In Sight Quarterly Pension Publication February 2010/Issue 9

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1 In Sight Quarterly Pension Publication February 2010/Issue 9 Welcome to In Sight Keeping you up to date with the latest developments in work-based pension schemes This quarter s round-up More pain, less gain for high earners Focus on the extension of the anti-forestalling measures and proposals from 2011 announced in the Pre-Budget Report. Good governance Results of the Pensions Regulator s fourth annual survey. Must-have controls New consultation on internal controls guidance. Final auto-enrolment regulations issued Extension of the implementation period and the transitional period for contributions. Without a net A recent court ruling asks: what would you do if the PPF wasn t there? PPF levies update Looking ahead to 2010/11 and 2011/12. The future in orange Data and observations from the Pensions Regulator s third annual Orange Book. Communication under the spotlight Consultation process under way on new disclosure regulations. The way forward for flexible retirement The DWP announces that its next step will be guidance, not legislation. Regular features On the horizon A glimpse of expected future developments. Governance diary Updating you on the Pensions Regulator s new TKU requirements. Seminar dates Trustee training seminars and teleconferences for 2010.

2 More pain, less gain for higher earners Special annual allowance charge extended In the Pre-Budget Report on 9 December, the Government announced that the special annual allowance charge for the tax years 2009/10 and 2010/11 was to be extended immediately. The effect of this change is that members will be affected by the special annual allowance charge if they have a relevant income between 130,000 and 150,000 in at least one of the last three tax years and they have changed their regular pension saving on or after 9 December The charge applies where this saving is more than 20,000 (or, if the contributions are infrequent, the lower of 30,000 and their average infrequent contributions over the past three years). The special annual allowance charge remains at 20% until April From April 2010 until April 2011, it will generally be between 20% and 30%, depending on the member s taxable income. Consultation starts on plans to restrict tax relief As part of the Pre-Budget Report, the Government also started consulting on its plans to restrict tax relief for higher earners from 6 April (Higher earners are defined as those with a gross income of 150,000 or more. Gross income is pre-tax income, plus the value of their pension contributions, the amount of any charitable donations, and the value of any pension benefit they receive from their employer.) Under the Government s plans, pension benefits will effectively be taxed like a benefit in kind, whether they are employee or employer contributions to a money purchase arrangement or defined benefit in nature. The tax charge will be a percentage of any contributions to a money purchase arrangement or the value of defined benefits earned. The percentage will be applied on a sliding scale: Gross income Tax charge* Over 180,000 30% Between 150,000 and 180,000 Less than 150,000 0% between 0% and 30%, on a sliding scale * The tax charge will be reduced by 10% (or to 0%) on the amount of the contributions which are in excess of income but below 150,000. How will defined benefits be valued? Pension accrual under a defined-benefit arrangement will need to be valued. The difficulty in coming up with a suitable method for this has been cited as a reason why this change could not be implemented before The Government has set out a number of options, preferring the use of factors based on the member s age and Normal Pension Age. The factors would be applied to the difference between the pension at the end of the year and the pension at the start of the year (increased in line with inflation). Adjusted factors could be used for pension taken early. Trustee and employer obligations This tax charge will generally be collected through self assessment. Employers must identify all employees with a pre-tax income in excess of 130,000 and ask trustees to provide a benefit statement for these employees for the relevant tax year by the following 6 July. If the charge is over 15,000, the member can choose to have it taken out of their pension, unless the scheme is heavily underfunded or is an overseas scheme which cannot make such payments. Change to National Insurance (NI) rate increase It was also announced that both employer and employee NI contribution rates will increase by 1% from April 2011, rather than by the 0.5% the Government announced a year ago. At the same time, the level of earnings at which NI contributions become payable will rise by 570. This means that those paying the standard employee rate and earning under 20,000 a year will pay lower NI contributions overall. The increase in NI rates will increase the potential savings from a salary sacrifice scheme, for employees and employers. These increased savings will mean that the cost of setting up a salary sacrifice scheme can be offset over a shorter period of time. Employees will be exempt if their pre-tax income (including the value of the individual s own contributions and the amount of any charitable donations) is below 130,000.The aim is to help individuals understand whether they are affected and reduce the administrative burdens for schemes. 2

