Pensions and Employment: Pensions Bulletin

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1 Pensions and Employment: 13 NOVEMBER 2014 ISSUE 17 Legal and regulatory developments in pensions In this issue FORTHCOMING EVENTS Pensions Law Update Seminar THE WATCH LIST NEW LAW A radical reform of pensions : joining the legislative dots Abolition of short service refunds: commencement postponed Shareholder engagement, stewardship and trustees investment duties: Proposed changes following Kay Review TAX New user guide for Pension Schemes Online CASES Discretionary pension increases were not established custom : Pension Ombudsman s Determination in relation to Bains POINTS IN PRACTICE Exercise by Regulator of its moral hazard powers: Reports in relation to MG Rover, UK Coal and Kodak The Purple Book: 9th edition Abolition of DB contracting-out: HMRC s Countdown Bulletin Issue 3 DWP Guidance on meaning of money purchase benefits There is no Employment Bulletin this week Back issues can be accessed by clicking here. To search them by keyword, click on the search button to the left. Find out more about our pensions and employment practice by clicking here. For details of our work in the pensions and employment field click here. For more information, or if you have a query in relation to any of the above items, please contact the person with whom you normally deal at Slaughter and May or Rebecca Hardy. To unsubscribe click here.

2 Forthcoming events 1. Pensions Law Update Seminar Two Bills currently making their way through Parliament herald a pensions revolution taking effect on 6th April, In a change to the published programme, our next Pensions Law Update Seminar, which takes place on Wednesday, 19th November, 2014, between 9.30 am and 1 pm, will look at the implications of this revolution for those running occupational schemes. An invitation accompanies this Bulletin. 2. The Watch List The Watch List is a summary of some potentially important issues for pension schemes which we have identified and where time is running out, with links to more detailed information. New items are in bold. No. Topic Deadline Further information/action 1. VAT recovery Was to be 3 rd August, 2014: awaiting HMRC guidance. 14/11 2. Information to retiring members about the guidance guarantee 3. Cap on charges in default fund for auto-enrolment qualifying scheme 4. Abolition of refund of contributions for members of occupational schemes with at least 30 days pensionable service who are just provided with money purchase benefits 5. Abolition of DB contractingout: managing additional costs 6. Abolition of DB contracting-out: practicalities 7. Registration for Individual Protection Proposed ban on corporate directors 6 th April, th April, st October, th April, th April, 2016 Before 6 th April, 2017 Not yet known 14/12 14/16 14/14 A deed of amendment will be required for such members where pensionable service began on or after 1 st October, 2015 unless the scheme provides for immediate vesting. 14/11 14/08 14/12 14/12 New Law 3. A radical reform of pensions : joining the legislative dots Two Bills currently making their way through Parliament together introduce what Pensions Minister Steve Webb described as a radical reform of pensions, intended to: with effect from 6th April, 2015, give members a greater choice in accessing their DC pension benefits, and with effect from 6th April, 2016, give employers a greater choice in the kinds of pensions they offer. The reforms in part, build on the single tier state pension, due to take effect on 6 th April, The Focus accompanying this Bulletin provides an overview of a number of aspects of the draft legislation and highlights what we see as potential difficulties in some key areas. We will be looking at various aspects of the reforms in more detail in future issues. 2

3 4. Abolition of short service refunds: commencement postponed On 22 nd October, 2014, the DWP announced that the abolition of short service refunds in relation to money purchase benefits will take place from 1st October, Section 36 of the Pensions Act 2014 (not yet in force) changes the preservation requirements for money purchase benefits, with the effect that, when all of a member s benefits are money purchase benefits, short service refunds of members contributions will no longer be allowed where the member has at least 30 days pensionable service. For more detail see 14/14 The change will apply only to members whose pensionable service begins on or after 1 st October, The preservation requirements are not overriding, so that schemes whose rules provide for short service refunds will need to amend them. Action point: Check preservation requirements in the trust deed and rules of any money purchase scheme or section of a scheme providing money purchase benefits to see what, if any, change is required. Member communications and scheme booklets may also need to be changed. 5. Shareholder engagement, stewardship and trustees investment duties: Proposed changes following Kay Review A. Background 1. On 27th October, 2014, the Department for Business, Innovation and Skills ( BIS ) published a progress report on its implementation of the Kay review of UK equity markets and long-term decision making (the Review ). 2. Issues considered by the Review, which reported on 23rd July, 2012, included: whether Government policies directly relevant to institutional shareholders and fund managers promote long-term time horizons and effective collective engagement, and the quality of engagement between institutional investors, fund managers and UK quoted companies, and the importance attached to such engagement, building on the success of the FRC s Stewardship Code. 3. Recommendations included that the Law Commission be asked to review the legal concept of fiduciary duty as applied to investment, to address perceived uncertainties and misunderstandings on the part of trustees and their advisers. 4. The Law Commission s report (July, 2014) ( 14/11) included guidance for pension scheme trustees ( Is it always about the money? ) on duties when setting an investment strategy. B. Government response to Law Commission recommendations 1. The Government s response to the Law Commission s specific recommendations is set out in a table in the progress report. 2. The Regulator is apparently to update its investment guidance to trustees in the course of Specifically, it is to review its DC publications generally to reflect the introduction of the new DC quality standards and charging requirements due to take effect on 6th April, 2015 (for details see our October, 2014 client focus). The Government says the Regulator will also supplement its DB Code of Practice on funding with more detailed guidance on investment strategy and integrated risk management. 3. The Government is to consult at the earliest opportunity on amending the provisions 3

