inbrief Legislation October 2010 Amendments to the investment regulations Consultation on contracted-out rebates for 2012 to 2017

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1 inbrief October 2010 Legislation Amendments to the investment regulations Rules on employer-related investments (ERIs) have applied since 1992, but the Pensions Act 1995 and the Occupational Pension Schemes (Investment) Regulations 2005 modified the requirements. Since April 1997, the provisions have, broadly, prohibited occupational pension schemes from investing more than five per cent of the market value of their assets in ERIs. In addition, they prohibit employer-related loans and prevent transactions from being made with the employer at an artificially low value. The 2005 investment regulations contained a number of transitional provisions and exemptions to the ERI restrictions. However, EU Directive 2003/41/EC (the IORP Directive) required that by 23 September 2010, member states should have legislation limiting schemes holdings of ERIs. As a consequence, UK legislation has now removed many of the existing easements and transitional provisions. In particular, it has removed the exemption for ERIs made via collective investment schemes (such as unit trusts). Abolition of DC contracting out and restrictions on transfers Contracting out on a defined contribution (DC) basis is being abolished with effect from 6 April From that date, there will be no contracted-out DC schemes, and protected rights (the part of the DC fund that relates to contracted-out benefits) will become ordinary DC pension rights, free from the current restrictions on payment. These changes will also affect defined benefit (DB) schemes that operate a protected rights underpin. As part of the preparation for the April 2012 change, the DWP has issued a consultation paper, Abolition of contracting out on a defined contribution basis: consultation on draft consequential legislation, containing several sets of draft regulations. These would remove references to contracted-out money purchase schemes, protected rights etc and would make various necessary technical changes. As a consequence of these changes, the legislation as drafted would prevent transfers of DB contracted-out rights (ie guaranteed minimum pensions and section 9(2B) rights) to DC schemes, such as personal pensions, after 5 April Representative bodies are lobbying against this. Consultation on contracted-out rebates for 2012 to 2017 The Government Actuary s Department (GAD) has published a consultation document on its proposals for the contracted-out rebates to be provided from April 2012 to April As contracting out on a DC basis is to be abolished in 2012, the report focuses on the assumptions underlying the rebate for contracted-out DB pension schemes. Instead of making a single recommendation, GAD proposes three alternative approaches for calculating the rebate (with a suggested rebate, or range of rebates, for each).

2 Delays to paternity leave provisions? In the April 2010 edition of inbrief we reported on regulations that would allow eligible employees (usually fathers) to take up to six months of additional paternity leave to care for a child before its first birthday if the child s mother returned to work without exercising her full entitlement to maternity leave (some of this may be paid depending on whether the mother has used up her entitlement to maternity pay). The regulations came into effect in April 2010 and apply where the expected week of birth begins on or after 3 April However, the regulations were made by the previous government just three weeks before it dissolved for the general election, and the coalition government has confirmed that it is considering the timetable. Its own plans for flexible parental leave are expected to be more radical than the approach set out in these regulations, giving parents more flexibility over how and when they share parental leave. As the details are not expected to be released until later this year, it is possible that the implementation date may be delayed pending a review. Possible changes to Agency Workers Regulations The coalition government has also confirmed a review of the Agency Workers Regulations that are due to come into force on 1 October There had been some resistance to the regulations and complaints that they were unclear and open to misinterpretation. In his first major speech as Business Secretary, Vince Cable confirmed that the government would review pending legislation, including the regulations under the Agency Workers Directive. It is unlikely that major amendments will be made since the government only has until 5 December 2011 to implement the EU Directive. There is no requirement to allow agency workers to participate in occupational pension schemes; however, they will be eligible for the autoenrolment provisions that will apply from Equality Act 2010 The majority of the Equality Act s provisions come into effect this month. New regulations under the Act maintain certain exemptions from age and sex discrimination for pension schemes. As the existing exceptions for occupational and personal pension schemes are replicated, there is little impact in this area. However, from a risk and healthcare perspective there are a couple of provisions that