Amendments to UK legislation required to enable defined ambition pension schemes 1 to be set up

Amendments to UK legislation required to enable defined ambition pension schemes 1 to be set up 9th June 2014 Updated from the version of 28th March, 2014 for comments received in APL Workshops held on 13th May, 2014 and 19th May, 2014 and the announcement in the Queen s speech on 4th June, 2012 of the Private Pensions Bill to enable collective DC schemes 1 1 These schemes could also be referred to as target benefit schemes or collective DC schemes.

Contents A. Introduction 01 B. Slaughter and May 03 C. Pensions legislation 04 1. Key definitions 04 2. Powers of the Pensions Regulator to issue a certificate that an occupational pension scheme is a Defined Ambition Scheme 04 3. Composition of the trustee body of a Defined Ambition Scheme 09 4. Appointment of advisers to a Defined Ambition Scheme 10 5. Information to members of a Defined Ambition Scheme 10 6. Valuation requirements in relation to a Defined Ambition Scheme 11 7. Publication of level of target (non guaranteed) benefits and valuation assumptions used to determine the level of target (non guaranteed) benefits 13 8. Lump sum death benefits 14 9. Transfers in 14 10. Transfers out 15 11. Open market option when benefits come into payment 16 12. No guaranteed pension increases 16 13. Revaluation of deferred pensions 16 14. Disapplication of provisions applying to Defined Benefit Schemes 16 15. Multi employer schemes 17 16. Pension Protection Fund 17 17. Supervision by the Pensions Regulator 18 18. Auto enrolment 18 19. Section 67 of the Pensions Act 1995 19 20. The level of target (non guaranteed) benefits from a Defined Ambition Scheme is not guaranteed 19 21. Actuarial factors 20 22. No gaming of the system 21 23. Charges 21 24. Sectionalisation 22 25. Conversion of past service rights into target (non guaranteed) benefits in a Defined Ambition Scheme 22 26. Priority position on winding up of a Defined Ambition Scheme 22 27. No repayment of surpluses to employers 23 28. Preservation requirements/vesting of benefits 23

D. Tax legislation 24 1. The shape requirements of the Finance Act 2004 24 2. Annual allowance and lifetime allowance 24 3. Lifetime allowance 25 E. Other legislation 27 F. Questions or comments 28 Appendix A Some points to consider in relation to a Defined Ambition Scheme benefit design 29 Appendix B Example clause of how the Pensions Regulator could issue a certificate confirming that an Occupational Pension Scheme was a Defined Ambition Scheme and that the liability of the employer was limited 31

A. Introduction 1. The idea of a Defined Ambition Scheme is covered in the Department of Work & Pension s Consultation on Reshaping workplace pensions for future generations 1 published on 7th November, 2013 (the DWP Consultation Paper ). The Queen s speech on 4th June, 2014 included the announcement of a proposal for a private pensions bill which would enable collective schemes to pool risk between members and potentially allow for more stability around pension outcomes for retirement. Note 1: As a matter of terminology, the Queen s speech distinguishes between Defined Ambition Schemes (called shared risk pension schemes) where there is some element of guarantee on part of the member s benefits and collective schemes which pool risk between members and potentially provide for greater stability around pension outcomes. Note 2: So our terminology of calling the shared risk scheme a Defined Ambition Scheme may, depending on how the new legislation unfolds, need amendment to refer, instead, to a Collective DC Scheme. That said, the rest of this paper uses the term Defined Ambition Scheme. 2. Set out below is a straw man of the amendments which we would suggest will be needed to pensions, tax and other legislation in relation to the establishment of an occupational 1 Cm8710. pension scheme which we have called a Defined Ambition Scheme. Such a scheme might also be referred to as a collective DC scheme or a target benefit scheme, such as were considered in Chapter 5 of the DWP Consultation Paper. 3. The DWP Consultation Paper referred in particular to research by Aon Hewitt modelling average salary replacements for different approaches to DC plans, and noted in relation to collective DC schemes that the ability to share risks amongst members does seem to create more stable outcomes than are possible in an individual DC scheme. In the context of recent discussions around public perceptions of the annuity market on the one hand, and the recent Budget announcement regarding new flexibility for DC members at the decumulation stage on the other, collective DC might be viewed as a middle path for the decumulation stage. It shares certain of the risk sharing advantages of annuitisation, but allowing the potential benefits of that risk sharing to continue through into retirement. 4. The DWP Consultation Paper uses the term Defined Ambition Scheme to mean a number of different things. This paper, setting out the straw man of the legislative amendments needed, uses the term Defined Ambition Scheme in the specific sense referred to in 2 above (ie a Collective DC Scheme) however, that is not intended to suggest that other forms of Defined Ambition Scheme would not also 01

