Pensions Newsletter Autumn 2009
Welcome to the Autumn 2009 Pensions Newsletter.
Inside this issue:
Corporate Activity – Staying Clear of the Pensions Regulator
In the current economic climate many companies will have no option but to consider some form of corporate re-arrangement or restructuring to realign their business. For any employer associated with a defined benefit/final salary pension scheme, before commencing with any activity it is important to consider how this will impact on the pension scheme, and more drastically whether the action could result in the Pensions Regulator using its anti-avoidance powers to issue a Contribution Notice (“CN”) or Financial Support Direction (“FSD”) to a party.
This article will outline considerations from the employer company’s perspective when contemplating a disposal or restructuring and the clearance procedure, particularly in light of the Pensions Regulator’s new code of practice in relation to the ‘material detriment test’.
Clearance
Since the Pensions Regulator was created in 2005, all companies operating a UK defined benefit scheme will have (or should have) checked before carrying out any corporate transaction to see if ‘clearance’ should be sought from the Regulator. Clearance is the term used to describe the voluntary process of obtaining a clearance statement from the Regulator which gives assurance that the Regulator will not use its anti-avoidance powers in relation to a particular scheme and a particular event.
Many events could be detrimental to the ability of a pension scheme to meet its liabilities. The Regulator, in keeping with its commitment to operate in a risk-based and proportionate manner, expects clearance to be sought only in relation to so-called ‘Type A Events’.
To assess whether an employer-related event, such as a change in group structure, is a Type A Event, the employer and trustees should:
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Compare the employer covenant before and after the event;
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Assess whether any weakening in the employer covenant is such that the event could be considered materially detrimental to the ability of the scheme to meet its liabilities; and
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Identify whether the scheme has a relevant deficit (which is usually the highest of its deficits according to the different deficit bases).
Employer-related Events
Scheme employers should be continuously aware of actions that might or could potentially be Type A Events. Some examples of employer-related events would be:
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A change in the level or ranking of security given to creditors;
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A return of capital or other reduction in the assets of the employer or employer group such as unusual dividend payments, share buy backs, de-mergers etc.;
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A change in group structure, including a change in control or a change to a parent or ultimate holding company;
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The granting or repayment of inter-company loans, particularly where not on ‘arms-length’ terms or where there is a credit risk;
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A business or asset sale, particularly where not on ‘arms-length’ terms or where the whole or a substantial part of the operating business is sold; or
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An event that would reduce sustainable cash flow cover for the wider employer group’s funding commitment to the scheme, such as an increase or reallocation of debt.
In the case where an employer identifies an employer-related event and, together with the trustees, believes that this constitutes a Type A Event, then they should consider and agree an appropriate form of mitigation. This may take the form of additional contributions, new security, guarantees or letters of credit or negative pledges.
Applying for Clearance
Once a Type A Event has been identified and mitigation considered and agreed, an application may be made by any of those parties that could be subject to a CN or FSD for a clearance statement. This could include the employer and someone associated with or connected to the employer. For example, a purchaser of part of the business of the employer who does not wish to take on any liability in relation to the pension scheme may wish to apply for a clearance statement in respect of the transaction. This would be worth considering as the purchaser could potentially be issued a CN or FSD requiring financial support to be put in place in relation to the scheme.
Material Detriment Test
The Pensions Regulator may issue a CN in a number of circumstances set out in legislation. One of these circumstances is when an act or failure to act meets the ‘material detriment test’. This test will be met if the Regulator is of the opinion that the act or failure has detrimentally affected in a material way the likelihood of accrued scheme benefits being received. How this is to be interpreted is set out in a new code of practice which is now in force.
The revised code lists circumstances where the Regulator may issue a CN under the material detriment test. One circumstance that has not been changed, despite much opposition to it from the pensions industry, is the ‘business model’ situation which could potentially catch out normal scheme transactions:-
‘a business model or the operation of the occupational pension scheme which creates from the scheme, or which is designed to do so, a financial benefit for:
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the employer; or
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some other person,
where proper account has not been taken of the interests of the scheme members, including where risks to members are increased.’
The Regulator must act reasonably in deciding to issue a CN. There is a ‘statutory defence’ to a CN which is that it was reasonable for the person to have concluded that the act or failure would not have a ‘materially detrimental effect’ on the likelihood of accrued scheme benefits being received.
Concerns for Employers
The Regulator will have the retrospective power to issue CNs under the new test in relation to acts or failures that occurred on or after 14 April 2008. Employers should also be aware that CNs can be issued against a wide range of persons involved or associated with the act or failure in question, including individuals such as company directors.
When contemplating any corporate activity, employers need to be mindful of the risk of a CN being made in relation to the pension scheme, and what can be done to manage or mitigate this risk. Remember that even events of a parent or holding company which itself is not directly linked to the pension scheme could constitute Type A Events. Clearance won’t be appropriate in every case as obviously there are time and cost issues to consider, however all factors taken into account and eventual decisions in relation to the action as a whole should be recorded as this information could form the basis of a statutory defence to the imposition of a CN.
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Upper Earnings Limit or Upper Accrual Point?
