Pensions after the election. Summer Finance Bill this will implement budget decisions and include a range of tax measures (see page 3).

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1 Aon Hewitt In Sight a quarterly pensions publication August 2017 This quarter s round-up Page 1 Pensions after the election 2 Regulator s annual funding statement 3 Other regulatory news 3 Pensions tax update 3 Consultation on new option for employer debts 4 DC charges 4 Other DC news 5 Pensions advice and guidance 6 Cases 7 News round-up Regular features 7 On the horizon 8 Training and events Pensions after the election The political uncertainty following the general election means that it is currently unclear how the new government will deal with certain pension policies. Some of the Conservative Party pension promises may be in doubt in light of its failure to secure a majority. There were no pension announcements in the Queen's Speech, but it confirmed the government's plans for a: Summer Finance Bill this will implement budget decisions and include a range of tax measures (see page 3). Financial Guidance and Claims Bill following a consultation at the end of 2016, this Bill will create a single financial guidance body that will replace the Money Advice Service, the Pensions Advisory Service and Pension Wise. The new body will be responsible for the coordination of debt advice as well as guidance on money and pensions. The Bill was published in June Data Protection Bill the new EU General Data Protection Regulation (GDPR) will apply automatically to the UK from May 2018 (it does not need to be transposed into UK law) but will need to be replaced when the UK leaves the EU. The new Bill is intended to ensure that the GDPR, or similar principles, continue to apply after Brexit so that the UK can maintain its ability to share data with other EU members states and internationally. It will replace the Data Protection Act 1998, aiming to provide a data protection regime that is fit for the 21st century. Triple lock on state pensions The policy agreement between the government and the DUP notes that there will be no change to the triple lock (under which the state pension is increased annually by the greater of average earnings growth, price inflation or 2.5%) for the duration of this Parliament. Risk. Reinsurance. Human Resources.

2 Regulator s annual funding statement The Pensions Regulator's annual funding statement takes a more directive approach this year, with the Regulator making it clear what it expects of trustees of defined benefit (DB) schemes. In some cases trustees may need to have difficult conversations with employers, in seeking to meet the Regulator s expectations. The Regulator warns that if it sees a situation where it believes that a scheme is not being treated fairly, it is likely to intervene. Managing deficits Specific actions are set out for various groups of DB schemes in managing their deficits. Scheme type 1 Schemes with employers that are (or are tending to) strong, where the funding position is on track, technical provisions are not weak and recovery plans are not unduly long. 2 Schemes with employers that are (or are tending to) strong, where technical provisions are weak and recovery plans are long. 3 Schemes with weaker employers but assumed to have a strong covenant because the employer is part of a stronger and larger group of companies, but no formal support is in place. 4 Schemes where the employer is (or is tending to) weak and the scheme is stressed (ie it appears that the employer is at risk of becoming unable to, or is already unlikely to, be able to adequately support the scheme). Regulator's expectation of trustees Continue with the current pace of funding the deficit, as a minimum - by not extending the recovery plan unless there is good reason. Seek higher contributions now. Seek legally enforceable support and, if this isn't provided, do not rely upon the covenant of the wider group to justify agreeing higher levels of risk in the valuation. Try to reach the best possible funding outcome, taking into account members' best interests. Trustees need to evidence that they have taken appropriate measures. The Regulator suggests that around 85-90% of schemes have no long term sustainability issues, with around 8% and 5% in the third and fourth categories respectively. Integrated risk management For schemes where the funding position is ahead of or in line with expectations, trustees should check progress towards their long term funding objective and the risk management plan that should be in place. Where the funding position is worse than expected, trustees should check and implement contingency plans (such as increasing contributions), reassess exposure to risks and set an acceptable risk management plan. Trustees need to have a contingency plan in place that details the actions that they will take in the event of downside risks materialising. The contingency plan needs to be agreed with the employer in advance and should be legally enforceable. Trustees should consider the extent to which a lack of visibility of the covenant beyond the short to medium term presents additional risks. They should also look at when their scheme is likely to be sufficiently well-funded to allow for little ongoing reliance on the employer's covenant, and review and adapt their journey plan in light of this. Setting assumptions Trustees should consider how changing market conditions affect their longer term views on risk and returns. Scenario planning and sensitivity analysis may help. On approaches to setting discount rates, the Regulator states that it is not prescriptive but that there must be a sound rationale for using a chosen method. Trustees should take into account their long term objective and their current position relative to it. What to expect from the Regulator More focus will be placed on pro-active casework, identifying cases that present the biggest risks to members and intervening early before recovery plans are submitted. The Regulator will quickly escalate actions using the full range of its powers as necessary. It intends to focus on two main areas: Fair treatment between schemes and shareholders including the impact of dividend payments on employer covenant. Where total distribution to shareholders exceeds deficit reduction contributions, the Regulator would expect a relatively short recovery plan underpinned by an investment strategy that does not rely excessively on investment outperformance. Late valuations a tougher approach is to be taken. There will also be an increased focus on smaller schemes. Trustees and sponsors of DB schemes, particularly those undertaking valuations with effective dates between 22 September 2016 and 21 September 2017, should read the statement alongside the Regulator's code of practice on scheme funding and supporting guidance, and discuss its implications for their schemes with their advisers. 2 In Sight August 2017

