Developments in Employee Benefits law and practice

07 December 2015

Week ending 6 Dec: OECD – Pensions at a glance 2015| Business leaders committed to pensions| Impact of new State pension & other stories

Pensions Act 2014 Amendments Order

This draft statutory instrument makes amendments to several Acts, consequential or supplementary to the new State pension for those reaching pensionable age on or after 6 April 2016. These changes come into effect on 6 April 2016.

The most significant change relates to the calculation of a State pension under the pre-2016 scheme for a widowed person who reached pensionable age before 6 April 2016 but whose deceased spouse or civil partner was in the new state pension.

The Social Security Contributions and Benefits Act 1992 (SSCBA 1992) is amended to, among other things, provide for the crediting of certain contributions in respect of periods of caring to be treated as if they were made before 6 April 2016 for the purposes of calculating the rate of transitional state pension.

The Social Security Administration Act 1992 is amended to remove two existing requirements to make legislation providing for revaluation, which are no longer needed. Other pieces of amended primary legislation include:

  • the Scotland Act 1998
  • the Social Security Contributions (Transfer of Functions, etc.) Act 1999
  • the Pensions Act 2008

State Pension and OPS Amendment Regulations

Under this draft statutory instrument, detailed features of the new State pension scheme are provided for, including how the pension increase earned through deferring is to be calculated and transitional arrangements for inheriting graduated retirement benefit. They also make amendments dealing with contracted-out occupational pensions schemes to provide for survivor benefits.

In more detail, further detailed requirements of the new State pension scheme are implemented including:

  • set out how the pensions increase earned through deferring the new State pensions is to be calculated where the rate of pension changes during the deferral period
  • contain the transitional arrangements for inheriting graduated retirement benefit where a person’s deceased spouse or civil partner reached State pension age or died before 6 April 2016
  • provide that a person who is an ‘overseas resident’ is not entitled to up-rating increases, including such increases that came into effect while the person was deferring their new State pension.

Amendments are also made relating to the abolition of contracting-out of the State additional pension for salary related pension schemes as a consequence of a defect in the Occupational Pension Schemes (Schemes that were Contracted-out) Regulations 2015, SI 2015/1452.

OECD – Pensions at a glance 2015

Pensions at Glance 2015 provides comparative indicators on the national pension systems of the 34 OECD countries, as well as for Argentina, Brazil, China, India, Indonesia, Russian Federation, Saudi Arabia and South Africa.

Key findings for the UK are:

  • The level of the current basic pension is low in comparison to the benefit level from mandatory schemes in most OECD countries. Average earners without a private pension have the third lowest replacement rate in the OECD, high earners the lowest and low earners are in the middle of the range.
  • Eligibility for the final year of full basic pension is around the OECD average, but at 16% of average earnings the current level of benefit is low in comparison to many countries, with the OECD average being equal to 20.5%. However, the value of the pension credit safety-net benefit is around the OECD average.
  • The introduction of the new state pension from April 2016 should increase the basic pension for the majority of future pensioners. Public pension expenditure as a share of GDP is forecast to increase from 7.7% to 8.4% over the next 50 years, under EU economic assumptions. Increasing the retirement age by 5 years by 2060 would almost fully offset this increase, unless productivity gains are low enough to make the triple-lock condition unaffordable.
  • Relatively long periods of unemployment or childcare as well as later entry into the labour market do not have an impact on future pensions from mandatory schemes, as only 35 years are required for the full new state pension. However, any voluntary (both occupational and personal) pensions, which are not included in the analysis, would be affected by contributing for shorter periods.
  • The United Kingdom is one of the few countries that still have different retirement ages for men and women with women retiring at 62 ½ years in 2014 compared to 65 for men, although the ages are converging to 65 by 2018. Future retirement ages will be amongst the highest in the OECD, reaching 67 by 2028 and being regularly reviewed thereafter to account for changes in life expectancy.

The OECD also comments on the April 2015 ‘freedom and choice reforms’:

It will be possible to withdraw the entire pot as a lump-sum of which 25% will still be tax-free. Policy makers will need to ensure that people fully understand that by not taking an annuity they will not be guaranteed a steady income flow in later life, as once the lump-sum has been spent it will no longer provide any financial security.

FCA consults on changes Compensation Sourcebook

The FCA has published a Consultation Paper that proposes some relatively minor changes to some of the rules in their Compensation sourcebook (COMP) that govern the operation of the Financial Services Compensation Scheme. They propose:

  • an increase in the non-investment (general and pure protection) insurance mediation compensation limit in relation to some types of insurance from 90% to 100%
  • changes to the eligibility of occupational pension schemes trustees to claim on the FSCS, and
  • changes to make express reference to how the compensation rules apply where a successor firm is in default or to assist the FSCS in handling claims.

Bullet 2 will be of interest to pension scheme trustees, as it proposes extending eligibility to claim on the FSCS to the trustees of money purchase occupational pension schemes with large employers so that members of these schemes are entitled to the same protection from the FSCS as members of schemes with small employers.