be helpful additions to the range of pension provision options. 5. Two key points to note in the use of the term Defined Ambition Scheme are: 5.1 that no level of benefit under the scheme is guaranteed, no level of investment return is guaranteed and no biometric risks are covered by the scheme 2. A key element of the Defined Ambition Scheme is the pooling of risk and return within and/or amongst generations of members in a fair manner which does not allow any one generation intentionally to game the system at the expense of another generation of members, and 5.2 that employer contributions to the scheme are fixed at a specified amount (or fixed subject to an upper limit as specified in the trust deed and rules of the scheme) and may not be increased without the written agreement of the employer in relation to the scheme. The Defined Ambition Scheme needs to be demonstrably a money purchase scheme for accounting and employer debt/funding purposes with no risk of the employer having to make any additional contributions in respect of prior periods. 5.3 Some points on benefit design for a Defined Ambition Scheme are set out in Appendix A to this paper. 6. We would also like to acknowledge (and thank): 6.1 Martin Lowes and Kevin Wesbroom of Aon Hewitt for their contribution to this paper and, in particular, their contribution to Section C.6 (Valuation requirements in relation to a Defined Ambition Scheme), and 6.2 those members of the Association of Pension Lawyers who attended APL workshops held on 13th May, 2014 or 19th May, 2014 and whose comments we have tried to reflect in this modified version of the straw man. 7. We would expect that the adjusted straw man is, in turn, capable of further improvement. 2 See Article 15(2) of Directive 2003/41/EEC which would otherwise require the scheme to fall within the funding requirements of that Directive. 02

B. Slaughter and May 1. Slaughter and May is a firm of solicitors with more than 110 partners. We act for a wide variety of pension clients, including pension fund trustees, sponsoring employers and insurance companies. 2. In addition to making our own submission on the DWP Consultation Paper, we also participated in the Defined Ambition Industry Working Group on behalf of the Association of Pension Lawyers and in preparing the Association of Pension Lawyers submission on the DWP Consultation Paper. 03

C. Pensions legislation Set out below are the points we suggest as our straw man to be covered in the legislation to enable Defined Ambition Schemes to be established: 1. KEY DEFINITIONS 1.1 As noted in Section A.2 above, the terminology used in this paper is to refer to collective DC scheme or target benefit scheme as a Defined Ambition Scheme. 1.2 Occupational pension schemes 3 would be divided into 3 categories: a. Money Purchase Schemes, b. Defined Ambition Schemes, and c. Defined Benefit Schemes (being anything which is not a Money Purchase Scheme or a Defined Ambition Scheme). 1.3 In this paper a Money Purchase Scheme is one which only provides pure money purchase benefits. 4 1.4 A Defined Ambition Scheme would be defined in the enabling legislation as an occupational 3 See Section 1 of the Pension Schemes Act 1993. 4 It is outside the scope of this paper to go into all of the permutations of what may or may not be money purchase benefits see Section 181B of the Pension Schemes Act 1993 as amended by Section 29 of the Pensions Act 2011. pension scheme in relation to which the Pensions Regulator has issued a certificate specifying that it is a Defined Ambition Scheme. 1.5 From an employer perspective, an important consequence of being certified as a Defined Ambition Scheme would be that legislation would provide for the scheme to benefit from equivalent exemptions to those currently existing for Money Purchase Schemes in relation to employer debt and key aspects of scheme funding legislation. 2. POWERS OF THE PENSIONS REGULATOR TO ISSUE A CERTIFICATE THAT AN OCCUPATIONAL PENSION SCHEME IS A DEFINED AMBITION SCHEME 2.1 Legislation would permit the Pensions Regulator only to issue a certificate that an occupational pension scheme is a Defined Ambition Scheme, if an application to the Pensions Regulator is made by the sponsoring employer in relation to the scheme (or by the Trustee in relation to the scheme) and the Pensions Regulator determines that the occupational pension scheme satisfies the following requirements: a. the scheme is established under irrevocable trust on terms that no payments could be made from the scheme other than authorised member payments per Section 164 of the Finance Act 2004 and certain scheme administration payments and 04

compensation payments (where an employer has a right of compensation in respect of a criminal, fraudulent or negligent act or omission by the member). As per 27 below, this would mean that employers would have no rights to surplus from the scheme. b. there is a pooling of risk and reward under the scheme s trust deed and rules: i. as between the same generation of members, and/or ii. as between different generations of members, in respect of the target (non guaranteed) level of benefits that the scheme is to provide for and in respect of each member out of the scheme s assets. c. the scheme provides: i. no guarantee of a given level of benefits, ii. iii. no cover against biometric risk, and no guarantee of investment performance, as these terms are used in Article 15(2) of Directive 2003/41/EEC (the Pension Funds Directive ). Note 1: Biometric risks are defined in the Pension Funds Directive as meaning risks linked to death, disability and longevity 5. 5 See Article 6(8) of the Pension Funds Directive. Note 2: However, where externally insured defined benefit lump sum death in service benefits are provided, those would not be treated as infringing the prohibition against providing cover against biometric risks. This is discussed further in 8 below. Note 3: A scheme does not provide cover against biometric risk if, for example, in the case of a pure money purchase scheme, it provides that, on the member s death in service or death in deferment, a lump sum is payable equal to the realised value of the member s retirement account in the scheme. Note 4: A scheme does not provide cover against biometric risk if it pays to a member in retirement a target (non guaranteed) pension until the date of the member s death. The amount of the member s target (non guaranteed) benefit is subject to adjustment up or down. In other words, no greater cover is being provided than would be provided if the member is provided with an income drawdown option under a money purchase scheme where, by definition, the undrawn balance at the date of the member s death can be used for payment of a lump sum benefit or a survivor s benefit (in both cases on a pure money purchase basis). d. employer contributions to the scheme are fixed at a specified amount or rate (or fixed subject to an upper limit as specified in the trust deed and rules of the scheme and may not be increased without the written agreement of the employer in relation to the scheme) and, subject to any contractual commitment which the employer may have given to its employees to the contrary, the employer may terminate its obligation 05