4 relating to Statements of Investment Principles in the Investment Regulations to: 3.1 amend to the reference to social, environmental and ethical considerations ( SEE considerations ) to ensure that the wording more clearly reflects the distinction between financial factors and non-financial factors, and 3.2 to require trustees to state their policy (if any) on stewardship, by reference to the FRC s Stewardship Code. 4. The Government agrees with the Law Commission that it would not be appropriate to attempt to codify the general law of fiduciary duties through legislation but says it will consult on including in the Investment Regulations a specific statement clarifying that trustees should consider any factors which may be material to financial interests of scheme members and beneficiaries, including long-term factors, and determine what weight should be attached to these factors in their investment decisions. 1 The Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378). Comment: As we noted in 14/11, the Law Commission report glossed over the duties owed by trustees to the employer in relation to investment decisions. We await the proposed new wording to see to what extent it places a duty on trustees to take SEE considerations into account. The progress report is on BIS website. Tax 6. New user guide for Pension Schemes Online On 21st October, 2014, HMRC published a user guide for its Pension Schemes Online service. The service is available to scheme administrators and appointed practitioners. The guide sets out how to register a new scheme with HMRC and how to register as a scheme administrator or practitioner. It also gives advice on how to complete mandatory online forms such as event reports and scheme returns. The guide is on HMRC s website Cases 7. Discretionary pension increases were not established custom : Pension Ombudsman s Determination in relation to Bains On 10th September, 2014, the Deputy Pension Ombudsman determined that the award of discretionary increases to pensions in payment by Hewlett-Packard ( HP ) over a number of years did not itself create an established custom. There had to be some recognition of the practice in the scheme s governing documentation. Following a scheme merger, the principal employer, HP, was therefore free to exercise its discretion under the scheme rules, which it had done properly and in a way that did not breach its implied duty of good faith. The Ombudsman also held that, as there was no established custom, the fact that the trustees had entered into a merger that expressly stated that discretionary increases were not exercised as an established custom did not mean they had breached their fiduciary duties and failed to act in the best interests of beneficiaries. Comment: This is the second occasion in recent weeks that the Ombudsman has decided that an employer could end a practice of awarding discretionary pension increases. For more details, see the attached Focus. 4

