On 29th March 2017, Theresa May gave formal notification of the UK’s intention to withdraw from the EU under Article 50 of the Lisbon Treaty.
In a new White Paper, the government emphasises its principal objective to ‘provide business, the public sector, and everybody in the UK with as much certainty as possible as we move through the [Brexit] process’.
This Let’s Talk considers the implications of Brexit on pensions and other employee benefits. It is based on a Parliament Briefing on Brexit and Pensions.
LEGAL & REGULATORY
From a legal perspective, nothing has changed as a result of the UK’s notification to withdraw from the UK.
The design of the UK pension system is largely the responsibility of the UK Parliament, and a myriad of Acts and Regulations have been passed to give effect to pension policy.
Legislation has also been enacted to implement EU provisions that impact on pensions and employee benefits; for example:
- establishing an internal market for funded occupational pension schemes and the minimum standards to protect scheme members;
- minimum guarantees concerning accrued rights in occupational pension schemes in case of the insolvency of the sponsoring employer; and
- anti-discrimination rules.
Despite encouragement for schemes to operate ‘cross-border’, in practice UK workplace pension schemes generally operate on a national basis. However, they access investment opportunities and service providers in the EU with a view to providing the best possible outcomes for the members and sponsors.
For the time being EU legislation continues to have an impact on pension schemes in the UK:
- directly, through pensions-specific EU legislation such as the Directive on Institutions for Occupational Retirement Provision (‘IORP Directive’), through the regulatory activities of EIOPA, and through EU employment law, such as the Equal Treatment Directive; and
- indirectly, because of the costs of complying with the EU’s investment markets legislation.
Against this backdrop, the initial legal and day-to-day operational implications of Britain leaving the EU are relatively minimal for UK pension schemes.
INVESTMENTS AND FUNDING
A DB scheme’s funding assumptions and investment strategy must be monitored in the light of changing economic conditions.
Also, trustees may need to reconsider their overall investment risk profile to ensure that it is maintained at appropriate levels and is sufficiently diversified to cope with market volatility as a result of Brexit uncertainty.
This is an issue at scheme/trustee level for DB arrangements. It is also relevant to individual members in DC schemes who are ultimately responsible for their own investment choices (although, in practice, the vast majority of DC members are in ‘default funds’ which should, themselves, be reviewed by schemes and providers as a consequence of Brexit).
There are other scheme specific considerations too such as the implications on any ‘hedging arrangements’.
Trustees of UK DB pension schemes are required, under scheme funding rules, to monitor the strength of the employer covenant. That means understanding:
- the current and prospective financial position of the employers supporting the scheme, including the scale of pension obligations compared with operating cash flow;
- the nature and health of the relevant industry sector and the employer or group’s position within that industry; and
- the position of the economy as a whole.
Trustees should also consider an analysis of the estimated outcome for the scheme in the event of an employer becoming insolvent.
Trustees need to be alert to this risk and, if necessary, seek assessments of the sponsor’s corporate risk analysis linked to a Brexit. The same would apply to any UK guarantor relevant to the scheme.
Information on the implications of Brexit across different industry sectors can be found on the Parliament website.
Trustees who consider their sponsor or guarantor to be at particular risk may seek additional security.
Both trustees and sponsors should also be aware of the circumstances in which any reporting or funding obligations under existing contingent assets could be triggered.
For DC arrangements, priorities include ensuring:
- the ongoing payment of contributions by employers; and
- the appropriateness of investment options available to members.
The Pensions Regulator has warned against “knee-jerk reactions” but said trustees should review their position to understand the risks in the scheme’s investment strategy and employer covenant.
ACTIONS FOR DB SCHEMES
In consultation with the employer, trustees should review their Integrated Risk Management (IRM) strategy. This could result in a revised statement of investment principles, or the need to review the investment strategy, an employer’s covenant or a contingent asset arrangement.
Trustees should also consider reviewing valuation discount rates, transfer value assumptions and cash commutation factors. This may be particularly relevant if de-risking exercises are being considered; e.g. pension increase exchange (PIE) or trivial commutation.
ACTIONS FOR DC SCHEMES
Trustees should review default investment fund strategies. This may also be an opportune time to remind members about their investment options and to refresh communications on the DC benefit flexibilities introduced in 2015. Consideration could be given to enhancing the information provided in benefit statements to include the new ‘freedom and choice’ options.
At this stage, a ‘watching brief’ is recommended.
Longer term, cessation of EU membership will affect freedom of movement which could change who can be actuary or auditor to a UK pension scheme.
Also, there will be implications for secondees from the EU to UK and vice versa in terms of preservation of State pension rights.
Payment of pensions overseas should not be affected as the UK already has double taxation agreements with all EU states which will subsist after we leave the EU.
Close attention needs to be paid to EU legislation due for implementation before 2019 as the UK approach to transposition may be more light touch, moving away from our traditional gold-plated policy.
And post 2019, there will eventually be a review of EU derived pensions law and what can be repealed. This is when it gets more interesting.
For further information on the issues discussed in this Let’s Talk, please get in touch with your usual JLT contact, or
John W. Wilson LLB(Hons) FPMI ACII, Head of Research| Email: firstname.lastname@example.org