Occupational Pension Schemes (Collective Money Purchase Schemes) (Amendment) Regulations 2023
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Viscount Younger of Leckie
That the Grand Committee do consider the Occupational Pension Schemes (Collective Money Purchase Schemes) (Amendment) Regulations 2023.
The Parliamentary Under-Secretary of State, Department for Work and Pensions (Viscount Younger of Leckie) (Con)
My Lords, I am pleased to introduce this instrument. Subject to your Lordships’ approval, these regulations will make two small technical amendments to the landmark Occupational Pension Schemes (Collective Money Purchase Schemes) Regulations 2022 to ensure that they operate in accordance with our published policy. The instrument clarifies requirements on trustees of authorised collective money purchase schemes, more commonly known as collective defined contribution, or CDC, schemes.
I will first set out the context. The Pension Schemes Act 2021 provided the statutory framework for CDC schemes in the UK. The guiding principle of our approach has been to ensure that it protects the interests of members. The Government believe that CDC schemes have an integral role in the future of pensions in this country. CDC schemes offer members a seamless transition from saving to receiving a regular retirement income.
We know that many people do not want, or feel ill equipped, to make complex financial decisions at retirement. The Government want to ensure that as many savers as possible can take advantage of the numerous benefits of CDC. By pooling longevity and investment risk across the membership, CDC schemes can shield savers from much of the uncertainty faced by members of DC schemes. This also allows the scheme actively to target higher investment returns for their members than a DC scheme through increased investment in growth-seeking assets. This in turn can lead directly to greater investment in vital UK infrastructure and the technologies of the future, such as transport and renewable energy. That is why the Government have provided the legislative framework for single or connected employer CDC schemes to be set up in the UK. The CDC regulations came into force on 1 August 2022.
Throughout the development of our policy, the Government have been engaging with stakeholders on how best to deliver CDC schemes in the UK and inviting challenge and scrutiny. In that vein, we have been helpfully advised that two areas of the current framework do not meet our published policy intent. CDC schemes can succeed only if there is confidence in this new type of provision. That is why it is important that we provide immediate clarity. This instrument ensures that, from the start, prospective schemes are set up to work as we intend.
I will now take noble Lords into the detail of this instrument. With regards to the first amendment, the existing regulations make provision in relation to the annual actuarial valuation and benefit adjustment process for CDC schemes. This means that each year benefits are reviewed and adjusted where required so that the value of assets held is in balance with the projected costs of benefits. This protects members from the need to fund a surplus and means that reductions to benefits are not deferred and stored up. Doing so would have a detrimental impact on future years and younger members, which would be unfair. It is important that CDC schemes follow strict rules around benefit adjustment to ensure that all members, without bias or favour, are subject to the same adjustments.
It is important that a balance is maintained between the value of the available assets of the scheme and the amount needed to provide the target benefits to members on an ongoing basis. If, for example, the value of the assets is lower than the amount needed to pay the benefits, the scheme may be required to make a cut to benefits to regain that balance. Conversely, if the value of the assets is more than the amount needed to pay the benefits, the trustees will be required to pay an increase to the members.
The policy intention is to provide that, where a cut to benefits must be made, the trustees of the CDC scheme can smooth the impact of the cut on members over three years. This is called a multiannual reduction. Regulation 17 currently provides that, if a subsequent annual valuation that occurs during a multiannual reduction shows that an increase in benefits is required, the trustees, having taken advice from the scheme actuary, will be required to apply that increase in addition to the planned reduction for that year under the multiannual reduction that is in effect.
I appreciate that this is quite complex, so let me provide an example of how it is intended to work in practice. In a period of extreme economic downturn where equities fall significantly in value, it is possible that a CDC scheme would have to make a cut to members’ benefits. Regulation 17 enables the trustees of the scheme to mitigate the impact of this market volatility on member benefits by spreading the overall cut over three years. To use an easy example, if the overall cut necessary were 6%—my maths is not too good, but here we go—the members’ benefits could be cut by 2% a year over the three-year period.