5 Points in Practice 8. Exercise by Regulator of its moral hazard powers: Reports in relation to MG Rover, UK Coal and Kodak A. Overview 1. The Pensions Regulator has power, under Section 89 of the Pensions Act 2004, to publish a report in relation to the exercise of its functions in a particular case. It has taken to doing so to explain circumstances where it has considered exercising its powers to issue financial support directions ( FSDs ) and contribution notices. B. MG Rover 2. In recent weeks, the Regulation has published reports detailing its interventions in relation to the MG Rover Pension Scheme, the UK Coal Pension Scheme and the Kodak Pension Scheme. They make interesting reading and provide an insight into the factors the Regulator takes into account when deciding whether to exercise its powers. 1. MG Rover Group Limited ( MGRG ) went into administration on 8th April, In March 2006 it entered creditors voluntary liquidation. MGRG was the principal employer of the MG Rover Group Senior Pension Scheme (the Scheme ), which entered a PPF assessment period. 2. In 2001, MGR Capital Limited ( Capital ) was established specifically for the purpose of acquiring a portfolio of vehicle finance agreements with former customers of MGRG (the loan book ). It was a joint venture company established by (i) private individuals who were also connected to 2 and involved in the business of MGRG, and (ii) a subsidiary of HBOS. Capital accumulated substantial net assets as a result of its acquisition of the loan book but, in 2009, it entered into a members voluntary liquidation. 3. In May 2005, the Secretary of State for Trade and Industry appointed inspectors to undertake an investigation into the affairs of the MG Rover Group. The inspectors published their report in 2009, finding, among other things, that a company within MGRG could have acquired the loan book, and that MGRG had advanced substantial capital to facilitate acquisition of the loan book. 2 This connection for the purpose of Section 43 of the Pensions Act 2004 is important. Without it the FSD could not be issued. 4. On 21st December, 2012, the Pensions Regulator issued a warning notice of its intention to issue an FSD to Capital for the benefit of the scheme. It considered it would be reasonable to do so on the basis that the acquisition of the loan book could have been structured in such a way as to have been acquired by, and be of benefit to, MGRG instead of Capital. 5. On 20th October, 2014, agreement was reached between Capital and the trustee of the Scheme that Capital would make a payment of 8.085m to the Scheme, following which the Regulator is no longer proceeding with the FSD. C. UK Coal Operations Limited section of the Industry-Wide Coal Staff Superannuation Scheme 1. UK Coal Operations Limited ( UKCOL ) was formed in 2012 as part of the restructuring of the UK Coal group. UKCOL is the sole statutory employer in relation to the UK Coal Operations Limited Section of the Industry- Wide Coal Staff Superannuation Scheme (the UKCOL Section ). The UKCOL Section replaced the UK Coal Mining section of the Scheme and received a bulk transfer of all assets and liabilities as part of the 2012 restructuring. 5

6 2. In early 2013, a fire at Daw Mill, one of UKCOL s deep mines, put the group s mining business ( Mineco ) at risk of insolvency. 3. UKCOL s management, the Regulator, the PPF and the Scheme Trustees engaged in a constructive dialogue in relation to the options available for the UKCOL Section. A restructuring was proposed under which the mining business, excluding Daw Mill, would be hived down to a new group. By leaving Daw Mill in Mineco, the new group would avoid the pit closure costs. The parties also proposed that the UKCOL Section would be attached to Mineco but this was not acceptable to the Regulator. In order to reach full funding, the Trustees would have had to seek increased investment return, exposing the UKCOL Section to unacceptable investment volatility. 4. A revised proposal was put forward by UKCOL under which the assets of the Mineco business would be hived down to a new group with a controlled entry of the UKCOL Section into the PPF following an assessment period triggered by an insolvency of UKCOL. As part of the restructuring, the Trustees would release part of their claim against UKCOL as an unsecured creditor, in return for which the PPF would secure significantly all of the economic interest and value in the new group for a series of debt instruments held in the new group s operating company. 5. The Regulator provided clearance in relation to the restructuring. While other creditors would receive a higher return compared with an uncontrolled insolvency (due to the trustees releasing part of their claims against UKCOL) this was considered to be reasonable given the expected improvement to the PPF s position under the restructuring. The PPF had obtained its own advice on the expected outcomes and structure of the group going forward and supported the proposal. 6. The restructuring, announced in July 2013, has, in the Regulator s view, provided the best available outcome for the PPF and has preserved the remaining business as a going concern, enabling the retention of around 2000 jobs. D. Kodak Pension Plan 1. Kodak Limited ( Kodak UK ) was the sole sponsoring employer of the Kodak Pension Plan (the Plan ), which had approximately 15,000 members. The Trustees had secured a guarantee from the US parent company to provide support to the Plan should it be required. 2. In January 2012, the US parent filed for Chapter 11 bankruptcy. The Plan Trustees filed a claim in the proceedings for $2.837 billion (being the scheme s buy-out deficit) on the basis of the guarantee. 3. Although Kodak UK was not subject to any insolvency proceedings, the Trustees considered that it would be likely to become insolvent if the US parent entered liquidation. 4. The Trustees agreed a deal with the US parent under which the Scheme would acquire part of Kodak s businesses, for which the Trustees would pay up to $325 million in cash (substantially lower than third party bids which had previously been rejected), release their claim against the US parent in Chapter 11, and release Kodak UK s liability to the Scheme by way of a regulated apportionment arrangement ( RAA ). 5. The Regulator determined it should approve the RAA and grant the clearances sought by various Kodak entities. The effect of the RAA (and the release of the guarantee from the US parent) was to leave the Plan with no sponsoring employer covenant, wholly reliant 6

