Actuarial profession issues warning on commutation factors

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1 22nd February 2007 Issue No: 8 Pensions Bulletin Actuarial profession issues warning on commutation factors Amidst concern that, as a result of falling long-dated nominal and real interest rates and higher longevity, scheme members are exchanging pension for a cash sum at retirement without having a clear understanding of the value of the benefits they are giving up, the actuarial profession has published an open letter to the Department of Work & Pensions and the Pensions Regulator. The actuarial profession asks both bodies to consider either: implementing a requirement for a risk warning and a suggestion that members should take financial advice when considering commuting a large amount of pension to cash; or introducing disclosure of cash commutation terms to members retirement benefit statements, so that members have an indication of the cost of replacing the benefit forgone on commutation. This action followed a report that the actuarial profession has published on issues arising from actuarial advice in connection with setting terms for cash commutation and other member options within pension schemes. Compulsory retirement not a breach of European age law On 15th February 2007 the Advocate General of the European Court of Justice (ECJ) gave his opinion in the Spanish case of Félix Palacios de la Villa v Cortefiel Servicios SA. The case concerns whether or not Spanish labour law provisions (the SPA) which, in effect, enable employers to compulsorily retire employees at age 65 are compatible with the age discrimination directive. The case is relevant to the UK because the UK Government has also sought to fix a national default retirement age of 65 under the age discrimination regulations, the legality of which is also currently the subject of a challenge in the ECJ (see Pensions Bulletin 2006/49). Sr Palacios de la Villa had been compulsorily retired at age 65 by Cortefiel in accordance with the SPA. He sued on age discrimination grounds and the Spanish court referred the case to the ECJ. The UK, Irish and Dutch governments are also represented as they too have implemented national laws permitting employers to compulsorily retire employees. The Spanish referring court asked two questions. Firstly does the legal framework laid down by the directive apply to national laws allowing compulsory retirement ages? Secondly, if the answer is yes does the national court have to disapply the national law? The advocate general answered the first question with an unambiguous no and also (although he did not have to) went on to also answer the second question in the negative. In short, the directive states on its face (the 14th recital of the preamble) that the directive shall be without prejudice to national provisions laying down retirement ages. To hammer the point home the advocate general also observed that to regard [compulsory retirement] as dismissal is in my view rather far-fetched. However, to reach these firm conclusions the advocate general had to engage in a detailed rebuttal of ECJ case law on equal treatment which tends in the opposite direction.

2 This opinion, if upheld by the ECJ is an unexpectedly clear victory for the Spanish government and may well sound the death knell of the challenge to the analogous UK law. Not all uncertainty surrounding the UK default retirement age is removed however. It is possible to distinguish between the Spanish and UK laws in that the Spanish version is linked to satisfying the conditions for state pension whereas the UK version is not. The UK government themselves intend to review the default retirement age in 2011 and so it is still possible that that it will have a limited shelf life. Deemed buyback cost increases The actuarial factors used when assessing the cost of buying back the state benefits foregone by an individual who has been contracted out and is now in an under-resourced scheme that is winding up have been updated. The overall effect is to increase significantly the cost of buying back such benefits. The factors are contained within the Occupational Pension Schemes (Contracting-Out) (Amount Required for Restoring State Scheme Rights) Amendment Regulations 2007 (SI 2007/366) which comes into force on 6th April 2007 (see also the explanatory memorandum). International accounting standards proposed for smaller companies The International Accounting Standards Board has released an exposure draft of a proposed new set of accounting standards for smaller and medium sized entities. These new standards may apply in future in European and other countries for smaller, non-listed companies. The new standards include a set of rules for accounting for pension plans, much simplified from the rules in the corresponding international standard for larger companies, IAS19. The main difference is that it is proposed that all actuarial gains and losses such as movements in a pension scheme deficit caused by movements in the stock market must be recognised immediately in the profit and loss account. This contrasts with IAS19 under which gains and losses can be amortised over a period of time or recognised outside the profit and loss account. The proposed rules on pensions are much shorter than those required under IAS19, although they will not greatly simplify the calculations in most cases. The rules requiring immediate recognition of gains and losses will make the pensions cost much more volatile than those under IAS19 or the UK standard FRS17. For many companies unpredictable movements in pension deficits could dominate the profit and loss account. Pension Protection Fund New compensation cap The draft Pension Protection Fund (Pension Compensation Cap) Order 2007 has been published which, when passed by Parliament, will set the pension compensation cap from 1st April 2007 at 29, an increase of 3.4% from the present cap of 28, This will mean that when applying the 90% provision, the maximum level of compensation available from the Pension Protection Fund, to those at age 65, will be 26, (see also the explanatory memorandum). Page 2