to contribute on notice in writing to the trustee which may expire at the time specified in the notice. e. the employer has no liability to pay any further amounts to the scheme (other than under (d) above or where the employer has elected in writing for a fixed period (which may be renewed) to contribute towards the expenses of the Defined Ambition Scheme up to a fixed amount or percentage). Note: A key employer concern is that Parliament may, in the future, move the goal posts. The certificate from the Pensions Regulator (and see also 14 and 20 below) is there to provide legal certainty of the position while recognising that Parliament s future powers may not be fettered. 6 f. the scheme is a registered pension scheme 7. g. the benefits provided by the scheme for members are benefits that would constitute authorised member payments under Section 164 of the Finance Act 2004. Note: But see also Section D below. h. adequate arrangements have been made in relation to the scheme for: i. the governance of the scheme, ii. the management of the investment strategy of the scheme to provide a reasonable (but not guaranteed) prospect of success of providing the 6 But see also 20.3 below for a protective provision that could be included in the trust deed and rules of a Defined Ambition Scheme. 7 i.e. one which is tax approved for the purposes of Part 4 of the Finance Act 2004. iii. target (non guaranteed) level of benefits under the scheme, and the management of risks in relation to the scheme to provide at least a reasonable prospect of the target (non guaranteed) level of benefits under the scheme being delivered. Note 1: Reasonable prospect means: better than a 50:50 likelihood of the target benefit being achieved, but may be less than the degree of certainty which a prudent funding approach would require. Note 2: It is not the intention to prohibit any particular type of scheme design so long as there is a reasonable prospect of the target benefit being delivered. There are different ways in which that reasonable prospect can be evaluated. For example it could be expressed as a confidence level that the core target benefit had a relatively high probability of being met but that the revaluation/indexation of the benefit had a lower probability of being met. Note 3: We would expect there to be a consultation and a Pensions Regulator code of practice on reasonable prospect funding levels, but with a very clear direction that there is no requirement that all aspects of the target benefit should be funded/determined on a prudent funding basis. However, the funding basis should provide at least a 50:50 prospect of the benefit being provided and with a strong expectation that any core element of the target benefit has a much higher prospect of being paid in full. 06

i. the scheme trust deed and rules provides an adequate mechanism for adjusting in a transparent and reasonable fashion as between members of the same generation and, where applicable 8, as between different generations of members the target (non guaranteed) level of benefits provided for under the scheme s trust deed and rules where a valuation of the scheme shows that as at the valuation date, the amount 9 of the scheme s target (non guaranteed) benefit level is less than the value of scheme s assets as at that valuation date. Note: The trust deed and rules will also make provision for any surplus shown as at a valuation date to be allocated amongst members in an equitable fashion by increasing the target (non guaranteed) level of benefits (but explicitly recognising that an expense reserve may be established). j. adequate arrangements have been made in relation to the scheme to prevent one generation of members of the scheme obtaining an unfair advantage relative to another generation of members of the scheme or as between transferring members and continuing members to the intent that there should be no opportunity for gaming the system. Note: As referred to in 22 below. 2.2 As per 1.4 above, a certificate from the Pensions Regulator would as a matter of law lead to the scheme being a Defined Ambition Scheme for pensions legislation purposes. This in turn would lead to the employer s liability being limited to the amounts determined under (d) and (e) of 2.1 above. 2.3 By way of example in other legislation: a. Section 3 of the Companies Act 2006 says that: A company is a limited company if the liability of its member is limited by its constitution. It may be limited by shares or limited by guarantee. b. Section 15(1) and (2)(c) of the Companies Act 2006 say as follows: (1) On the registration of a company, the registrar of companies shall give a certificate that the company is incorporated. (2) The certificate must state (c) whether it is a limited or unlimited company, and if it is limited whether it is limited by shares or limited by guarantee,. c. Section 15(4) of the Companies Act 2006 says: 8 See 2.1(a)(ii) above where risk sharing is between generations. 9 The amount for this purpose would be the present capital value, using the applicable actuarial method and assumptions (see 6 below) of the expected future payments to be made to and in respect of members of the scheme of the current target (non guaranteed) level of benefits under the scheme assuming no changes were made to the target (non guaranteed) level of benefits as at the valuation date. The certificate [of incorporation issued by the registrar of companies] is conclusive evidence that the requirements of this Act as to registration have complied with and 07