employers should be aware of, relating to pre-employment questionnaires and disability discrimination. Pension scheme exemptions age discrimination The Equality Act implies into occupational pension schemes a non-discrimination rule, to protect people who have protected characteristics, one of which is age. The Employment Equality (Age) Regulations 2006 ( the Age regulations ) were introduced from 1 October 2006 to prohibit discrimination in employment on the grounds of age. The Age regulations prohibited most age discrimination in relation to pay and other benefits, but made exceptions for certain age-related rules and practices that were considered necessary for the proper operation of pension schemes. For example, they permitted schemes to set minimum and maximum ages for admission and age-related contributions provided that the intention was to provide a more nearly equal benefit at retirement. The Equality Act 2010 (Age Exceptions for Pension Schemes) Order 2010 reproduces the provisions for pension schemes from 1 October 2010, so that they can continue to operate age-related rules and practices without breaching the prohibition on age discrimination. As the new Order contained a couple of errors, the Equality Act (Age Exceptions for Pension Schemes) (Amendment) Order 2010 was made to correct these. The Amendment Order replicates the existing exemptions for contributions to personal pension schemes, thereby allowing the continued use of certain age-related practices in relation to employer contributions to personal pension schemes. Pension scheme exemptions sex discrimination The Pensions Act 1995 implied a sex equality rule into occupational pension schemes for the equal treatment of men and women, which is replicated in the Equality Act. The Equality Act 2010 (Sex Equality Rule) (Exceptions) Regulations 2010 allow existing exceptions to continue, for instance in the use of bridging pensions and different actuarial factors for men and women.

3 Pre-employment health questionnaires One issue for consideration relates to employer processes around assessing an individual s state of health. Such enquiries, usually completed in the form of pre-employment health questionnaires, should not be made until that person has either been offered a job (on a conditional or unconditional basis), or has been included in a pool of successful candidates to be offered a job when a suitable position becomes available. There are specific exemptions for employers, namely: 1. To establish whether a job applicant would be able to participate in an assessment to test their suitability for the job 2. To find out what reasonable adjustments may need to be made to enable a disabled person to participate in the recruitment process 3. To ascertain whether the applicant can undertake a function that is intrinsic to the job (with reasonable adjustments in place as required) 4. To monitor diversity 5. To support positive action in employment 6. To identify suitable candidates for a job where there is a genuine requirement for the person to be disabled. Where an employer asks health-related questions outside of these exceptions they are potentially acting unlawfully. If an employer rejects the applicant having made health-related enquiries then a claim for direct discrimination can be brought to an Employment Tribunal. In such circumstances, the burden of proof is on the employer to disprove discrimination. Discrimination arising from disability A further provision means that an employer will discriminate against an employee if it treats that employee less favourably, not because of the disability itself, but because of a consequence of that employee s disability. This represents a new form of disability discrimination and an example of potential discrimination would be where an employer operates a reward policy based on attendance. It could be deemed discriminatory if a disabled employee does not qualify for an attendance reward due to the fact that they need to take time off for medical reasons relating to their disability. Any unfair treatment by the employer would need to be objectively justified. In order for discrimination to occur the employer must know, or be reasonably expected to know, that the employee has a disability. Guidance The Equality and Human Rights Commission (EHRC) has started to issue guidance on the Equality Act 2010, for employers, workers, service providers and service users, which set out its view on compliance with the legislation. HM Revenue & Customs (HMRC) Pensions tax relief The government previously announced that it was not intending to implement the previous administration s policy relating to restricting pensions tax relief for high earners due to take effect from 6 April As well as taking steps to repeal the relevant legislation, the government is consulting on an alternative approach based on the reform of existing allowances, including a reduction of the annual allowance (AA). The AA, which limits the amount that can be saved taxeffectively each year in a registered pension scheme, is currently 255,000. The government s initial view is that a lower figure in the region of 30,000 to 45,000 could generate the revenue that the government requires. The government is also consulting on a number of other design features. If any