Business leaders committed to pensions

According to new research from the Confederation of British Industry (CB), business leaders remain committed to pensions - with 96% believing there is a strong business case for providing a pension – but there is clear concern about regulatory changes eroding the incentives that are left to save for retirement. Key findings are:

Business leaders want regulatory stability

  • Despite all the recent changes to the pensions framework, business leaders see pensions as a key employee benefit, with 96% believing there is a strong business case for providing a pension.
  • 67% of boardroom leaders believe they have an obligation to contribute to workplace pensions, increasing to 81% among SME respondents.
  • 52% of business leaders believe regulatory stability must now be the top pensions priority for government.
  • As part of achieving stability, business leaders are clear that they do not want to see more change in the pension taxation system, with 79% stating this should not be a priority for government.

Defined benefit costs remain a big issue

  • The cost of defined benefit (DB) schemes is weighing heavily on business activities, with 65% of business leaders reporting a negative impact on business investment, rising to over 80% for mid-sized firms.
  • Volatility of DB liabilities remains a particular challenge, with 90% of business leaders very concerned or concerned about volatile markets worsening their funding position.
  • This is also translating into company performance, with 82% of business leaders saying that DB costs are having an impact on their results in company accounts.
  • To manage the cost and risk associated with DB, 21% of businesses with DB pension schemes are closing them to existing members. This trend is being accelerated by the ending of contracting out.

Auto-enrolment

  • 97% of businesses with eligible employees are still due to stage, all of them small and micro employers that may struggle with the process.
  • 82% of respondents say they do not believe reviewing statutory minimum contribution levels should be a priority, rising to almost nine in ten SME respondents.
  • With all mid-sized businesses now in, the number of respondents that cite ease of administration as one of their top priorities when looking for an auto-enrolment solution has jumped to nearly 70%, up from 41% in 2013.
  • Overall the biggest auto-enrolment challenge for firms is on-going compliance, with 73% of respondents citing this as an issue.
  • The changing regulatory environment has added to the problems of compliance, which 65% of respondents cite as either very challenging or challenging.
  • Most employees are still not making the most of their employer’s contributions, with just 37% taking advantage of the highest available employer pension contribution rate.

Freedom and choice

  • 48% of business leaders say that the pension freedoms in the 2014 Budget have made DC pensions more effective in ensuring employees can afford to retire.
  • Businesses are taking steps to adapt their pension provisions to the new freedoms, including looking at additional propositions such as providing more guidance to members.
  • Asked about the most likely responses of employees on reaching age 55, 45% of pension specialists believe that the main action of their employees will be to take their tax-free lump sum.
  • Maximising employee engagement has now become the top pensions priority for leaders of businesses with DC pension schemes (cited by 29%), ahead of attracting and retaining talent (25%).

FCA update on pensions and retirement income

The FCA have published a pensions and retirement income update on their website.

As part of that update, they have announced that they now anticipate that the FCA will launch the Retirement Outcomes review in the second quarter of 2016.

By revising the timing of the review, the FCA will be able to sequence it effectively with other FCA work and wider initiatives, including the Financial Advice Market Review, ongoing consultation on changes to pension rules and guidance, data collection exercises and the Government’s next steps on exit charges and pension transfers. It will allow the FCA to use a longer data set for their review, providing them with a more robust picture of how the market is developing.

FCA infographic on pension freedoms

Impact of new State pension

A report detailing the impact the new State Pension will have on an individual's pension entitlement during its first 15 years has been published by the Department for Work and Pensions. Around three-quarters of people who reach State pension age under the new system will have a notionally higher state pension than under the old system. The report shows:

  • the average notionally higher or notionally lower State Pension amount under the new State Pension system;
  • the possible reasons why an individual’s outcomes might look different than under the current system.

This report aims to clarify the effects of the new State Pension, allowing stakeholders to clearly see implications broken down by year and gender.

Key findings are:

  • In the first 15 years of the new State Pension system, around three-quarters of people who reach state pension age under the new system will have a notionally higher state pension than under the old system.
  • When compared to males, a greater proportion of women than men will have a notionally higher outcome under the new system – just over 75% of females, compared to just over 70% of males.
  • Because contributions under the current system will be recognised in the new State Pension system, subject to the minimum qualifying period, at the point of implementation nobody will have an amount that is lower than the pension they could have become entitled to based on their own pre-implementation contributions under the current system’s rules.

DWP guidance on Contracted-Out Pension Equivalent (COPE) amount

From November 2015, the Department for Work and Pensions (DWP) is including a Contracted-out Pension Equivalent (COPE) amount on State Pension statements. The DWP has therefore published a new fact sheet which explains more about COPE and why it is being included in State Pension information.

Under the current State Pension system people with sufficient NI qualifying years can get the basic State Pension and also build up entitlement to the Additional State Pension (S2P or SERPS). Many people have been contracted-out of the Additional State Pension.

For those who reach State Pension age after 5 April 2016, the new State Pension replaces both the basic and the Additional State Pension.