3 trustees perform a critical role in protecting and managing pensions, and are faced with challenges in this difficult economic context. Tony Hobman, Pensions Regulator Chief Executive, Governance Survey announcement, November 2009 Good governance In November, the Pensions Regulator reported on the findings of its fourth annual governance survey, which monitors the governance activity of trust-based occupational pension schemes. The main aim of the survey is to help the Regulator determine the most effective ways of helping trustees to improve their scheme governance. Here are some of the key findings from the 2009 survey: Economic uncertainty has had an impact on scheme governance. There tends to be more governance activity in larger schemes. The Regulator s Trustee toolkit is a key source of knowledge for existing and new trustees. Trustees are increasingly confident that they have processes in place to manage conflicts of interest. Most trustees have a risk register in place, but fewer are confident that they have adequate internal controls. (The Regulator is consulting on new draft guidance on internal controls see Must-have controls on page 4). Not many schemes have used the Regulator s communications guidance to date. Default investment options remain the most popular option with members where they are offered, with nearly two-thirds of members choosing the default. The survey highlighted a number of findings relating to sponsor covenants, as illustrated in the charts below: Two-thirds of respondents strongly agreed that their trustee board monitored their sponsor s covenant effectively. (In 2008 the figure was one-half.) There was a significant increase in the number of respondents who reviewed the sponsoring employer s business plans in 2009 compared to previous years. This may have been the result of the financial crisis and economic downturn. Most defined benefit schemes had obtained independent advice to help them understand areas related to their sponsor s covenant. Just over one-third had not sought any advice. Larger schemes are more likely to seek external advice, which may be a reflection of the complexity of larger sponsoring employers businesses. The trustees who had not sought advice generally classified their scheme knowledge as excellent. Improving governance standards and a more difficult economic environment appear to have sharpened trustees focus on monitoring and assessing their sponsor s covenant. However, around one-third of trustees have some doubts about how effectively they are monitoring their sponsor s covenant. Reviewing employer sponsor Obtaining independent advice in 2009 Aspects of employer sponsor reviewed Accounts Covenant Credit rating Business plans Proportion of schemes (%) Reason for seeking advice Assess employer s ability to make agreed deficit contributions Inform funding negotiations Understand employer s strengths and weaknesses Proportion of schemes (%) 3

4 Must-have controls The 2004 Pensions Act states that trustees of occupational schemes must establish and operate adequate internal control mechanisms. As part of its ongoing campaign to improve standards in scheme governance and administration, the Pensions Regulator recently issued a consultation document revising its existing guidance on internal controls, along with a set of e-learning modules. The Regulator originally published its code of practice on internal controls in November 2006, followed by guidance in February The guidance was aimed at providing trustees, particularly those of smaller schemes, with further support, especially around the aims and objectives of a risk management exercise. The Regulator believes that there are still weaknesses in some specific management activities undertaken by small defined benefit schemes and defined contribution schemes. It launched a formal review and consultation, including an online questionnaire, in the autumn of 2008, and held workshops in January The outcome was that the Regulator decided the code of practice should remain unchanged, but it should develop practical and targeted guidance. The Regulator has now issued a consultation document on the proposed new guidance, which: Considers the controls covered in other guidance notes, including conflicts of interest, clearance, record keeping, and open-market options; Clarifies which risks trustees should focus on, how to assess them, and how these should be monitored; and Provides case studies. The proposed new guidance has been designed primarily as a web-based product, which will allow users to navigate to relevant risk areas. The preliminary section covers risk management processes and the roles and responsibilities of trustees. The remainder of the guidance concerns seven key risks that the Regulator has identified and which need to be addressed if standards of governance are to be improved. These are: Lack of knowledge and understanding; Conflicts of interest; Relations with advisers; Record-keeping; Employer covenant; Investment risk; and Retirement processes. The consultation closes in March and the new guidance is expected later in Final auto-enrolment regulations issued On January 12th, final regulations for auto-enrolment processes were published. We have summarised here the main changes to previous proposals. The regulations included the re-branding of Personal Accounts as the National Employment Savings Trust (NEST). Implementation extended staging period The original three year staging period over which the employer duty to auto-enrol employees was to have been implemented has been extended to 4 years in the final regulations. Each employer will now be required to comply with their duties from a specific staging date between 1 October 2012 and 1 September 2016 (not 2015): PAYE size Staging date 120,000 or more employees 1 October ,250 to 119,999 employees A date between 1 November 2012 and 1 September to 1,249 employees* A date between 1 October 2013 and 1 September 2014 Under 50 employees A date between 1 October 2014 and 1 September 2016 * plus two sets of employers with under 50 employees Transitional periods The transitional period for defined contribution schemes is to run for five years (previously four years was proposed) from 1 October 2012 to 30 September 2017, as follows: From October 2012 October 2016 October 2017 Minimum contributions 2% (including 1% employer) 5% (2% employer) 8% (3% employer) Employers providing DB or hybrid qualifying scheme membership will be able to defer their automatic enrolment obligations for four years, until October 2016 (not 2015 as had previously been proposed). Waiting periods Employers are permitted to operate waiting periods, effectively postponing auto-enrolment for jobholders regardless of the length of their contract (it had been proposed this was not to be permitted if contracts were for three months or less). 4