of these changes would have the effect of increasing the revenue raised, the level of the AA could be increased; conversely, the AA would need to be lowered if other changes are made which reduce revenue. The government is due to confirm its intentions any day now and draft legislation is expected in the autumn. The Finance Bill 2011 will be used to introduce changes. The anti-forestalling provisions are to remain in place in the period leading up to April There was no clarification on how employer-financed retirement benefit schemes (EFRBS) are to be treated. Flexibility in retirement The government s consultation document Removing the requirement to annuitise by age 75 sets out its plans for removal of the effective requirement for those with DC pension funds to purchase an annuity by age 75. The new proposals are expected to apply from April 2011 with transitional measures for those who

4 reach age 75 between 22 June 2010 (the date of the emergency Budget) and April The proposals are more far-reaching than expected and potentially affect anyone who wishes to defer taking pension benefits beyond age 75 (whether from DB or DC arrangements) and anyone who wants the flexibility to start drawing down their pension benefits and take part of their fund in the form of taxed lump sums, as opposed to regular income. DC schemes will have the choice of whether or not to offer their members the additional flexibility that these proposals would allow. However, where this flexibility is not offered, or where the scheme is DB, individuals who wish to take advantage of the new rules will usually have the option to do so by transferring to a suitable arrangement. The Pensions Regulator (TPR) Financial Support Direction TPR s Determinations Panel has made a determination to issue a Financial Support Direction (FSD) under the Pensions Act 2004 against six companies within the Lehman Brothers Group. These include the group s main operating companies in the UK and Europe and the US parent. When the US parent filed for bankruptcy in September 2008, it triggered insolvency for the majority of the group companies. The determination states that these companies should provide financial support to the failed banks UK pension scheme (The Lehman Brothers Pension Scheme a hybrid arrangement). A request for financial support from several of the smaller UK group subsidiaries was not upheld. This is only the third FSD to be issued by the Determinations Panel. Lawyers are questioning TPR s ability to enforce the FSD, due to the ongoing insolvency proceedings. Employer insolvency and regulated apportionment arrangements TPR has issued a statement describing the process to be followed when applying for approval for a regulated apportionment arrangement (RAA). RAAs are very rare, applying to an employer departing from a multi-employer scheme, where the scheme is either expected to enter a Pension Protection Fund (PPF) assessment period, or is already in the assessment period. They enable an employer that is at the point of insolvency to pass pension liabilities to the PPF on payment of an agreed amount in mitigation. Both TPR and the PPF need to agree to such an arrangement and they will not do this lightly. The Pension Protection Fund and the Financial Assistance Scheme (FAS) Long-term funding strategy The PPF has issued details of its first formal long-term funding strategy. The strategy sets out the PPF s aim to be fully funded in 20 years. PPF bulletin Issue 5 The PPF s latest bulletin its bi-monthly electronic newsletter features updates on the PPF s investment strategy, levy invoicing and improvements to the assessment period. Switching from RPI to CPI regulations for PPF and FAS The government is consulting on draft regulations intended to effect the switch from using the retail prices index (RPI) to the consumer prices index (CPI) for the calculation of certain benefits by the PPF and the FAS. The consultation proposes that accrued pensions would be revalued by reference to RPI for periods up to 31 March 2011 and then by CPI thereafter. The regulations also apply to increases to the FAS cap, and to PPF valuations. The draft regulations only apply to the PPF and the FAS. Separate regulations are still expected that will deal with CPI indexation and revaluation for occupational pension schemes. PPF consultation on 2011/12 levy The PPF s consultation document on the 2011/12 Pension Protection levy contains a levy estimate (the overall amount that the PPF aims to collect) of 600m. For the last three years the PPF s policy has been to set a levy estimate of 675m indexed with earnings; had that policy been maintained for 2011/12, the levy estimate would have been 730m. This reduction reflects the expected move