that the company is duly registered under this Act. 2.4 In other words, there is already a statutory precedent for an Act of Parliament providing for a statutory limitation of liability. An example of how clauses in the Private Pensions Bill 2014 could be drafted to cover this point is set out in Appendix B. 2.5 There will be no procedure whereby the certificate from the Pensions Regulator that a scheme is a Defined Ambition Scheme could be set aside. 2.6 Instead: a. no amendments could be made to the Scheme which would allow any guaranteed 10 benefits to be provided from the scheme (see further 20.2 below) or permit any increase in the employer contribution levels (without the consent of the employer) see also 20.2 below. b. if the Pensions Regulator had concerns over the way the scheme is being operated, it would be able to use its existing powers: i. to wind up the scheme (see Section 11 of the Pensions Act 1995), or ii. to remove and appoint a trustee of the scheme (see Sections 3 and 7 of the Pensions Act 1995). 2.7 However, if the scheme were to convert into a Money Purchase Scheme under a provision to that effect in the trust deed (see 20.3 below), 10 In the sense used in C.2.1(b) above. then it would automatically cease to be a Defined Ambition Scheme. 2.8 As a practical matter, an overriding model rule 11 could be prepared to go into the trust deed of a scheme which was applying to become a defined ambition scheme to cover the key attributes of a defined ambition scheme, including: a. that no benefit under the scheme fell within Article 15(2) of the Pension Funds Directive (see 2.1(c) above), b. that the employer contributions were fixed at the amount specified in the overriding rule (see 2.1(d) above), c. that the employer s liability was limited as specified in 2.1(e) above, d. that the scheme could not be amended in any way which would provide any guarantee (falling within Article 15(2) of the Pension Funds Directive) or which would increase the employer contribution rate or employer liability to the scheme (unless the employer expressly agreed in writing to that increase), and e. an automatic conversion of the scheme from a Defined Ambition Scheme to a Money Purchase Scheme immediately before any overriding legislation took effect that would alter any of the key attributes referred to in (a), (b), (c) or (d) above. 11 We acknowledge and thank Jonathan Moody of Mayer Brown International LLP and current Chair of the Association of Pension Lawyers Legislative and Parliamentary Sub Committee for having made this suggestion at one of the two APL workshops to consider the straw man in the original version of this paper. 08

Comment: There is a proven track record of the use of overriding rules in relation to occupational pension schemes. See, for example: i. the overriding Inland Revenue limit rules that applied to exempt approved schemes prior to 6th April, 2006, and ii. the model GMP contracting out rules. 3. COMPOSITION OF THE TRUSTEE BODY OF A DEFINED AMBITION SCHEME 3.1 The trustee body of the scheme must be comprised of the following: a. unless the trustee (or all of the trustees) is independent, not less than one third and not more than one half of the trustees must be representatives of the sponsoring employers in relation to the scheme. b. unless the trustee (or all of the trustees) is independent, not less than one third and not more than one half of the trustees are representatives of the members of the scheme in relation to the scheme. Note 1: References to trustees should be read as including references to directors where the trustee of the scheme is a sole corporate trustee. Note 2: The same test of independence for this purpose would apply as under the Regulation 2(k) or Regulation 3(m) of the Occupational Pension Schemes (Member nominated Trustees and Directors) Regulations 2006. Note 3: The process for selecting trustees/ directors of a trustee company under (b) above is as per the existing member nominated trustee/ director requirements of the Pensions Act 2004 (see Sections 241 243). 3.2 One question would be whether there should be a requirement that at least one trustee (or at least one director of a trustee company) should be an independent trustee/director with a particular level of additional expertise. Our own view is that, on balance, the provision of more flexibility as to the exact composition of the trustee board within the parameters set out in 3.1 above is to be preferred. 3.3 There are already knowledge and understanding requirements for trustees/directors of trustee companies which must be met. 3.4 We note, as a practical matter, that, at the inception of a Defined Ambition Scheme, much of the benefit design will be guided by the employer and the actuary advising the employer. Initially the emphasis will be on the scheme to invest the assets of the scheme with the aim of keeping costs to the minimum (subject to any contribution in respect of costs which the employer wishes to make). 3.5 As the Defined Ambition Scheme grows in size, we would expect the skill set of the trustee board to evolve and that, in turn, may lead to either an investment committee being established which has one or more individuals on it with particular investment expertise or particular risk management expertise and this can be backed up by an appropriate code of practice from the Pensions Regulator which can reflect the development of the way in which Defined Ambition Schemes evolve. 3.6 We also note that the Pensions Regulator already has the power to remove and appoint trustees under Section 3 and 7 of the Pensions Act 1995. In addition the Pensions Regulator has power 09

to serve improvement notices under Section 11 of the Pensions Act 2004 (for example, for non compliance with the knowledge and understanding requirements in Sections 247 and 248 of the Pensions Act 2004). 4. APPOINTMENT OF ADVISERS TO A DEFINED AMBITION SCHEME 4.1 The Defined Ambition Scheme is to have: a. an actuary (satisfying the same criteria as is required to be an actuary of a Defined Benefit Scheme see Section 47 of the Pensions Act 1995). b. an auditor (satisfying the same requirements as required to be an auditor of a Defined Benefit Scheme see Section 47 of the Pensions Act 1995). c. one or more fund managers (satisfying the same requirements as required to be a fund manager of a defined benefit scheme this ties in with Section 47 of the Pensions Act 1995 and also has a cross link to the Financial Services and Markets Act 2000 which requires, in summary, the fund manager to be authorised or exempt (or appointed in circumstances where the appointment does not amount, in summary, to carrying on investment business in the United Kingdom)). 4.2 The Trustee may appoint other advisers/service providers in accordance with Section 47 Pensions Act 1995 (such as legal advisers, custodians, investment consultants, etc.). 5. INFORMATION TO MEMBERS OF A DEFINED AMBITION SCHEME 5.1 The initial communications to members on joining and annually thereafter shall: a. explain in clear and plain language: i. the target benefit provided under the scheme, ii. iii. that it is not guaranteed, the assessed confidence level for delivery of the target benefit (and if different parts of the target benefit have different levels of assessed confidence for delivery, those differences), b. outline clearly the methodology for adjusting up or down the target (non guaranteed) level of benefits, c. where there is any variation in the confidence level for a particular target benefit (or particular part of a target benefit) being provided, a clear explanation of that variation, and d. where there has been any change in the assumptions used to assess that confidence level, a clear explanation of the reasons for that change. 5.2 A member of a Defined Ambition Scheme must be given each year (following the annual valuation of the scheme see 6 below): a. a statement as at the valuation date of the share of fund (or value) as at that valuation date which corresponds to the accrued target (non guaranteed) benefits of the 10