3 Pension Protection Fund Amendments to levies The draft Occupational Pension Schemes (Levies) (Amendment) Regulations 2007 have been published, which, when passed by Parliament, will make a number of changes to certain Pension Protection Fund (PPF) levy arrangements (see also the explanatory memorandum). The regulations are in line with the proposals made in October 2006 (see Pensions Bulletin 2006/43) in that they: set the PPF administration levy for the 2007/08 levy year using the same rates as initially proposed; and require the PPF administration levy to be waived in most circumstances when either or both the riskbased or scheme-based components of the pension protection levy is waived. The regulations also remove all references to the PPF Ombudsman levy. It is anticipated that such a levy will be set in 2008/09 that will cover the expected costs of the PPF Ombudsman for 2007/08 and 2008/09. Many respondents to the consultation expressed concern about the near 50% increase in the PPF administration levy. This is now explained as being necessary to reflect the increased running costs of the PPF, the recovery period for set up costs and a shortfall in collection of this levy in previous years. Pension Protection Fund Notional levy ceiling The draft Occupational Pension Schemes (Levy Ceiling) Order 2007 has been laid before Parliament, which when passed, will set the Pension Protection Fund (PPF) levy ceiling for the 2007/08 financial year at a notional level of m (see also the explanatory memorandum). The actual ceiling will be m. Separately the PPF Board has set a target of 675m (see Pensions Bulletin 2006/51). The Order updates the levy ceiling of 775m set for the 2006/07 financial year (see Pensions Bulletin 2006/06) by the increase in the general level of earnings for the twelve months ending on 31st July 2006 ie 3.8%. However, the Pensions Act 2004 provides that for the first financial year after the transitional period (the transitional period being the 12 months beginning on 1st April 2006), the levy ceiling can be set at a lower amount. Regulations issued in October 2006 (see Pensions Bulletin 2006/42) set this ceiling at m for 2007/08. Next year s Order should follow the m and add a further twelve month s rise in the general level of earnings to this amount. Page 3

4 Retrospective treatment of national insurance contributions Following the enactment of the National Insurance Act 2006, a number of regulations have been laid before Parliament that make consequential provisions for where payments are retrospectively treated as earnings for national insurance contributions (NICs) purposes. Amongst these is the draft Social Security, Occupational Pension Schemes and Statutory Payments (Consequential Provisions) Regulations 2007 which ensures that from 6th April 2007 such retrospective NICs count for contributory benefits, occupational pensions and statutory payments purposes (see also the explanatory memorandum). In particular, the regulations, in relation to contracted-out money purchase schemes (COMPS): enable the employer to recover from the employee, the employee s rebate relating to retrospective earnings, from any subsequent payment made to the employee during the same tax year in which the retrospective earnings arose, but not before 6th April 2007; and require the employer and employee s rebate in respect of retrospective earnings to be paid to the scheme trustees by the 19th May following the end of the tax year to which the earnings relate (starting with the 2007/08 tax year). Tax law rewrite project Corporation tax HM Revenue and Customs has published a series of draft clauses and explanatory notes for consultation on Bill 5, the first of two expected future bills to rewrite current corporation tax law as part of its tax law rewrite project (see Pensions Bulletin 2006/22). Comments on the draft clauses are invited by 11th May The Income Tax Bill (Bill 4) is currently working its way through the House of Commons. Tripartite memorandum of understanding published A memorandum of understanding has been published that establishes a trilateral framework for co-operation between the Department for Work and Pensions (DWP), the Pensions Regulator (tpr) and the Board of the Pension Protection Fund (PPF) in the field of pension regulation and protection. The document sets out the role of each public body, and explains how they will work together towards the common objective of pension security, with the division of responsibilities being based on the four guiding principles of clear accountability, transparency, no duplication and regular and appropriate exchange of information. This Pensions Bulletin should not be relied upon for detailed advice or taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you. Page 4

5 ane Clark & Peacock LLP provides a full range of actuarial, consultancy, risk analysis and administration services to companies in the UK and internationally. LCP is part of the Alexander Forbes group of companies, one of the top 10 international risk and financial services organisations, employing over 5,500 people in more than 30 countries. Alexander Forbes is a public company listed on the JSE in South Africa. 30 Old Burlington Street London W1S 3NN Tel: Fax: St Paul s House St Paul s Hill Winchester Hampshire SO22 5AB Tel: Fax: LCP DC Link Ltd Churchgate New Road, Peterborough Tel: Fax: Alexander Forbes House 6 Bevis Marks London EC3A 7AF Tel: Fax: *Union House Union Street, St Helier Jersey JE4 8UU Tel: Fax: *PO Box 12 Maison Allaire Smith Street, St Peter Port Guernsey GY1 4AG Tel: Fax: LCP Belgium Marcel Thirylaan 200 Avenue Marcel Thiry 200 B Brussel - Bruxelles, Belgium Tel: +32 (0) Fax: +32 (0) LCP Libera AG Stockerstrasse 34 CH-8022 Zürich Switzerland Tel: +41 (0) Fax: +41 (0) All rights to this document are reserved to Lane Clark & Peacock LLP. This document may not be copied or used in anyway without prior permission from Lane Clark & Peacock LLP. LCP is a limited liability partnership registered in England and Wales with registered number OC LCP is a registered trademark in the UK (Regd. TM No ) and in the EU (Regd. TM No ). All partners are members of Lane Clark & Peacock LLP. A list of members names is available for inspection at 30 Old Burlington Street, W1S 3NN, the firm s principal place of business and registered office. The firm is regulated by the Institute of Actuaries in respect of a range of investment business activities. A member of the Multinational Group of Actuaries & Consultants Main offices in: AFRICA AUSTRALIA EUROPE NORTH AND CENTRAL AMERICA * No regulated business is carried out from these offices ACTUARIAL CONSULTANCY OF THE YEAR Page 5