5 in indexation from the Retail Prices Index to the Consumer Prices Index. The levy scaling factor has been calculated as 2.07, with a scheme-based levy multiplier of The consultation outlines changes to the taper and the levy cap to reflect the improvement in funding that occurred in the year to 31 March The levy cap is being raised from 0.5% to 0.75% of liabilities (so that it is expected roughly to help the weakest 10% of schemes); and the start/end of the taper are being increased so that the taper would apply from 135% to 155% funding (meaning that schemes will need to be 155% funded to avoid paying a risk-based levy). The PPF has also published its draft Determination, which expresses these rules in a legal form. A further consultation on the future of the levy is expected this month. Consultation on removal of the default retirement age The government s consultation on the removal of the default retirement age (DRA) of 65 proposes that after 1 October 2011, employers will not be able to use the DRA to compulsorily retire employees. It is currently lawful to discriminate on the grounds of age when it comes to retirement, provided that the employer follows the duty to consider retirement procedures. Earlier retirement ages are prohibited unless employers can objectively justify them. The consultation proposes removal of the DRA (and associated retirement procedures) from 6 April Transitional arrangements will apply for the first six months where retirements have already been initiated (provided that they meet all the requirements of the DRA procedure and the retirement date falls before 1 October 2011). The DRA would be removed completely from 1 October It will still be possible for an employer to operate a compulsory retirement age from April 2011, provided that it can be objectively justified as being a proportionate means of achieving a legitimate aim. With specific regard to employee benefits that are often linked to age such as death in service, critical illness, private medical insurance and group income protection the government does not believe that there is any compelling evidence to support the argument that removing the default retirement age will result in reduced benefit provision. However, employers will have to consider benefit provision for older workers and in what circumstances they may be able to justify not providing certain benefits. Some headline thoughts in this area include: Pension schemes The removal of the DRA will mean contributions and benefit accrual may continue beyond age 65. The normal pension age under the pension scheme does not need to be the same as the employer s retirement age (if it continues to operate one), but the employer will need to consider the role of the scheme and the trustees will need to ensure that they have the appropriate powers to make any requested rule amendments. This clearly has cost and funding implications as well as other considerations for both employers and trustees. Death in service Insurers will need to work to a benefit termination age for overall costing purposes and this may default to age 75, the maximum age that cover can presently be provided under a registered group contract. Exemptions afforded to occupational pension schemes, and therefore death in service benefits written on a trustee re-assurance basis, will continue to apply. However, as these exemptions will not apply to standalone group life arrangements, any age-related practices within such plans may need to be reviewed and objectively justified. Group income protection Clearly insurers need to have a benefit termination age written into the policy contract. If they are prepared to provide benefits to a higher cessation age than they do currently, the cost of such cover is likely to be disproportionately expensive, although prohibitive cost is not likely to be a successful objective justification for not providing the benefit. In addition to future benefit provision, employers will also need to consider issues such as dealing with current claimants (or individuals in the deferred period) where the benefit is due to be payable to age 65. Whether

6 employers can retire such employees at age 65 or whether they will be left with a potentially unlimited uninsured liability are important questions to address. Private medical insurance The expectation is that over time the costs associated with cover will increase as the age profile of schemes increases. Experience-rated contracts are typically costed using under-65 and over-65 rates, with over-65 rates being subject to a significant premium loading. This method of costing (based around the concept of a retirement age) may well be reviewed by insurers going forward and this may result in an active employee rate and a retiree rate, if applicable. Employers should be reviewing the age elements within their risk and healthcare benefits, whether insured or not, to ensure that they are compliant and to consider re-design options as appropriate. Other benefits matters Holiday pay Khan v Martin McColl In a recent Employment Tribunal case regarding holiday pay during sickness absence, Khan v Martin McColl, Mr Khan argued that upon the termination of his contract of employment his employer (Martin McColl) had made an unlawful deduction in respect of six weeks accrued but untaken holiday for the 2007 and 2008 holiday years. Mr Khan transferred his employment under the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) to Martin McColl in 2007, went off sick in May 2008 and resigned having not returned to work in August At the point of transfer he had carried two weeks holiday over (from 2007) and he had not taken any holiday in 2008 or 2009 due to his sickness absence. When Mr Khan resigned Martin McColl made a payment in lieu of the untaken 2009 holiday but not the untaken 2007 and 2008 holiday. Mr Khan brought a