member as at that valuation date (after any adjustment of the target (non guaranteed) benefits as at that valuation date to allow for any (pre adjustment) valuation surplus or valuation deficit), and b. a reminder that: i. the aggregate for transfer values/ shares of fund of all of the members of the Defined Ambition Scheme as at the valuation date is equal to the value of the net assets of the Defined Ambition Scheme (apart from any part of the assets set aside as an expense reserve), and ii. a statement that the value of the accrued target (non guaranteed) benefit as at the next annual valuation date may be higher or lower and a clear explanation of the main features that would affect that value as at the next valuation date. 5.3 By way of illustration of the confidence level concept the risk management approach adopted in the New Brunswick 12 target benefit scheme has two test levels: a. a primary risk management goal that, on the methodology and assumptions used, the probability over 20 years of the base target benefit being delivered is at least 97.5% (tested annually), and b. a secondary risk management goal that, on the methodology and assumptions used, the probability over 20 years that ancillary benefits (e.g. revaluation or indexation) being delivered is at least 75%. Note: See Rebuilding New Brunswick: The Case for Pension Reform, a Government of New Brunswick Report February 2013, page 12 and see also Appendix D, page 20. 6. VALUATION REQUIREMENTS IN RELATION TO A DEFINED AMBITION SCHEME 6.1 In order to avoid confusion with Defined Benefit Schemes (and to avoid any suggestion that for the purposes of the Pension Funds Directive the scheme is one which underwrites biometric risk such as a regulatory own funds scheme) a Defined Ambition Scheme would benefit from the same exemption from Part 3 of the Pensions Act 2004 as a Money Purchase Scheme. 6.2 However, there would be valuation requirements applying in relation to a Defined Ambition Scheme (relative to its target benefits), which could be based on the Part 3 framework subject, critically, to the lack of any statutory funding objective as per Section 222 of the Pensions Act 2004 and with certain other modifications described referred to below (and with other appropriate consequential modifications). 6.3 A Defined Ambition Scheme s technical provisions means the value of the target (non guaranteed) benefits which the assets of the scheme are expected to be sufficient to provide in accordance with the scheme s statement of financial management principles 13. 12 A Province of Canada. 13 This would be broadly equivalent to a statement of funding principles for a Defined Benefit Scheme, but adjusted to reflect the nature of the Defined Ambition Scheme. 11

6.4 For the avoidance of doubt, Section 222(5) of the Pensions Act 2004 shall not apply. Note: Section 222(5) says: (5) Any provision of the scheme rules that limits the amount of the scheme s liabilities by reference to the value of its assets shall be disregarded Comment: The essence of a Defined Ambition Scheme is that it can never have a deficit. 6.5 The statement of financial management principles will cover the criteria applied by the Trustees when they review the target benefits, including: a. the required likelihood or if applicable the minimum and maximum likelihood and the period over which that likelihood is assessed, of asset returns being sufficient to deliver the target benefits, b. the required likelihood or if applicable the minimum and maximum likelihood and the period over which that likelihood is assessed, of asset returns being insufficient to deliver the current benefits and hence cuts to benefits would be required, and c. the approach to be adopted where adjustments are made to target benefits which might include allowing the likelihood of provision of the target benefits to vary within a specified range; adjustment of the target future revaluation and increases; adjustment of the current target benefit and the interaction between these. 6.6 The Trustees may from time to time review the above principles subject to consultation with the Pensions Regulator, notification to the members of the scheme and consultation with any participating employers 6.7 The statement of financial management principles would not be expected to contain the detail of the actuarial methods and assumptions to be used for the review of target benefits. Or if it does, these will be contained in a separate annex which can be reviewed and amended by the Trustees on actuarial advice without the need to consult members or participating employers 6.8 Actuarial assessment of Defined Ambition Schemes shall be annually (and may be more frequent than annually if the trustee considers this to be appropriate in the light of market movements or otherwise). Note 1: The time limits for completing the valuation of a Defined Ambition Scheme would be shortened to, say, no more than 3 months from the valuation date. 14 Note 2: As these are new benefit designs, the administration arrangements and valuation arrangements should all be established so that, reflecting modern systems and processes, this information can be provided in more or less real time. 6.9 The assumptions to be used for each actuarial assessment shall be decided by the Trustees based on advice from the scheme actuary. The assumptions may be as to the distribution of 14 Thought will be required as to the interaction with the time limit for obtaining audited accounts for an occupational pension scheme See Regulation 2 of the Occupational Pension Schemes (Requirements to Obtain Audited Accounts and a Statement from the Auditor) Regulations 1996. The adjustment to target benefits, to the terms on which benefit is purchased, and to transfer values, all need to be much closer to real time than would be implied by waiting for audited accounts on a 7 month timescale. There would seem to be no block to accelerating the audit requirements for Defined Ambition Schemes. 12