If a person was contracted-out of the Additional State Pension they either paid lower NI contributions or some of their NI was instead paid into their workplace or personal pension. So to take into account that they have paid less into the NI system, the amount of State Pension they will get will be lower than that received by people with similar earnings who were not contracted-out.

However, in most cases, the pension a person will get from their workplace or personal pension(s) should include an amount that will be equivalent to the additional State Pension they would have got if they had not been contracted-out. This is known as the Contracted-out Pension Equivalent (COPE) amount.

From November 2015, the DWP is including an estimated COPE amount on State Pension statements to help people realise that they opted out of some of their State Pension when they were contracted-out. This should help them understand why they may not be entitled to the full amount of new State Pension if they have been contracted-out.

The DWP has now published a fact sheet entitled 'Introducing the Contracted-out Pension Equivalent (COPE) amount', which explains more about COPE and why it is being included in State Pension information.

Latest TPR/PPF Purple Book published

The tenth edition of The Purple Book, which provides comprehensive data and analysis on the defined benefit (DB) pensions' landscape, has been published by The Pension Protection Fund and The Pensions Regulator. It shows that over the last 10 years the percentage of DB schemes open to new members fell from 43% in 2006 to 13% in 2015, whilst schemes continued to de-risk through asset allocation changes. 2015 Highlights from the Purple Book are:

  • The number of active membership (people who are in pensionable service under an occupational scheme), fell by 3 per cent in 2015, to 1.75 million.
  • Schemes with 2 to 99 members were the least likely group to be closed to new members. The largest schemes have the largest proportion of schemes where members can still accrue benefits.
  • 13% of schemes are open to new members. A further 51% continue to accrue benefits for existing members.
  • Active memberships fell by 3.4% from 2014, the smallest drop in active members recorded in the Purple Book. The number of active memberships is around half of those found in the expanded Purple 2006 dataset.
  • Between end-March 2015 and end-September 2015, scheme funding has deteriorated by a further 1.5 percentage points, mainly reflecting the impact of lower equity markets and gilt prices on assets which more than offset the impact of higher gilt yields on liabilities.
  • The aggregate s179 funding position of the schemes in the Purple 2015 dataset as at 31 March 2015 was a deficit of £244.2 billion. This is the largest s179 deficit at an end March date since the establishment of the PPF (although the funding ratio was lower in 2009 and 2012).
  • The s179 funding ratio for 2015 is 84 per cent. Total liabilities have increased from £1,176.8 billion in 2014 to £1,542.5 billion this year. Total assets have increased from £1,137.5 billion to £1,298.3 billion.
  • The data in the Purple Book is at 31 March 2015, so it is the first set of data published since the freedoms were announced but predates the launch of the freedoms in April 2015.

10 year Highlights from the Purple Book include:

  • Between 2006 and 2015, the equity share of total assets fell from 61.1 per cent to 33 per cent, the gilt and fixed interest share rose from 28.3 per cent to 47.7 per cent, and the ‘other investments’ share of total assets  rose from 10.6 per cent to 19.3 per cent. The UK quoted share of total equities has almost halved. The hedge fund share rose from 1.5 per cent in 2009, the first year the data was collected, to 6.1 per cent in 2015. The cash and property shares also rose as did the residual “other” category which included hedge funds before 2009.
  • Between 2008 and 2015, the UK-quoted share of total equity holdings fell from 48 per cent to 25.6 per cent, while the overseas-quoted equity share rose from 51.6 per cent to 65.4 per cent.
  • ONS data suggests that employers made special contributions to DB pension schemes of over £120 billion between the first quarter of 2006 to the second quarter of 2015.
  • The value of risk transfer deals – buy-outs, buy-ins and longevity swaps - since 2006 sums up to £105 billion. Just under half of the deals were longevity swaps.

Public Service Pension Scheme administration guidance

This paper, from the Government Actuary’s Department, outlines how risks within local government pensions can be mitigated and how Audit Committees can be used to ensure proper governance.

The briefing paper outlines a series of risks to good governance of the schemes, including:

  • record keeping
  • how departments secure funding to finance the pension benefits being earned by employees
  • correct accounting procedures
  • management of future legislative and systemic changes to mitigate risk
  • correct management of suppliers
  • management of reputation

The briefing paper also outlines a series of examples of adverse outcomes and mitigations to avoid recurrence. In addition it provides a checklist to assess whether the audit and risk assurance committees can fulfil their role as oversight bodied.

Discussion paper on ‘robo-advice’

The Joint Committee of the European Supervisory Authorities have carried out an assessment of the potential benefits and risks of increased automation in the field of financial advice. Potential benefits include:

  • lower costs,
  • higher consistency of advice, and
  • a larger number of customers being reached.

Potential risks are increased vulnerability to IT failures and the inability of consumers to talk to a human advisor who can guide them through the process and provide clarifications.

Contact:

John W. Wilson LLB(Hons) FPMI ACII, Head of Research| Email: john_wilson@jltgroup.com

Julian Rowe, Head of Technical | Email: julian_rowe@jltgroup.com