5 If my conclusion in the present case is soundly based, I would expect a similar approach to be adopted in any instance where trustees seek to take advantage of the existence of the PPF as a justification for acting in a way which would otherwise be improper. Mr Justice Henderson, Independent Trustee Services Limited v Hope, Nov 2009 Without a net? Trustees are likely to find a recent ruling of the High Court to be of interest when making significant decisions, particularly if they have concerns over their employer s covenant. The case concerned the Ilford Pension Scheme and whether the scheme s trustees should take the existence of the Pension Protection Fund (PPF) into account in making a particular decision. The High Court ruled that the trustees should not take the existence of the PPF into account in making their decision. Although the case concerned specific circumstances, the implications of the judgment are likely to be relevant to many schemes. Similar principles might be expected to apply in other situations where trustees try to justify actions that would be improper if the PPF did not exist. Trustees should ask themselves if they would make the same decision if the PPF safety net was not available, and obtain legal advice if they are uncertain. PPF levies update The PPF has published its formal Determination, setting out how schemes levies will be calculated for 2010/11. The headline figures are unchanged from those set out in the PPF s September consultation document: The PPF aims to collect a total of 720 million. For the risk-based levy, the scaling factor to be used is 1.64 (compared to 2.22 in 2009/10). The maximum levy paid will be reduced from 1% of a scheme s liabilities to 0.5%. This is to protect more of the weakest schemes in the current economic environment. Stability in the total levy is unlikely to mean stability for individual schemes. The reduction in the maximum levy means that stronger schemes will see a 5% increase in their levy, ignoring any other changes. The main change to the September proposals relates to the penal treatment applied by the PPF where details of a block transfer have not been correctly submitted to the PPF. Where an entire scheme has transferred before 1 April 2010, the PPF will apply the same penal treatment as in 2009/10, rather than the more penal treatment it had proposed. Where a significant part of a scheme has been transferred (more than 20 million or 20% of either schemes assets whichever amount is greater), the PPF will not apply penal treatment. Deadlines are set out in the table below. The 30 March 2010 deadline is particularly important, as the PPF has recently proposed changing the way in which employers failure scores are calculated (in conjunction with D&B). Employers only have a short space of time to take any action which may improve their new failure score. 2010/11 levy year deadlines 31 March 2010 Certification of new contingent assets or re-certification of existing ones 9 April 2010 Certification of deficit reduction contributions (this deadline has been extended from the usual 7 April date because of the Easter weekend) 30 June 2010 Certification of block transfers of an entire scheme that have taken place before 1 April 2010 All actions are to be completed by 5pm on the relevant day. 2011/12 levy year deadlines (provisional) 30 March 2010 Providing information to D&B regarding employers failure scores 31 March 2010 Updating Exchange with levy-related information, including any new section 179 valuation results 30 June 2010 Certification of significant partial block transfers that have taken place before 1 April 2010 All actions are to be completed by 5pm on the relevant day. 5

6 We urge trustees to continue to take a prudent approach to assessing schemes technical provisions, to maintain an honest and open dialogue with employers, and to remain aware of the changing economic situation as they focus on the long term interests of scheme members. Pensions Regulator chair, David Norgrove, November 2009 The future in orange In its latest Orange Book its annual analysis of schemes recovery plans the Pensions Regulator urges trustees to continue taking a prudent approach, maintain dialogue with employers and remain aware of the changing economic situation. This follows its analysis of the data that it received from schemes that were in deficit on the date of their last valuation. The data is divided into three years to enable comparisons, based on the effective dates of valuations ending in the 12 months to 21 September 2006, 2007 and The data reveals that trustees and employers appear to have heeded a key message of the 2008 Orange Book, when the Regulator reiterated that the scheme funding regime has the flexibility to allow for the difficulties of employers in challenging economic conditions. In particular, it suggested that a back-end loaded recovery plan might be appropriate where an employer has short-term difficulties. This year s Orange Book reveals that recovery plans that breached the Regulator s trigger for excessive back-end loading increased to 12% for 2008 (up from 9% for 2007). The Regulator also made the following observations: The average length of the recovery plan for 2008 was 8.0 years, up from 7.3 years for The Regulator noted that the change in approach appears to show trustees taking advantage of the funding regime s flexibility to accommodate turbulent market conditions. The average margin (over the gilt yield) assumed in the discount rate an effective single discount rate was 1.4% for 2008, up from 1.0% for The Regulator noted that the apparent increase may indicate a greater reliance on investment outperformance to meet scheme liabilities. Most trustees are adopting mortality tables that reflect more up-to-date mortality experience. The Regulator observed a large increase in the use of 00 tables and some use of the newer S1 tables in The Regulator also noted that trustees are increasingly allowing for higher future mortality improvements, including underpins. The number of clearance applications reduced in 2008/09, apparently reflecting a decrease in corporate activity over the period. However, anecdotal evidence suggests that the complexity of each application has increased. The Regulator also noted that it has refused only three applications. 6

