decision-making function. Two joined cases had been referred from the Court of Appeal Futter v Futter and Pitt v Holt both of which sought to rely on the Hastings-Bass rule in order to set aside trustee decisions made in error. The cases were separate, but both turned on the issue of whether a court could void a decision made by trustees acting on professional advice, where their action had unforeseen consequences. In both cases the Supreme Court found that the advice provided to the trustees was wrong, but it did not allow the actions of the trustees (made on the basis of that advice) to be set aside. These tax cases involved private trusts, not occupational pension schemes, but the ruling is important in understanding the rules governing trustee decision-making, and how to avoid and correct mistakes. Compulsory retirement may be justified In the August 2012 edition of In Sight, we reported on the Supreme Court decision in Seldon v Clarkson Wright and Jakes that a mandatory retirement age may be justified, although employers must also be able to show that their selected retirement age is the right one. The case returned to the employment tribunal which has now decided that for this law firm, a mandatory retirement age of 65 for partners was a proportionate means of achieving the legitimate aims. The tribunal emphasised that its decision was made on the basis that, at the relevant time, 65 was the default retirement age. The question of what is proportionate now that there is no default retirement age has been left open. Pensions tax issues Finance Act 2013 receives royal assent The Finance Act 2013 provides for reductions in the annual allowance (to 40,000) and the lifetime allowance (to 1.25 million) from 6 April The Act received royal assent on 17 July. The Act also covers the workings of the fixed protection 2014 regime, which will be similar to the fixed protection introduced when the lifetime allowance was reduced in April Individuals who apply for fixed protection 2014 before 6 April 2014 will retain a lifetime allowance of 1.5 million but, to maintain protection, they will generally have to opt out of further defined benefit pension accrual and will not be able to make further contributions to a defined contribution arrangement. The Finance Act also introduces restrictions on family pension plans, amends tax legislation to enable bridging pensions to cease at state pension age once this is above 65, and increases the capped drawdown limit from 100% to 120% of the value of an equivalent annuity. A new regime for individual protection Before the lifetime allowance goes down, individuals with benefits exceeding 1.25 million at 6 April 2014 will need to consider applying for transitional protection. HM Revenue & Customs (HMRC) is consulting on the details of a new option individual protection (IP14) that will sit alongside the fixed protection 2014 regime described above. Under the proposals, members who are eligible for IP14 would be given a personal lifetime allowance based on the value of their benefits at 5 April 2014, capped at 1.5 million. If the standard lifetime allowance rises above the individual s personal lifetime allowance in future then IP14 will fall away and the standard lifetime allowance will apply. Unlike fixed protection, individual protection will not be lost as a result of additional accrual or pension contributions. Individuals will have up to 5 April 2017 to apply for IP14. It will not be available to those who already have enhanced protection or primary protection, but members with either form of fixed protection will be able to apply. Where both fixed protection and IP14 apply, fixed protection will take precedence with IP14 available if fixed protection is subsequently lost. The legislation is not expected to be in force until summer 2014, although it will be backdated to 6 April Additional disclosures for registered pension schemes Draft regulations would require schemes to provide HMRC with details of members whose pension accrual in the scheme exceeds the annual allowance. Schemes are already required to send such members a pensions saving statement setting out their pension input amount so they can complete their self-assessment form. However, if individuals neglect to include this information, HMRC might not discover that there is an annual allowance charge liability. The proposed amendments will require scheme administrators to include this information on the Event Report from the 2013/14 tax year. 6 In Sight Aon Hewitt Quarterly Pensions Publication August 2013

7 The Pensions Regulator Corporate plan The Pensions Regulator will continue its work on reducing risks to members of defined benefit schemes and improving outcomes for those in defined contribution schemes. These are the key themes in the edition of the Regulator s corporate plan, which also retains a focus on raising standards of governance and administration, as well as on delivering operational efficiency and effectiveness. For defined benefit schemes, the Regulator s primary focus will be on scheme funding and effective risk management. The challenge with defined contribution arrangements is to maximise compliance with automatic enrolment, so the Regulator will focus on trustees, providers and software developers. Work will continue on the six principles for work-placed defined contribution schemes and the underlying features. Later in 2013, the intention is to develop a compliance and enforcement strategy, including an explanation of how the presence of the quality features will be monitored. Annual governance survey The Regulator has reported that the majority of pension schemes believe their trustee boards provide effective governance overall, although this year a lower proportion of respondents believe that their board is working together as an effective unit. The 2013 occupational scheme governance survey also found that more trustee