This mechanism helps to reduce volatility and ensures that current and future benefits remain relatively stable. It contrasts with individual DC schemes, where there is no pension-smoothing mechanism. Members of these schemes would have experienced a significant reduction in the value of their retirement savings immediately, which for savers closer to retirement may be unrecoverable. The intention of Regulation 17 was that, where a market recovered during the period of such a reduction, increases in benefits resulting from subsequent annual valuation would offset, in whole or in part, planned cuts under a multiyear adjustment before being applied as an increase to future benefits in the normal way. This would have the benefit that any bounce-back immediately after a period of very poor performance could help to smooth outcomes and avoid cuts, which would then be unnecessary, while maintaining the principle that the costs of current and future benefits remain in balance with the value of scheme assets.
If we did not do this, the benefit of the recovery would instead be likely to go to future pensioners. This would run against our principle that, as far as possible, all members—current pensioners, those who are currently accruing benefits and those who are not contributing but have rights to a future pension from the scheme—should all share in upsides and downsides at the same time.
The instrument also makes a consequential change to Regulation 19. Any variation to a multiannual reduction as a result of offsetting an increase against must be reported to the Pensions Regulator, ensuring proper oversight.
I turn to the second of these amendments, which addresses an issue that may arise where a scheme winds up and the value of members’ accrued rights are transferred to suitable pension schemes or alternative payment arrangements. A key element of the wind-up process is calculating the share of the fund for each person who is a beneficiary at that time. The scheme rules may provide that the person may be a member or a successor of that member. Potential successors will be determined by the scheme rules, but could include a spouse, a child, a cohabitant or a person financially dependent on the deceased beneficiary. That share of the fund is applied to the scheme’s assets at the end of the winding-up to produce the beneficiary’s pot, which is then used to discharge the scheme’s obligations to the member by transfer to another scheme offering flexi-access income drawdown.
I ask noble Lords to imagine a scheme that has provided for these categories of people to be a beneficiary under its rules. If a member of that scheme dies during the winding-up process, their benefits are reallocated to the deceased’s stipulated beneficiary. They are not reallocated among the collective. The policy intention has always been that, if the beneficiary dies during the winding-up period, the pot allocated to them would not be extinguished but would instead be reallocated among their successors, where a scheme’s rules provide for that. This instrument therefore amends Schedule 6 to the regulations to ensure that the deceased member’s accrued rights in wind-up may be discharged in this way.
In conclusion, CDC schemes are an important addition to the UK pensions landscape and, when well designed and run, have the potential to provide a good retirement outcome for members. The effect of this instrument will be to provide clarity for schemes moving forward by more accurately reflecting the intent of the regulations that it is amending. I commend it to the Committee and beg to move.
Lord Palmer of Childs Hill (LD)
My Lords, I thank the noble Viscount for his clarification of the papers, which is very welcome—as usual. This is a statutory instrument with a more than usually snappy title, which will probably be more noted than some of the things in the instrument.
This statutory instrument is good news. It helps pave the way, as I understand it, for the introduction of the UK’s first collective defined contribution pension scheme, which I believe is by the Royal Mail. Collective defined contribution schemes in various forms are common in Scandinavia, the Netherlands and Canada. Work on these risk-pooling arrangements started during the coalition years when we, the Liberal Democrats, worked collaboratively with the Labour Front Bench and the Communication Workers Union to get the Royal Mail to implement the first scheme of this sort. I believe that it has not yet gone live, although perhaps the noble Viscount can tell me more about that.
The next developments of CDC, in my view, are, first, the extension of multi-employer or industry-wide CDC—when does the Minister expect to publish the next consultation on this?—and, secondly, the development of retirement-only or decumulation-only CDC schemes, so that a person could take his or her own pot and pool it with other people’s. Any comments on that would be gratefully received.
These regulations tidy up some issues that are causing practical problems. The main part is to do with what happens each year, as the noble Viscount said, when a scheme reviews whether it has enough money to meet its target pension payouts. As things stand, if the scheme is short, it can reduce planned pensions. But what happens if, a year later, it thinks that things are better? What these regulations appear to make clear is that the first thing you do is reduce or eliminate the planned pensions cuts. I think this was covered by the Minister’s comment about “a smoothing mechanism”.
One thing that comes out of this SI is that, as so often, there seems to be a lot more valuation work for actuaries. I am sure they will be very grateful. I am very grateful for the guidance in the papers and the elucidation from the Minister. I think the principles are right and we on these Benches agree with the instrument.
Viscount Younger of Leckie (Con)
My Lords, I thank all noble Lords for their helpful contributions to this short debate. Furthermore, I thank some noble Lords for the advance notice of their questions, particularly because this is quite a technical set of regulations, as I think we all understand. Given the incessant rain that we have been suffering over the past weeks, frankly, the drier the better—and that goes for this subject, too.