3 Other regulatory news Fines for failure to provide information to the Regulator The Regulator has secured its first criminal convictions and fines for failure to provide documents it requested. The first case related to a pension scam investigation where a solicitor and his firm (who were not under investigation themselves) failed to provide relevant documents. The second case involved the head of a charity who refused to provide information relating to an investigation of unusual scheme investments. The third conviction was made against the former office manager of a company at the centre of a multimillion pound scam inquiry, who refused to provide information relevant to the investigation. Corporate plan for 2017/20 Continuing with its 21st century trustee initiative, the Regulator intends to drive up standards of trusteeship across all schemes, with a particular focus on professional trustees and chairs of trustee boards. It will also maintain its focus on standards of record-keeping and data maintenance. Other priorities outlined in the latest corporate plan include delivering interventions more often and faster where DB schemes are underfunded or avoidance is suspected, and implementation of the new master trust regime. These cases demonstrate the use of the Regulator's powers to enforce provision of information by relevant parties. Pensions tax update Finance Act introduced reduction to MPAA expected to be retrospective In order to pass the Finance Act 2017 quickly before the snap general election, a number of clauses were dropped from the Finance Bill. These included: The reduction in the money purchase annual allowance (MPAA) from 10,000 to 4,000 from 6 April The income tax exemption for the first 500 spent by the employer on pension advice (see page 5). The government has confirmed that these provisions will be included in the second 2017 Finance Bill, to be introduced in the autumn, and that they will apply as originally announced. Therefore, both of the above measures are expected to apply retrospectively, from 6 April Trustees should review communications and consider providing an update to members. Scottish rate of income tax The introduction of the Scottish rate of income tax from April 2016 means that pension scheme members are taxed on pensions, and receive tax relief on their contributions, based on their residency tax status. HMRC has published several recent newsletters confirming that from January 2018 it will contact scheme administrators operating relief at source (RAS) pension schemes to advise them of their individual members' residency tax status needed to identify RAS rates to be used from April HMRC will use data submitted by the administrator on the previous year's annual return. Until April 2018 RAS claims are being made at the UK basic tax rate with HMRC making any relevant adjustments and providing relief direct to the scheme member. The newsletters focus on the new online Secure Data Exchange Service (SDES) that will be used by HMRC and pension scheme administrators to exchange information. HMRC is also developing a look-up service to allow RAS administrators to check the taxpayer status of a new scheme member, or one who re-commences contributions after a period of inactivity - it aims for this to be available to use before the start of the 2018/19 tax year. Consultation on new option for employer debts The Department for Work and Pensions (DWP) has carried out a short consultation on proposed changes to the employer debt legislation for multi-employer DB schemes. The proposals would introduce a new option that will enable employers ceasing to employ an active member to defer the requirement to pay an employer debt. Such a deferred debt arrangement would be subject to conditions, including that the employer retains all of its previous responsibilities to the scheme and continues to be treated as if it were the employer in relation to that scheme, for example for scheme funding purposes, whilst the debt remains deferred. Trustee consent would also be required. The new deferred debt arrangement is likely to be of particular interest to non-associated multi-employer schemes (NAMES). However, the option is not explicitly limited to NAMES and there could be circumstances where it is of wider interest. Aon Hewitt 3

4 DC charges The government has consulted on regulations that would introduce a cap on early exit charges and extend the ban on member-borne commission payments in certain occupational pension schemes. Its consultation response confirms that the regulations are intended to come into force on 1 st October Capping early exit charges Broadly, early exit charges are charges borne by members in money purchase or cash balance arrangements who transfer their benefits or put them into payment after normal minimum pension age (usually age 55) but before the member s expected retirement date. Such charges will be prohibited for members joining the scheme on or after 1 October 2017 and for other members capped at 1% of the value of the benefit. Market value adjustments and discretionary terminal bonuses are not regarded as exit charges and hence will be excluded from the cap. The cap will apply to occupational schemes that provide money purchase benefits, including AVCs. Such charges are