7 Communication under the spotlight The DWP has issued a consultation document proposing amendments to the current disclosure regulations for occupational, personal and stakeholder pension schemes. The proposed changes are largely concerned with the extent to which information may be provided electronically (by or by reference to a website address). These changes are intended to come into force on 1 October It is also proposed to reduce the time limit for providing basic information about a scheme from two months to one month from the date of becoming a member, in line with the introduction of the new Personal Accounts regime (now to be called NEST ). This consultation confirms that the Government will not be proceeding with other parts of its March 2009 proposals in particular, there will be no overarching disclosure principle to replace some detailed provisions. The way forward for flexible retirement The DWP has finished consulting on possible changes to pensions legislation around flexible retirement provisions. The Government found that the consultation had not provided enough robust evidence to introduce exceptions into the legislation (as proposed in its December 2008 consultation). It has decided not to proceed with any changes to the law but to consider the prospects for further general guidance on occupational pension schemes and age discrimination. The response had been delayed by the Government while waiting for the High Court s judgment in the Heyday Case, which was delivered on 25 September The Government s statement that it does not intend to legislate any further is the end of a series of consultations on the topic which started in October On the horizon Key dates for expected legislative developments impacting occupational pension schemes are highlighted in the chart below. Oct 2010 New disclosure regulations 2010 Changes to debt regulations 2010 New Regulator guidance on internal controls October 2012 Auto enrolment starts for large employers 1% employer contributions required October 2016 All employers have auto enrolment 2% employer contributions required On the horizon April 2010 Normal minimum pension age increases to Review of default retirement age Late 2010 PPF to finalise new levy structure April 2011 New pension contribution tax regime for high earners 2012 or later Contracting out abolished for DC schemes October % employer contributions in place 7

8 Governance diary With the snow came a flurry of activity from the Pensions Regulator. In addition to the consultation on revised internal controls and the results of the 2009 governance survey discussed earlier in this issue of In Sight, we have seen a revised code of practice on trustee knowledge and understanding (TKU). Released on 8 December 2009, the new version of the code of practice on TKU does not represent a major change from the previous version. The Regulator has taken the opportunity to change the emphasis of the guidance in certain areas. Trustees will need to introduce these changes into their programme and assessment tools. New statements in the Code of Practice Every Trustee should read the Scheme s trust documentation thoroughly (rather than just to know the essential elements, as in the previous version). Trustees should review their own knowledge and understanding at least annually. The Regulator expects trustees to have completed the Toolkit or another equivalent training course. Changes to the Scope Guidance An increased emphasis on the importance of good administration. Additional PPF related guidance. Clarification of the TKU requirements relating to future proposed legislation, including personal accounts. Additional items on new developments in scheme investments, employer covenant, trustees understanding of their powers, implications of possible wind ups and buy-outs. Seminar dates Unless it says otherwise, all courses take place in central London. Full Day Course Introduction to Trustees Responsibilities Essentials for DB Trustees Investment Essentials for DB Trustees (half day) Essentials for DC Trustees PMI Award in Pension Trusteeship (2 days) Teleconferences 2010 Dates 23 Feb (Birmingham), 3 Mar, 20 Apr (Birmingham), 22 Apr, 26 May, 9 Jun (Birmingham), 8 Jul, 1 Sep, 14 Sep (Birmingham), 7 Oct, 3 Nov, 16 Nov (Birmingham), 9 Dec 24 Mar, 11 May (Birmingham), 23 Jun, 29 Sep, 26 Oct (Birmingham), 17 Nov 25 Mar, 24 Jun, 30 Sep, 18 Nov 10 Feb, 9 Mar (Birmingham), 12 May, 6 Jul (Birmingham), 15 Sep 24/25 Feb, 5/6 May, 20/21 Oct (Woking) Keep up with current issues from the comfort of your own desk through our regular series of one-hour teleconferences. Aimed at trustees, these will help you to keep abreast of current pension matters and developments in the industry and discuss the practical issues you should be considering. The teleconferences are free of charge to register to attend, ukevents@hewitt.com Teleconferences 4 February, 6 May, 9 September, 11 November If you have any questions, please speak to your usual Hewitt consultant or contact Maggie Cruise on: Tel: +44 (0) maggie.cruise@hewitt.com Hewitt, Parkside House, Ashley Road, Epsom, Surrey KT18 5BS 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. Consultants will be pleased to answer questions on its contents but cannot give individual financial advice. Individuals are recommended to seek independent financial advice in respect of their own personal circumstances Hewitt Associates Limited Hewitt Associates Limited is registered in England and Wales. Registered No: Registered Office: 6 More London Place, London SE1 2DA. SB2025