For an individual member of a CDC scheme, this instrument’s key effect will be to help to ensure that in a period of extreme economic downturn the principles of CDC continue to operate correctly. When, as expected, Royal Mail launches its CDC scheme later this year—I hope that this answers the questions from the noble Baroness, Lady Sherlock and the noble Lord, Lord Palmer—that member and their approximately 115,000 colleagues will be able to have more confidence that their new scheme will provide them with a regular income in retirement, with less exposure to the unexpected market shocks than might otherwise be the case. The noble Baroness, Lady Sherlock, raised a number of questions about the future of CDC schemes and Royal Mail, and I shall attempt to answer them in more detail later in my speech.
Noble Lords raised a number of questions about the multiannual reduction provisions, which I shall attempt to answer. First, the noble Baroness, Lady Sherlock, asked why the weakness in the current drafting was not identified before. It is important that all new legislation is monitored carefully to ensure that it works as we intended it to. It is through this monitoring process that we identified that the current drafting did not meet all of our published policy intention. If CDC schemes are to succeed, it is essential that prospective schemes are clear about those requirements. I hope that answers one of the questions from the noble Baroness.
The noble Baroness, Lady Sherlock, also asked whether approval from the Pensions Regulator was required or needed before any offsetting could be implemented. The decision to implement a multiannual reduction, including any offsetting, rests with the trustees of the scheme. It is based on the most recent actuarial valuation prepared by the scheme actuary and is subject to the scheme rules. Pre-approval is not required, but the Pensions Regulator will have ongoing scrutiny over such decisions in the normal way and the trustees are required to share the actuarial valuation with the regulator, again in the normal way.
The noble Baroness, Lady Sherlock, queried whether the trustees could be penalised if they failed to provide relevant information to the Pensions Regulator. As she may know, the standard civil penalties provided for in legislation, for example up to £5,000 in the case of an individual and up to £50,000 in any other case, can be imposed by the Pensions Regulator if the requirements are not met.
Both the noble Baroness, Lady Sherlock, and the noble Baroness, Lady Drake, asked whether offsetting following a bounce-back in investment performance could be applied retrospectively. Perhaps I can reassure them that it cannot be applied retrospectively because a key principle of this provision is that any bounce-back should smooth outcomes going forward and avoid the need for cuts, where possible, while ensuring that the costs of current and future benefits remain in balance with the value of the scheme’s assets. I think that chimes with some of my opening remarks, and I hope that it answers the question.
The noble Baroness, Lady Drake, asked whether an actuarial threshold was required before the full three years of a multiannual reduction could be deployed. I will answer that. There is no threshold, as it is for the trustees, who are independent and acting in the interests of the members, to decide whether to apply a multiannual reduction based on the information contained in the most recent annual valuation, which is prepared by the scheme actuary. A significant cut to benefits would likely be required only in extreme circumstances, but we would expect the trustees to utilise the multiannual reduction mechanism in this scenario, if it is provided for in the scheme rules. If they did not do this, they would need to explain their reasoning to the Pensions Regulator.
The noble Baronesses, Lady Sherlock and Lady Drake, and the noble Lord, Lord Palmer, all queried the policy intention of Regulation 3(5) and what implications it had for the front-ending or back-ending of the offsetting of the remaining planned reductions of the multiannual reduction. I would argue that this gets to the meat and granularity of the policy. The aim is to ensure that, while a degree of smoothing is allowed over a multiannual reduction, as we know, over three years, cuts are not stored up and deferred by backloading the cuts. That is why the legislation ensures that the reduction applied during each year of a multiannual reduction must not be greater than that applied in the previous year: that is very clear.
The noble Baroness, Lady Drake, asked how a transfer value would incorporate a scenario where the member transferred out before the multiannual reduction was completed or any potential offsetting was applied. Transfer values will be based on the conditions applicable at the time the member requested the transfer and when they actually transferred out of the scheme. Their transfer value will reflect any cuts planned for future years under a multiannual reduction. This means that nobody choosing to leave a CDC scheme will get more or less than the value of their benefits at that particular point.