future outcomes (for example the mean and uncertainty as to future investment returns) or may be (as for defined benefit schemes) prudent deterministic (single point) assumptions (chosen to reflect the required degree of confidence). 6.10 Based on these assumptions, the scheme actuary will: a. project forward the assets and the target benefits and assess the probabilities that the assets will remain sufficient to provide the target benefits and whether cuts will be required to current benefits, or b. compare the asset value with the net present value of target benefits and where appropriate will assess the impact of amending the (rate of increase of and/or the current amount of) target benefits. 6.11 Based on the actuarial assessment, the Trustees must decide the adjustment if any to the anticipated rate of increases to target benefits and/or to the current amount of target benefits for each member in accordance with the Statement of Funding Principles. 6.12 The scheme actuary must certify that the decision made by the Trustees in relation to target benefits each year following the actuarial assessment meets the criteria set out in the Statement of Funding Principles on the basis of the assumptions used for that year s actuarial assessment. 7. PUBLICATION OF LEVEL OF TARGET (NON GUARANTEED) BENEFITS AND VALUATION ASSUMPTIONS USED TO DETERMINE THE LEVEL OF TARGET (NON GUARANTEED) BENEFITS 7.1 A Defined Ambition Scheme will be required to make available, on a public website, the initial valuation report at inception of the scheme and each subsequent valuation report as to: a. the target (non guaranteed) benefits level, b. the valuation assumptions, c. the contribution rates to be paid with the aim of providing those target (non guaranteed) level of benefits, and d. where there is a central initially fixed anchor point confidence level for delivery of the target (non guaranteed) benefits (and a specified reasonable bandwidth around that anchor point confidence level), that information (together with any variation in the actual assumed confidence level within the permitted bandwidth around the central anchor point confidence level). 7.2 The Defined Ambition Scheme shall also publish on the same website: a. the full details of the methodology used to adjust the non guaranteed target level of benefits (including illustrated worked examples) where a valuation of a Defined Ambition Schemes shows that the previous target (non guaranteed) level of benefits as at the valuation date is greater than or less than the amount of the assets of the Defined Ambition Scheme as at that valuation date, 13

b. quarterly investment performance updates, and c. any other information that may from time to time be determined by the Pensions Regulator to provide transparency and to prevent gaming of the system see 22 below. 7.3 Transparency should provide both reassurance to members and also assist in reducing the risk of over optimistic assumptions being chosen to prevent target (non guaranteed) target benefit levels being reduced. 7.4 However, it is to be noted that transparency can also lead to herding so that in optimistic times assumptions are set with insufficient caution and in pessimistic times assumptions are set with insufficient optimism. 7.5 So it is also necessary to see whether there is scope for a counter cyclicality control mechanism recognising the long term nature of pension provision with time horizons well in excess of 20 years. 8. LUMP SUM DEATH BENEFITS 8.1 These may be provided in a defined benefit form to the extent that they are payable if and to the extent that the amount in question has been insured with an insurance company and the insurance company pays the amount in question to the trustee of the Defined Ambition Scheme for the benefit of the survivors of the deceased member. 8.2 See, for example, Regulation 2 of the Occupational and Personal Pension Schemes (Miscellaneous Amendment) Regulations 1997, which says that any reference in Part 1 of the Pensions Act 1995 to a money purchase scheme includes a scheme which provides money purchase benefits and death benefits. 8.3 See also the Occupational Pension Schemes (Scheme Funding) Regulations, Regulation 17(1) (j) which provides an exemption from Part 3 of the Pensions Act 2004 where: the only benefits provided for (other than money purchase benefits) are death benefits, if the death benefits are secured by insurance policies or annuity contracts. 8.4 As a matter of benefit design, the Defined Ambition Scheme might provide a survivor s lump sum death benefit equal to the member s transfer value as an alternative to providing a surviving spouse/civil partner/dependant pension (but with timing of the calculation and, if necessary, conversion to a cash lump sum pending distribution, being determined by reference to the transfer window referred to in 9.2 and 10.5 below). 9. TRANSFERS IN 9.1 Given that these will be occupational schemes (albeit perhaps industry wide rather than tied to a single corporate group), a Defined Ambition Scheme would not market itself to accept transfers in from anyone who is not employed by a sponsoring employer in the scheme. 9.2 Furthermore, no member may make a transfer into a Defined Ambition Scheme except during a one month annual transfer in window unless otherwise determined by the Trustee. 9.3 The transfer window would open after the annual valuation of the scheme had taken place. Transfer credits would be granted by reference to the 14