claim for six weeks unpaid and untaken holiday. The tribunal dismissed the case on the basis that it was out of time and that there was no denial of holiday. One of the arguments put forward by the employer was that because they had paid his untaken holiday entitlement for 2009 the last deduction would have been on 31 December 2008, ie in respect of that holiday year and the carried over 2007 holiday. As a result that claim was outside the stipulated timeframe. The HM Revenue & Customs v Stringer case had established that an unlawful deduction claim under the Employment Rights Act 1996 can only be brought within three months of the last of a series of deductions. The Tribunal agreed that the payment in respect of the 2009 holiday had broken the series of deductions and that a claim in respect of the untaken 2007 and 2008 holiday pay could therefore only have been made within three months of the end of the 2008 holiday year. The tribunal also found that there was no denial of holiday. Holiday entitlement can be carried forward if the employee is denied the right to take holiday, but since Mr Khan had not requested any holiday, it had not been denied. The tribunal found that if there was no need to request holiday, those on long-term sick would be in a better position than those working. This ruling appears to be good news for employers in that sick employees might not be able to build up holiday entitlement, potentially over more than one holiday year, and then receive payment in lieu of all untaken holiday upon termination of their employment. However, it should be noted that had Martin McColl not made the payment in respect of accrued but untaken holiday in his last holiday year (2009) and effectively broken the series of deductions chain, the outcome could well have been different. Pension simplification revisiting death in service decisions The July edition of inbrief reminded trustees of the need to ensure that their rules are in order before the transitional period under the Finance Act 2004 expires. In addition, it mentioned potential problems with payments of surplus to the employer. This edition examines the particular issues for death in service arrangements. The tax rules relating to the treatment of death in service benefits changed from 6 April 2006 (A-Day). At A-Day, exempt approved schemes were replaced by registered pension schemes and Inland Revenue limits were replaced by allowances, for example the Lifetime Allowance. Any lump sum benefit paid via a registered arrangement up to an individual s Lifetime Allowance is normally paid tax free, with any lump

7 sum benefit paid above the Lifetime Allowance being subject to a tax charge at 55%. In order to give schemes sufficient time to update their rules in the light of the new regime, HMRC allowed a number of transitional provisions that are relevant to registered death in service benefits. These included: Existing approved schemes prior to A-Day often had provisions in their rules that limited benefits payable to the old Inland Revenue limits. These limits were removed with effect from A-Day. Transitional arrangements gave protection until 5 April 2011 to schemes which had not changed their rules to hard code in whatever limits they required Where benefits prior to A-Day were calculated with reference to the statutory earnings cap, the cap could potentially be retained until 5 April These transitional provisions will expire at 5 April Therefore employers and trustees should review their rules to ensure that they are appropriate. In particular: Do either the lump sum or the pension benefit payable on death under the scheme rules refer in any way to the old Inland Revenue limits? Is either benefit calculated with reference to a salary figure that is subject to the earnings cap ( Permitted Maximum )? In either case, a rule change might be needed before 6 April 2011 in order to ensure that members do not acquire rights to benefits greater than is intended. Employers operating standalone registered group life schemes should also ensure that they are familiar with the role and requirements of a Scheme Administrator. Experience suggests that the employer usually acts as both the Scheme Administrator and the trustee - therefore understanding the responsibilities that this entails is important to mitigate the risk of a scheme being deregistered or losing tax privileges.

8 About Aon Hewitt Aon Hewitt is the global leader in human capital 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. For more information on Aon Hewitt, please visit Aon Consulting Limited 55 Bishopsgate London EC2N 3BD Tel: enquiries@aonconsulting.co.uk Published by Aon Consulting Limited Registered office Briarcliff House, Kingsmead, Farnborough, Hampshire GU14 7TE Copyright Aon Limited All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any way or by any means, including photocopying or recording, without the written permission of the copyright holder, application for which should be addressed to the copyright holder. Aon Consulting Limited is authorised and regulated by the Financial Services Authority. Produced by Marketing & Communications RH4810 MD The professionally printed copies of this document are produced on material containing 50% recycled waste & 50% virgin fibres from a sustainable forest.