boards are documenting their schemes internal controls and administration standards, but only one-third have a documented policy on trustee knowledge and understanding. The Regulator also feels that there is room for improvement when it comes to communicating with members. Although it is a legal requirement, only 54% of defined contribution schemes have reviewed their statement of investment principles within the last three years. The majority of schemes claim to be aware of the six principles for good workplace defined contribution schemes and those that are aware say they have a good understanding of them, but just under a third believe their scheme meets all the principles. Knowledge of charges in these schemes remains broadly unchanged, with few boards understanding the charges that are levied. Pension Protection Fund Doubts over PPF entry for overseas companies The Court of Appeal has overturned last year s High Court ruling that a Greek company, Olympic Airlines, could enter insolvency in the UK as secondary proceedings to those in Greece. This will be a concern for trustees of UK pension schemes sponsored by an overseas company because an insolvency under UK law is necessary in order for the pension scheme to enter the Pension Protection Fund (PPF). These schemes may not be able to enter the PPF if the sponsor becomes insolvent even though they pay annual levies to the PPF. The original High Court ruling held that Olympic Airlines should be treated as having an establishment in the UK because it still had a London office and employees at the date of the trustees request for winding-up. However the Court of Appeal disagreed, ruling that the definition of establishment under EU law was not met, as this requires the company to be carrying out economic activity with human means and goods at the date of the request to begin insolvency proceedings. Although the company still had a London office and employees at this date, this was only a skeleton staff employed to facilitate the windingup of the company, and did not meet the requirement for economic activity. It is unclear whether an earlier application to the UK courts would have affected this decision as the Greek insolvency occurred some nine months before the UK request. The ruling means that the UK courts have no power to trigger UK insolvency proceedings in this case. As a consequence, there is no way by which the pension scheme can enter the PPF. The judges expressed regret at this conclusion and it is hoped that legislation will be amended to remove this inconsistency. Compensation cap to increase Plans have been announced to increase the maximum compensation available to longer serving members of pension schemes that are entering the PPF. For most members under normal pension age at the point that an employer becomes insolvent, the PPF protected benefit is 90% of the member s pension, reduced further to reflect a compensation cap. The cap does not apply to other members. The compensation cap is due to increase for those with more than 20 years service with an employer by 3% for every full year of service above 20 years. The revised cap would be subject to a maximum of double the standard cap (which is currently 34,867 at age 65 for 2013/14), with the maximum pension compensation being 90% of the cap. The Government intends to bring forward legislation as soon as parliamentary time allows. 7

8 Goodbye FSA The regulation of financial services in the UK has changed, with the abolition of the Financial Services Authority (FSA) and the establishment of two new regulators: the Financial Conduct Authority and the Prudential Regulation Authority. These new regulators have shared responsibility for most of the functions that fell under the FSA s remit: the Financial Conduct Authority is responsible for regulation of the conduct of financial services firms and financial advisers, while the Prudential Regulation Authority (which is part of the Bank of England) is responsible for the prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms. This change may have little immediate impact on pensions in practice, but documents that refer to the FSA are likely to need to be updated. Seminar and teleconference dates Unless it says otherwise, all courses take place in central London. Courses Defined Benefit part 1 (one day) Defined Benefit part 2 (one day) Defined Contribution (one day) PMI Award in Pensions Trusteeship (two days) Pensions Management Committee Training (half day) Support with the Pensions Regulator's Toolkit Pre-retirement Seminars (half day) Other events Current Issues for Trustees Seminars 5.30 pm Trustee Teleconference 9.00 am Dates September, 12 November January September, 4 December November /10 October Woking, Surrey September (am) Courses organised on request Courses organised on request 2013 dates 24 September 19 November 10 September 12 November If you have any questions, please speak to your usual Aon Hewitt consultant or contact Helen-Mary Finney on: t: +44 (0) e: helen-mary.finney@aonhewitt.com Aon Hewitt Parkside House Ashley Road Epsom Surrey KT18 5BS About Aon Hewitt Aon Hewitt is the global leader in human resource consulting and outsourcing solutions. The company partners with organisations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. Nothing in this document should be treated as an authoritative statement of the law on any particular aspect or in any specific case. It should not be taken as financial advice and action should not be taken as a result of this document alone. Individuals are recommended to seek independent financial advice in respect of their own personal circumstances Aon Hewitt Limited Aon Hewitt Limited is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales. Registered No: Registered Office: 8 Devonshire Square, London EC2M 4PL. This document has been produced using a minimum of 50% recycled material from a sustainable forest. SB3885