7 on its assets. The Trustees made a proposal to members: either they could remain in the Plan, which would transfer to the PPF, or they could elect to transfer to a new scheme (the Scheme ) which would offer benefits better than the PPF but lower than the Plan. Members representing in excess of 94% of the total liabilities in the Plan voted in favour of a transfer of their accrued benefits to the new scheme. 6. In order to mitigate the risk of the new scheme to the PPF, the Trustees of the Scheme and the Regulator agreed a governance framework involving: regular, scheduled monitoring of the performance of the Scheme s businesses and the Scheme s funding position, restrictions on the augmentation of benefits, restrictions on investment, and triggers for the winding of the Scheme. 7. The Regulator notes that the reduction of accrued benefits that occurred in this case is a step which trustees should approach with utmost caution. The Regulator should be consulted before any such exercise is begun and will expect trustees to conduct a thorough and balanced communication exercise with members prior to a decision or vote of the membership. The Regulator would not expect any proposal for reduction of benefits to be made unless all other creditors and shareholders have similarly agreed to compromise their rights, and in some cases those rights should be entirely sacrificed. The Section 89 Reports are on the Regulator s website 9. The Purple Book: 9 th edition This was published on 30 th October, The Purple Book pulls together the latest analysis of DB schemes as at March 2013, including in areas such as the scheme size, industry type, funding levels, rates of insolvency, risk reduction, and the way assets are invested. The dataset covers 6,057 mostly private sector DB schemes, representing 11.1 million people. The bulk of the analysis uses (i) funding on a Section 179 basis and (ii) D&B failure scores as indicators of insolvency risk. The Purple Book 2015 will use the failure scores from the PPF-specific insolvency risk model that applies for the 2015/16 levy year. Key points are: the percentage of schemes that are closed to future accrual rose from 30% in 2013 to 32% in 2014, the percentage of schemes that are open fell from 14% in 2013 to 13% in 2014, the number of active memberships fell by 6.5% in 2014 to 1.8 million. Active memberships have fallen by 50% since 2006, scheme funding improved from 84% in 2013 to 97% in 2014 (on a Section 179 basis) and from 61% to 67% (on a full buy-out basis), the total number of contingent assets recognised by the PPF for 2014/15 was 780, lower than the previous year and reflecting a fall in the number of Type A contingent assets following stricter validation standards introduced by the PPF, and total risk transfer business covering buy-outs, buy-ins and longevity hedges amounted to 71.8 billion between the end of 2007 and the first quarter of Just under half of these deals were longevity hedges. The Purple Book 2014 is on the PPF website 7

8 10. Abolition of DB contracting-out: HMRC s Countdown Bulletin Issue 3 This was published on 27th October, It notes that: there are only 18 months until the end of DB contracting-out, there have been 1,889 requests to use HMRC s Scheme Reconciliation Service, the number of queries HMRC has received following issue of data by the service is much lower than expected, suggesting to HMRC that schemes have requested the information but are not looking at the data. It urges trustees to ensure that administrators return queries arising from the data to HMRC as soon as possible. Action point: All requests to use the Scheme Reconciliation Service must be made by 6 th April, Schemes that have not already done so should put in a request. Although use of the service is not compulsory, it is the responsibility of administrators and trustees to make sure records are accurate. The Bulletin is on HMRC s website 11. DWP Guidance on meaning of money purchase benefits On 5th November, 2014, the DWP published guidance to help trustees identify benefits that might be affected by the recent change to the meaning of money purchase benefits. The definition of money purchase benefits was amended with effect from 24th July, 2014 (backdated to 1st January, 1997) with the effect that only the following benefits now qualify: a benefit other than a pension in payment, where the rate or amount of that benefit is calculated solely by reference to the assets, which must necessarily suffice for the purposes of its provision, and a benefit which is a pension in payment where it is secured by an annuity contract or insurance policy made or taken out with an insurer and, prior to coming into payment, at all times it came within the above. Regulations 3 (the Regulations ) provide easements for affected schemes, in most cases validating past actions of trustees. The guidance sets out the different circumstances in which the new definition may apply and looks in detail at the Regulations and how these apply in particular circumstances. The DWP notes that trustees may need to seek professional advice on how the new definition applies to the particular circumstances of their scheme. The majority of schemes affected are likely to be hybrid schemes i.e. schemes that provide both money purchase and non-money purchase benefits and so are already subject to regulatory measures in relation to those non-money purchase benefits. The affected benefits are: cash balance benefits, money purchase and cash balance underpin benefits, top up benefits (i.e. an arrangement where a member has, under the scheme, rights to a benefit that tops up a money purchase benefit to a pre-set level if there is a shortfall at the relevant date), and pensions derived from any of the above. 3 The Pensions Act 2011 (Transitional, Consequential and Supplementary Provisions) Regulations