far more common in contract-based schemes, such as personal pensions, which have been subject to a similar cap since 31 March Service providers (broadly anyone providing an administration service direct to the trustees) must confirm in writing to the trustees that they are complying with the early exit charge requirements by 1 November Banning member-borne commissions Where a scheme that is being used for automatic enrolment provides money purchase benefits (including AVCs), a prohibition on memberborne commission payments (ie charges levied on members to recover the cost of commission payments made to advisers for certain advice or services) applies to arrangements entered into on or after 6 April From 1 October 2017 the ban will be extended to payments made after that date under contracts entered into before 6 April Trustees of affected schemes are required to notify providers of administration services within three months of the scheme becoming used for automatic enrolment (which has been the case since the ban was introduced for new arrangements). Service providers are then given a period to comply with the ban and they must confirm to the trustees that they have done so. For contracts entered into before 6 April 2016, the regulations give service providers six months from 1 October 2017 (or the date notification is received from the trustees if later) to comply. Service providers then have a further month to confirm compliance to the trustees. Trustees of schemes with money purchase benefits should confirm whether their scheme might be affected by these charges and ensure they notify service providers if the scheme is being used for automatic enrolment and so the member-borne commission ban applies. They should also check that the necessary confirmations are received from the service providers in due course. Other DC news Pension funds and social investment The Law Commission has published a report on pension funds and social investment, in response to its 2016 call for evidence. The Law Commission was asked by the government to look at social investment (an investment which combines financial and social objectives) by defined contribution (DC) pension schemes and provide an account of the law in this area. The report concludes that there are no legal or regulatory barriers to pension schemes making social investments but, unlike in other countries, UK DC schemes are not investing in social investments like property and infrastructure. The Commission makes several recommendations to help lift the perceived structural and behavioural barriers, including: Amending the law so that schemes have to report on their policies on evaluating social impact, considering members ethical concerns and exercising stewardship powers. For the FCA to publish guidance about how contract-based pension providers can take into account non-financial factors (such as social impact) when making investment decisions. Further guidance from the Pensions Regulator and the FCA on how pension schemes can manage illiquid investments in their funds, such as investment in infrastructure. That the government should consider taking steps to address barriers to consolidation of DC schemes so they are more able to invest in illiquid assets; and that it should encourage pension providers and the pensions industry to devise terminology around social investment to help pension savers understand where their money is invested. New legislation on master trusts now in force The Pension Schemes Act 2017 introduces the framework for a new authorisation and supervision regime for master trusts, which is expected to commence fully in October Some transitional measures are already in force, including the requirement to notify the Regulator when certain triggering events take place (such as a decision to wind up a scheme). Much of the detail of the regime will be in regulations. An initial consultation on draft legislation is scheduled for the autumn, with the intention of laying final regulations during the summer of Trustees of master trust schemes should ensure that they are familiar with the transitional arrangements. 4 In Sight August 2017

5 FCA publishes rules on annuity comparisons The Financial Conduct Authority has published rules requiring annuity providers to inform consumers how much they could gain from shopping around before buying an annuity at retirement. This includes having to show the difference between the provider s own quote and the best quote available to the member from all other providers on the open market. There are some changes to the proposals consulted on, including a new requirement to include a clear and prominent warning that customers should consider whether they are eligible for an enhanced annuity. The new rules will come into force on 1 March 2018 but can be implemented sooner. Pensions advice and guidance Income tax exemption for pensions advice From April 2017, a new pension advice allowance allows members to take up to 500 tax-free from their defined contribution (DC) pension pot to put towards the cost of retirement financial advice. This can be taken on three occasions during a member's lifetime, but only once in any tax year. In the May edition of In Sight, we outlined a separate income tax exemption to cover the first 500 worth of employer-financed pension advice. However, this measure was unexpectedly removed from the Finance Act in order to expedite its passage prior to the dissolution of Parliament (see page 3). It is now expected to be included in the second 2017 Finance Bill and to apply retrospectively, from 6 April Definition of financial advice Regulations are in place that will amend the definition of financial advice for regulated firms so that they will only be giving financial advice where they provide a personal recommendation. This is intended to give firms the confidence to develop better guidance services without fear of inadvertently straying into providing regulated advice. There is no change to the rules applicable to nonregulated firms or individuals. The new definition will apply from 3 January The Financial Conduct Authority (FCA) will consult on updated guidance later in Draft guidance on providing advice FAMR The FCA, in conjunction with the Pensions Regulator, has issued draft guidance outlining what advice employers and trustees can provide to employees about workplace pensions and other financial matters without stepping over the boundary into financial advice and hence being subject to formal regulation. The FCA aims to publish the factsheet in September The factsheet is part of a wider consultation on recommendations of the Financial Advice Market Review (FAMR) and was issued alongside a progress report. The FAMR was launched in 2015 to identify ways to make the UK s financial advice market work better. The government has committed to implementing the recommendations for which it is responsible, which include the pensions advice issues above, the pensions dashboard (see page 7) and the single financial guidance body (included in the Financial Guidance and Claims Bill - see page 1). A review of the outcomes from FAMR will be conducted in FCA consults on pension transfer advice The FCA has published new proposals on advice to individuals relating to transfers of safeguarded benefits (broadly defined benefits). The changes are primarily directed at transfers from defined benefit to defined contribution arrangements, following the introduction of the pension flexibilities, and aim to ensure that advice to members takes account of an individual s circumstances to help them make an appropriate decision. The proposals include: Replacing the current transfer value analysis with a comparison showing the value of the benefits being given up. Requiring transfer advice to be provided as a personal recommendation that reflects the client s circumstances and provides a suggested course of action. Updating FCA guidance on assessing suitability when giving a personal recommendation to convert or transfer safeguarded benefits, so that advisers focus on whether a transaction is right for a particular individual. Introducing guidance on the role of a pension transfer specialist. Consultation closes on 21 September 2017 and the FCA intends to publish its new rules by early Transfers of safeguarded-flexible benefits From 6 April 2018 trustees will be required to provide personalised risk warnings to members who have safeguarded benefits which are also flexible benefits (such as guaranteed annuity rates that exist in certain money purchase arrangements) and are considering options that might result in the loss of these potentially valuable guarantees. The risk warning must include two illustrations comparing the member s potential income if they exercised the guarantee with the income that would be available on the open market; and it must be issued at least two weeks before the transaction resulting in the loss of the guarantee is completed. The new regulations also introduce a more straightforward method to value such arrangements for assessing against the 30,000 threshold (to determine whether independent financial advice is required). Aon Hewitt 5

6 Cases Legal case aims to clarify requirements for GMP equalisation Proceedings have started in the High Court, to obtain clarification on equalisation for the effect of unequal guaranteed minimum pensions (GMPs). The case concerns Lloyds Banking Group Pensions Trustees Limited and three related schemes. The Department for Work and Pensions consulted on this issue recently and has said that it will consider its position in light of any legal decisions arising from the Lloyds case. The High Court is being asked to answer two broad questions are trustees required to equalise for the effect of GMPs and, if they are, how should such equalisation be achieved? The answers to these questions are likely to be of significant interest for all schemes that were contracted out between 1990 and 1997, with GMP liabilities they could end the long running uncertainty surrounding the requirements and assist other trustees in taking action to address the issue. The case is not expected to be heard until Pension rights for same-sex partners The Supreme Court has held that a surviving civil partner is entitled to a spouse s pension based on all years of service, rather than only service from 5 December 2005 (the date at which civil partnerships became legal). In the case of Walker v Innospec, the Court decided that the entitlement to a spouses pension falls on the member s death, so long as they remain married. As the entitlement is to a future pension scheme payment it does not occur at the point that each year of service was accrued (although these are relevant to its calculation), so it cannot be restricted to service from 5 December The Court found that the Equality Act 2010 provision permitting such a restriction of benefits is discriminatory and incompatible with EU equality laws. Schemes that have not fully equalised survivor benefits for civil partners and same-sex partners can no longer rely on the December 2005 cut-off in the Equality Act and should take legal advice. More court cases on determining pension increases There have been several recent court rulings in relation to how schemes can be amended to change the way in which they grant pension increases. These cases each depend on their own specific facts, and in particular the wording of the scheme rules. In the British Airways case, the High Court ruled that the trustees decision to introduce a discretionary pension increase power was valid, and that their subsequent decision to grant a 0.2% discretionary increase on 1 December 2013 was also valid. The case arose because the scheme rules resulted in pension increases being changed from RPI to CPI in However, the case is about trustee decisionmaking, and in particular: how the trustees amended the scheme rules to introduce a power for them to grant discretionary increases, and the trustees considerations in deciding whether to grant a discretionary increase using that power. British Airways will be appealing the decision. The Thales case considered whether the scheme s rules allowed future pension increases to be based on CPI instead