With effect from 6 April 2009, the upper earning limit (“UEL”) (currently £43,888) was replaced with the new “upper accrual point” (“UAP”) (currently £40,040) which is the new threshold for the calculation of both State Second Pension (“S2P”) and contracted-out rebates.
The band of earnings on which the rebate is calculated remains in line with the band of earnings on which S2P accrues. That is, from April 2009, the rebate is paid on earnings between the Lower Earnings Limit and the Upper Accrual Point.
This change will be of relevance to those schemes whose governing documentation specifically refers to the UEL in which case appropriate amendment may be appropriate.
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Anti-forestalling Provisions – Bad News for High Earners
The Chancellor announced that from April 2011 tax relief on pension contributions for those earning more than £150,000 will be restricted. The tax relief available will taper down from the current higher rate (which by 2011 will be 50%) to the basic rate of 20% for those earning over £180,000. The Government is in consultation on the details of this tax change, however it has announced immediate measures to prevent high earners from maximising their tax relief before the taper comes in – these have been dubbed the Anti-forestalling provisions.
This legislation affects individuals with an annual income of £150,000 or more in the tax years from 2007-08 onwards. The measures will apply if, on or after 22 April 2009, there is an increase in contributions (including employer contributions) or in the way benefits accrue, and the resulting additional amount exceeds £20,000 in that tax year. If so, there will be a Special Annual Allowance charge on the amount which exceeds £20,000 which will effectively limit the relief to basic rate. The charge will not apply to 'normal, regular ongoing pension savings' – individuals will want to take advice and be confident about this point if relying on it if they want to avoid an unexpected tax charge.
The government has at the last minute modified the Special Annual Allowance to make the rules less unfair to the self-employed. A new provision allows for an increased Special Annual Allowance of up to £30,000 in certain circumstances where contributions have been paid less frequently than on a quarterly basis, as may often be the case for self-employed individuals.
The Anti-forestalling provisions are complex and HMRC’s guidance already runs to several hundred pages. Contrary to the Government’s policy objective of simplifying pensions, these new measures will present trustees and pensions professionals with a further layer of complicated regulation. Although the provisions apply equally to defined benefit (DB) and defined contribution schemes, it is in the area of DB pension provision that the measures will be most difficult to apply, as they will require a method of valuing a member’s DB benefits at several points in time to gauge whether the Anti-forestalling provisions will come into play. This has the potential to be time-consuming and costly for scheme administrators. At a time when the number of open private sector DB schemes continues to plummet (from 17,900 in 2000 to 2,240 in 2007, according to ONS occupational pension schemes surveys), a further barrage of legislation and administration is far from welcome.
The changes to tax relief for high earners is a further disincentive to saving for retirement through a pension, particularly taken together with paying tax on employer contributions. From the employer’s perspective the increased regulatory and tax burden will likely make DB pension provision even less attractive.
Trustees and administrators would be advised to consider how they intend to respond to member queries on the Anti-forestalling provisions, and in particular whether their scheme rules permit Contribution Refund Lump Sums, and if so whether they wish to allow them. Employers should pay careful attention to the Anti-forestalling measures in formulating effective executive pay packages. Under the new measures, an increase in existing pension benefits such as a termination bonus could trigger a Special Annual Allowance charge.
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Foster Wheeler Appeal
On the issue of equalisation, the Foster Wheeler appeal was decided recently. At first instance, the court had held that in order to comply with EU law, scheme members with benefits accrued by reference to more than one normal retirement date (“NRD”) were entitled to take all their pension at the lower NRD which was 60. As the scheme’s early retirement rules made no reference to benefits that had accrued by reference to an NRD of 65 being reduced on retirement at age 60, this construction could have left the scheme with substantial additional liabilities.
At appeal, the court decided that the appropriate solution would depend on the circumstances of the scheme in question, but that a number of ‘guiding principles’ should be applied. The appropriate solution for this scheme was for the part of an affected member’s pension that had accrued by reference to an NRD of 65 to be treated in accordance with a rule of the scheme which allowed for a reduced deferred pension in respect of benefits with an NRD of 65.
The Foster Wheeler case shows the potentially drastic effects of failing to effectively eliminate unlawful sex discrimination. Although the appeal decision will come as a relief to many employers, employers and trustees would be well advised to have their schemes reviewed if they have not already done so to ensure that any amendment relied upon has been effected correctly.
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Review of Default Retirement Age
The Government announced that it will bring forward its review of the default retirement age to 2010 to decide if this is still appropriate and necessary. The Government is keen to give people flexibility to choose whether to work for longer. The current default retirement age of 65 is operated by many employers, although there is a statutory right for individuals to request postponement of retirement beyond such age.
This is in the context of the Heyday case which was back in UK courts, in which Age Concern claimed that it was age discriminatory under EU law to allow employers to force employees to retire at 65. Earlier this year the ECJ decided that such a provision was not contrary to EU law if it can be justified in the context of UK employment policy and the way in which it is achieved is not disproportionate. That position was confirmed by the English High Court last month, in holding that the default retirement age of 65 is lawfull. However, the judgement referred to the review that the Government has brought forward. Mr Justice Blake commenting that "I cannot presently see how 65 could remain as a (default retirement age) after the review". Watch this space!
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The information contained in these articles is given for general information only, reflects the current law on the date of the article, and does not constitute legal advice on any specific matter
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