9 Action point: If you have, or may have, a scheme with benefits that fall into any of these categories, you should read the DWP guidance. The Regulator has previously ( 14/11) asked schemes that find they have benefits that fall outside the new definition of money purchase benefits to notify it. For assistance, please get in touch with your usual pensions contact at Slaughter and May. The DWP guidance is on the GOV.UK website

10 This Bulletin is prepared by the Pensions and Employment Group of Slaughter and May in London. We advise on a wide range of pension matters, acting both for corporate sponsors (UK and non-uk) and for trustees. We also advise on a wide range of both contentious and non-contentious employments matters, and generally on employee benefit matters. Our pensions team is described in the 2014 edition of Chambers: on technical ability: the team s advice is always clear and logically set out ; on problem solving: members are creative in finding ways to help us ; and on responsiveness: we find individuals are very quick in their responses and work exceedingly hard. Our recent work includes advising: Imperial Chemical Industries Limited and Akzo Nobel N.V. on the de-risking of the ICI Pension Fund by way of a circa 3.6 billion transaction. The transaction, which was announced on 26th March 2014, involved the Trustee of the ICI Pension Fund entering into bulk annuity buy-in policies with Legal & General Assurance Society Limited and Prudential Retirement Income Limited respectively in relation to in aggregate circa 3.6 billion of liabilities of the ICI Pension Fund (which comprise approximately one quarter of the Akzo Nobel pension liabilities). The Legal & General buy-in is the largest ever bulk annuity policy arranged by a pension scheme in the UK BBA Aviation plc on the pensions aspects of its disposal of the APPH entities and a section 75 debt apportionment arrangement with the trustees of its defined benefit pension scheme, the BBA Income and Protection Plan (the IPP ), and thereafter on the structuring and implementation of an asset backed funding arrangement with the trustees of the IPP. The asset backed funding arrangement replaces a previously agreed schedule of contributions and is designed to generate an annual income stream of approximately 2.7 million for the pension scheme whilst minimising the risk of scheme over-funding in the future Aviva on the de-risking of the Aviva Staff Pension Scheme by way of a circa 5 billion longevity swap transaction involving insurance and re-insurance arrangements. The transaction is the largest of its type to date and allows the defined benefit scheme to re-insure the longevity risk relating to approximately 19,000 of its members (roughly a third of its total longevity risk). Aviva s in-house legal team also advised. Premier Foods, on a revised funding arrangement with the group s defined benefit pension schemes as part of Premier Food s refinancing plan. Revisions to the funding arrangements included reduced pension deficit contributions and the granting of additional security to the pension schemes If you would like to find out more about our Pensions and Employment Group or require advice on a pensions, employment or employee benefits matters, please contact Jonathan Fenn jonathan.fenn@slaughterandmay.com or your usual Slaughter and May adviser. Unilever Plc on the creation of an innovative pension funding vehicle under which a unit-linked life policy was established to fund centrally certain overseas unfunded retirement benefit obligations General Motors, on the pensions aspects of the sale of Millbrook Proving Ground Limited (the test and engineering technology centre). The sale was dependent on structuring a pensions reorganisation so that the Millbrook Pension Plan and all pension liabilities were retained in the General Motors group ConocoPhillips, on complying with its auto-enrolment duties, including analysing how different categories of employees would be provided with pension benefits in compliance with those duties and setting up a new DC pension plan and a new registered life cover pension plan Royal Mail on a benefit change exercise which enabled Royal Mail to use some of the c 2bn of assets remaining in the Royal Mail Pension Plan following the 2012 transfer of its pension liabilities to HM Government to fund a 300 million a year gap which would otherwise have opened up between the pension contributions which it could afford and the amount which was required to keep the Plan open for the future accrual of benefits. We had previously advised on the 2012 transfer of approximately 30 billion of Royal Mail s historic pension liabilities to HM Government The Trustee of the General Motors UK Retirees Pension Plan, on the surrender in October, 2012 of 2 insurance policies and the purchase of a bulk purchase annuity policy with Rothesay Life. The transaction covered all or substantially all of the Plan s benefit obligations and had an aggregate value of approximately 230 million London T +44 (0) F +44 (0) Brussels T +32 (0) F +32 (0) Hong Kong T F Beijing T F Published to provide general information and not as legal advice. Slaughter and May, For further information, please speak to your usual Slaughter and May contact.