I move on to the theme of wind-ups, which was raised by the noble Baronesses, Lady Drake and Lady Sherlock, who asked who qualifies as a successor and how you define one. I hope that I helped to answer that in my opening remarks, but perhaps I can go a bit further. Subject to scheme rules, this is an individual nominated by a dependant nominee or another successor to receive benefits following their death. Also, the scheme administrator can nominate a successor when, after that beneficiary’s death, there is no individual or charity nominated by that beneficiary.
I shall go a bit further on the question of transfers, which was raised by the noble Baroness, Lady Drake. The beneficiary has a number of discharge options they can choose from that are set out in the regulations. They include a flexi-access drawdown, which is where, subject to what the pension scheme rules allow, in any year the beneficiary can choose to take no payment of drawdown pension, a regular series of payments, an irregular payment stream or their whole flexi-access drawdown fund as a single payment. So there are a number of options there. Trustees must have completed the transfer process before the wind-up of the scheme can be completed. The value of the accrued rights to benefits transferred would be calculated based on the circumstances at the point of the transfer request.
The noble Baroness, Lady Drake, asked a number of questions about how the Royal Mail CDC scheme will operate. Royal Mail has informed us that it and its unions have agreed that the vast majority of existing employees with more than 12 months’ service will be enrolled into its collective plan at the so-called go live. It has also informed us that eligible new employees who join after go live will not be required to make an active decision unless they decide to opt out of contractual enrolment to the collective plan once they reach at least 12 months’ service with the employer. Which scheme Royal Mail chooses to use as a nursery scheme for its employees’ first 12 months of service is a decision for it and its union, as long as it meets the requirements of automatic enrolment.
The noble Baronesses, Lady Drake and Lady Sherlock, asked about the take-up of CDC in the UK. The Government are proud of the progress that we have made so far. During this Parliament, my officials worked closely with industry stakeholders to develop and bring into force legislation in 2021 to facilitate the introduction of single or connected employer CDC schemes. Over the past 12 months, the Government have announced a comprehensive package of pension reforms to provide better outcomes for savers and better support the UK economy. As part of that, we have been exploring the role that CDC can play in these reforms.
In answer to questions from the noble Lord, Lord Palmer, and the noble Baroness, Lady Drake, I am pleased to say that our consultation on CDC provision for unconnected multi-employer schemes and master trusts demonstrated significant appetite for it. A number of noble Lords mentioned timing; we intend to consult on regulations this spring.
The noble Lord, Lord Palmer, asked when we will extend the CDC provision to unconnected multi-employer schemes, including master trusts. We are committed to facilitating further CDC provision as quickly as possible, but we want to make sure that we get the legislation right to help ensure that the interests of members in these new schemes are generally protected. We engaged extensively with industry during the drafting process to ensure that this will be the case. As was mentioned earlier, we will consult on draft regulations to facilitate whole-life, multi-employer CDC schemes later this year. Subject to parliamentary approval, we intend for them to come into force in 2025.
The noble Lord asked what work is being done to legislate for decumulation-only CDC. The answer is the same: we are keen to facilitate access to CDC schemes where this would provide better outcomes for members, as long as we can ensure the necessary member protections. I come back to that important word, “protections”. Building on our work to develop a whole-life, multi-employer legislative framework, we are working closely with the pensions industry and regulators to explore what will be needed.
I thank all noble Lords for this fairly short but valuable and constructive debate. I also thank noble Lords for giving me their questions in advance. I see that the noble Baroness, Lady Drake, is itching to get up so I will give way.
Baroness Drake (Lab)
I did not want to get up too quickly. I do not want to hold up the closure of the debate on these regulations, but I was disconcerted by the Minister’s response on successors. Could he write to formally record what he said about that? For a trustee, a set of tax rules apply when the pension savings go into the estate and inheritance tax and a further set apply when the pension pot is handed over to a nominated beneficiary. Here we are talking about a second tier—a nominated successor to a nominated beneficiary. Trustees have to be very careful under which tax regime and to whom pension pots are being allocated. I struggled to follow what he said on that—because it is complicated, not because he did not explain it. I was thrown by the word “successor” when I read the regulations. It would be helpful if what he said could be written down, if we need to interrogate it further, rather than deal with it now.
Viscount Younger of Leckie (Con)
I quite accept what the noble Baroness has raised. She acknowledged that I gave out a lot of detail in defining what we think is right in terms of who would be a successor, cascading along the process if the successor had died and so on. However, if there is more to say—I hope that there might be—I shall write to the noble Baroness and copy in all noble Lords who have taken part in this debate. I thank her for her question.