level of target (non guaranteed) benefits of the scheme immediately following that valuation (but subject to any necessary market related adjustments to the valuation assumptions (e.g. the discount rate)). 9.4 In other words, immediately after the grant of the transfer credit there is neither a funding strain nor a funding surplus. 10. TRANSFERS OUT 10.1 A member of a Defined Ambition Scheme would only be able to have a statutory right to transfer out in the following circumstances: a. within 12 months of employment with the scheme employer ending; b. at the time the member elects that his pension should come into payment; Note: This would, be under the Finance Act 2004, no earlier than age 55 unless the member would qualify to draw a pension on grounds of ill health 15 under the Finance Act 2004. c. once the member s target benefit has come into payment, the member would have an opportunity to transfer out once every five years. Note: This restriction is for further discussion as it is a halfway house between: i. income drawdown from a money purchase scheme; and ii. the provision of a pension from a defined benefit scheme or the purchase of an annuity from an insurance company. However, the cost of this particular option would need to be evaluated (as well as its impact on the financial stability of the scheme). 10.2 The purpose of this restriction is to allow for the Defined Ambition Scheme to be able to invest for the longer term and to invest in illiquid investments (e.g. certain types of infrastructure investments) without the scheme being a forced seller to create liquidity. 10.3 The valuation assumptions for calculating the transfer value would be those derived from the most recent valuation of the scheme updated for changes in market conditions. 10.4 Immediately following the payment of transfer value there should be neither a funding strain or a funding surplus as a result of the transfer value having been paid. 10.5 If the pot follows member requirements are to apply to a Defined Ambition Scheme (for small pots ), then this would be done within 12 months of employment with the scheme employer ending (see 10.1(a) above) but within the annual transfer window. Transfers out would only take place within the annual transfer window referred to in 9.2 above so, the timings referred to in 10.1(a), (b) and (c) would be modified to fit within the annual transfer window. 15 See Finance Act 2004, Schedule 28, paragraph 1. 15

11. OPEN MARKET OPTION WHEN BENEFITS COME INTO PAYMENT 11.1 Before a member s benefits at retirement come into payment from a Defined Ambition Scheme, the member would have an open market option in the sense of being able to: a. transfer his benefits to another registered pension scheme, or b. to purchase an annuity from an insurance company with his available transfer value, or c. to elect for income drawdown: i. from the Defined Ambition Scheme by electing to transfer to the income drawdown section of the Defined Ambition Scheme (but only if the Defined Ambition Scheme offered that option), or ii. from another registered pension scheme willing to accept the transfer (e.g. a personal pension scheme) and offering that option. Note: If the member can elect for a transfer under 10.1(c) every five years after his target (non guaranteed) benefit has come into payment, unless the member had any particular needs (for example to purchase a Lamborghini), the member may well prefer to stick with the relative certainty of the target (non guaranteed) benefit from the Defined Ambition Scheme. 11.2 The Financial Conduct Authority Rules relating to financial advice by financial advisers advising on transfers from defined benefit schemes would apply equally to financial advisers giving advice on transfers from Defined Ambition Schemes. 12. NO GUARANTEED PENSION INCREASES 12.1 It follows from the inherent legal nature of the Defined Ambition Scheme that no increases to benefits in payment from the scheme would be guaranteed. 12.2 Accordingly, Sections 51 54 of the Pensions Act 1995 will not apply. 13. REVALUATION OF DEFERRED PENSIONS 13.1 The provisions of Sections 83 86 of the Pensions Act 1993 (Revaluation of benefits) would be modified so that no guaranteed revaluation was required to be applied to any benefits from a Defined Ambition Scheme. 13.2 Instead, an appropriately modified version of the money purchase method set out in Schedule 3 of the Pensions Act 1993 would apply which would broadly require the level of increase for the deferred member s level of target benefits to be determined in the same way as the level of the increase for a comparator active member s benefits (while recognising that different increases may apply to benefits purchased for different years of membership). 14. DISAPPLICATION OF PROVISIONS APPLYING TO DEFINED BENEFIT SCHEMES 14.1 Unless specifically applied, no pensions legislation currently applying to occupational pension schemes which are not Money Purchase Schemes would apply to Defined Ambition Schemes. 16

14.2 This would, accordingly, disapply, among other things: a. Section 75 of the Pensions Act 1995 (Employer Debt), and b. the moral hazard provisions in Sections 38 to 58 of the Pensions Act 2004. In other words, no power for the Pensions Regulator to issue contribution notices or financial support directions in relation to a Defined Ambition Scheme. 14.3 Section 38 (Contribution notices where avoidance of employer debt) of the Pensions Act 2004 says: this section applies in relation to an occupational pension scheme other than (a) (b) a money purchase scheme, or a prescribed scheme or a scheme of a prescribed description. Note: The references in the primary legislation to Money Purchase Schemes would be expanded to include Defined Ambition Schemes. 14.4 Section 43 has the same exclusion in relation to the Pensions Regulator s power to issue financial support directions. 14.5 The disapplication of the legislation applying to Defined Benefit Schemes from applying to Defined Ambition Schemes would be included in primary legislation which is not capable of being modified via a regulation making power to bring Defined Ambition Schemes back in scope as Defined Benefit Schemes via the back door. 14.6 Unless specifically disapplied or modified, all legislation applying to Money Purchase Schemes applies to Defined Ambition Schemes. 15. MULTI EMPLOYER SCHEMES The same provisions that apply to multi employer Money Purchase Schemes in existing pensions legislation shall apply to multi employer Defined Ambition Schemes where these relate to the process of obtaining employer consents or agreements. Note 1: This allows for, for example, the process of consultation in relation to a statement of investment principles for a multi employer Money Purchase Scheme to be conducted in the same way in relation to a statement of investment principles for a multi employer Defined Ambition Scheme. Note 2: See for example Regulation 3 of the Occupational Pension Schemes (Investment) Regulations 2005 which deals with the way in which the consultation requirements in relation to statement of investment principles are to apply to a scheme with more than one employer. 16. PENSION PROTECTION FUND 16.1 For Pension Protection Fund purposes a Defined Ambition Scheme is to be treated in the same way as a Money Purchase Scheme. 16.2 In summary, the Pension Protection Fund may make fraud compensation payments in respect of money purchase schemes (as more particularly detailed in Sections 182 to 189A of the Pensions Act 2004). These provisions would apply equally to a Defined Ambition Scheme. 16.3 It should also be noted under Regulation 10 of the Occupational Pension Schemes (Employer 17