of RPI. The scheme had two separate increase rules - each had a trigger to reconsider the appropriate index and, if the trigger occurred there were specific requirements for how this reconsideration should be carried out. The High Court concluded under both rules that the trigger had occurred because of changes to the compilation of RPI, which was considered to have 'materially changed' and 'otherwise altered'. However, although this triggered a review of the appropriate index, in both cases, RPI (as amended) was still considered the only basis that could be used to calculate subsequent increases. The scheme rules did not permit the use of CPI or any other index. In FDR vs Dutton, the Court of Appeal considered how the scheme s (amended) pension increase rule should operate to ensure that members accrued benefits were not reduced. The original increase rule provided for annual pension increases of 3%, but the 1991 amendment provided for annual increases in line with inflation up to 5% (LPI). For certain members, the High Court had ruled that increases should be paid each year at the greater of 3% and LPI. However, to avoid those members receiving an unintended windfall, the Court of Appeal ruled that the relevant pension payable in any given year should be the higher of two cumulative calculations: the pension at retirement increased to the present date by either (i) 3% a year or (ii) LPI each year. The Court ruled that this approach gives least interference to the amended scheme rules. In November 2016, an appeal in the Barnardos case upheld the original judgment that the relevant scheme rules prevented a switch from RPI. We understand that this case will be heard in the Supreme Court. 6 In Sight August 2017

7 News round-up Review of state pension age In the May edition of In Sight we reported that two reports had been submitted to Parliament, intended to help inform the government s review of the state pension age (SPA). The government was due to respond to the recommendations before 7 May 2017, but this was postponed due to the general election and there was no mention of the review of SPA in the Queen's Speech (see page 1). Pensions dashboards Following the development of a prototype, the Association of British Insurers has announced the next phase of the pensions dashboard project. The stated aims are to establish a cost benefit analysis for the wider industry including the requirements and costs for a secure service between data providers and consumers; to research customer needs and establish what features are likely to be most useful; to further develop the technical data standards for all firms; and to work with PASA on agreeing a code of conduct in line with the Pensions Regulator's requirements. The government intends that from 2019 pensions dashboards will be offered by organisations, allowing individuals to view all of their retirement savings in one place. FCA study on asset management market The Financial Conduct Authority (FCA) has published the final findings of its study of the asset management market, alongside a package of proposals intended to address its concerns. The final report confirms the interim findings that price competition is weak in parts of the industry (as reported in the February 2017 edition of In Sight). The remedies the FCA is proposing fall into three areas that are intended to help protect investors who are not well placed to find better value for money, drive competitive pressure on asset managers and help improve the effectiveness of intermediaries. The report includes several detailed recommendations, including that the DWP removes barriers to pension scheme consolidation and pooling. Fraud compensation levy to be raised The Pension Protection Fund (PPF) has confirmed that it will raise a Fraud Compensation Levy in 2017/18 at a rate of 25p per member. The levy is payable by most occupational pension schemes. The Fraud Compensation Fund is run by the PPF and can make payments in cases where the employer is insolvent and the assets of a scheme have been reduced as a result of an offence involving dishonesty, including intent to defraud. The amount of any payment is determined by the PPF and may not exceed the amount of the loss, less any recoveries. Applications for compensation may be made by the trustees, administrators or members of the scheme concerned. The levy is raised only as and when needed this is the first time in five years it has been charged. It is collected by the Pensions Regulator alongside the annual General Levy. On the horizon Here are some key future developments likely to affect pensions. 30 Sep October 2017 April 2018 November 2018 End of auto-enrolment transitional period for DB/hybrid schemes Introduction of cap on early exit charges for trust-based schemes Extension of member-borne commission ban Lifetime allowance due to rise in line with CPI Auto-enrolment minimum DC contributions increase to 5% (including 2% employer) State pension age reaches 65 for women May 2018 April 2019 New EU General Data Protection Regulation will apply Auto-enrolment minimum DC contributions increase to 8% (including 3% employer) Aon Hewitt 7

8 Training and events Dates scheduled for our pensions training seminars are set out below. Unless it says otherwise, all courses and events take place in central London. If you would like to make a reservation, or receive a copy of the brochure or further information, 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) Pension Governance Committee (half day) PMI Award in Pension Trusteeship (two days) Dates September (Leeds), 18 October, 29 November January, 20 February (Leeds) November (Manchester), 13 December March November March September (am) /12 October (Surrey) /15 March (Surrey) 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 professional services firm providing a broad range of risk, retirement and health solutions. Our 50,000 colleagues in 120 countries empower results for clients by using proprietary data and analytics to deliver insights that reduce volatility and improve performance. 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.