Debt) Regulations 2005, an employer in relation to a Money Purchase Scheme has an additional liability in respect of paying a deficit levy (by way of general levy or fraud compensation levy where the amount of those levies exceeds the unallocated assets of the scheme). 16.4 Furthermore, in relation to a Money Purchase Scheme, the employer also has a liability to make up the deficit in a Money Purchase Scheme which arises because of certain criminal acts or omissions 16. 16.5 The same would apply to a Defined Ambition Scheme, but this would be hard coded into primary legislation and could not be varied by statutory instrument (to avoid the legal rules being changed except through primary legislation). 17. SUPERVISION BY THE PENSIONS REGULATOR 17.1 The Pensions Regulator shall supervise a Defined Ambition Scheme to the same extent as the Pensions Regulator supervises a Money Purchase Scheme but with the additional modifications provided for in 17.2 and 17.3 below. 17.2 The Pensions Regulator shall supervise the funding of the target (non guaranteed) benefits in a Defined Benefit Scheme in the same way as under Part 3 of the Pensions Act 2004 for a Defined Benefit Scheme (for funding/valuation) under current UK legislation, but with: 16 See Regulation 3 of the Occupational Pension Schemes (Fraud Compensation Payments and Miscellaneous Amendments) Regulations 2005, where the prescribed defence is any offence involving dishonesty (and for this purpose, dishonesty includes an intent to defraud). a. no power to impose a schedule of contributions or a recovery plan (as a Defined Ambition Scheme can never have a deficit, it never has need of a recovery plan and employer contributions are fixed by the Defined Ambition Scheme s rules), b. an express power in relation to the adjustment of the target (non guaranteed) level of benefits following a valuation, if the Pensions Regulator had proper grounds for overriding the trustee s determination (but without going outside of the parameters in the trust deed and rules) and c. the other modifications to Part 3 of the Pensions Act referred to in 6 above). 17.3 The Pensions Regulator will also have, as noted in 22.3 below, an anti gaming the system power. 18. AUTO ENROLMENT 18.1 A Defined Ambition Scheme will qualify as a qualifying scheme if the level of contributions to the scheme in respect of a member is at least equal to the level of contributions applicable to that member in a scheme which provides qualifying money purchase benefits for the purpose of the Pensions Act 2008. Note: The other requirements that apply to Money Purchase Scheme in order to become an automatic enrolment scheme would also apply, with the necessary changes to a Defined Ambition Scheme. 18.2 To draw out the point made in 18.1 above, it should be noted that this will require what may be expressed as a uniform employer contribution rate (e.g. 10% of pensionable pay) to be re expressed as an age related member specific 18

rate by reference to the target (non guaranteed) benefit which each member is to accrue. 18.3 An alternative approach would be for the Defined Ambition Scheme to qualify by meeting a modified version of the test scheme provided for under the Pensions Act 2008 in relation to contracted in Defined Benefit Schemes. 18.4 We note in this context that the Government has said that: The Government is keen to explore whether there are simpler ways to determine whether schemes which are not money purchase schemes (including defined ambition schemes) are good enough to be automatic enrolment qualifying schemes. 17 19. SECTION 67 OF THE PENSIONS ACT 1995 19.1 Section 67 of the Pensions Act 1995 shall be modified to the extent necessary to allow for the amount of the target (non guaranteed) level of benefits under a Defined Ambition Scheme to be adjusted in accordance with the trust deed and rules to be equal to the scheme s assets following a valuation. Note: If the Trust Deed of the Defined Ambition Scheme were drafted with sufficient automaticity, the benefits could be automatically modified without the need for a disapplication of Section 67. However, to avoid potentially excessively formulaic provisions of the trust deed and rules themselves becoming fossilised, an 17 See paragraph 165 of the Department for Work and Pension s paper: Technical Changes to Automatic Enrolment Government response to the consultation on draft regulations and other proposed changes (October 2013). additional degree of flexibility would sensibly be built. 19.2 No amendment may be made to the trust deed and rules of a Defined Ambition Scheme without the agreement of the trustees of the scheme and the employers in relation to the scheme. 19.3 No amendment may be made to the mechanism provided for in the trust deed and rules of the scheme for adjusting the level of target (non guaranteed) benefits except with the approval of the Pensions Regulator (or, in the alternative, an appropriate actuarial certificate). Note 1: This ties in with the requirement at 2.1(h) above. Note 2: See also, for example, Section 37 of the Pension Schemes Act 1993 dealing with the circumstances in which amendments may be made in relation to contracted out rights (and Regulation 42 of the Occupational Pension Schemes (Contracting out) Regulations 1996). 20. THE LEVEL OF TARGET (NON GUARANTEED) BENEFITS FROM A DEFINED AMBITION SCHEME IS NOT GUARANTEED 20.1 The primary legislation providing for Defined Ambition Schemes would include wording to the effect that a certificate issued by the Pensions Regulator under 2.1 above shall be conclusive that: a. the Defined Ambition Scheme does not provide any guarantee as to the given level of benefits, b. that no cover is provided against biometrics risks (but with a carve out for defined 19