Pensions Act 2011 (Consequential and Supplementary Provisions) Regulations 2014

Lord Kirkwood of Kirkhope Excerpts

Wednesday 9th July 2014 Grand Committee

My Lords, I am satisfied that these regulations are compatible with the European Convention on Human Rights. They make consequential and supplementary changes to primary legislation to support the clarified definition of money purchase benefits in Section 29 of the Pensions Act 2011.

A further, and more detailed set of regulations, The Pensions Act 2011 (Transitional, Consequential and Supplementary Provisions) Regulations 2014, deal with consequent changes to secondary legislation. These were laid before Parliament on 3 July 2014. Both sets of regulations will come into force at the same time as the clarified definition in Section 29 of the Pensions Act 2011.

The clarified definition of money purchase benefits will ensure that only benefits which cannot develop a deficit in funding can be money purchase benefits. Noble Lords may be familiar with the decision of the Supreme Court in 2011, in the case of Houldsworth and another v Bridge Trustees Ltd, that certain benefits which could develop funding deficits or surpluses could still fall within the definition of money purchase benefits.

While this decision concerned two specific types of benefit structure found in a particular scheme, it created widespread uncertainty in the pensions industry. That was because the decision could also be interpreted as covering other types of benefits and place these outside the protection of the regulatory framework for benefits that are not money purchase, even though they had the potential to develop funding deficits.

Section 29 of the Pension Act 2011, which has retrospective effect, and the supporting regulations remove that uncertainty. Where in the past decisions have been made by schemes that are in keeping with the clarified definition, the retrospective effect of Section 29 will ensure they remain valid, despite the fact that those decisions may be incompatible with the Supreme Court’s judgment. Where decisions have been made that are inconsistent with the clarified definition there is transitional provision in the regulations so that schemes will not need to unpick past decisions. Going forward, however, it is important that the trustees and managers of schemes know what action they need to take in respect of benefits they have previously treated as money purchase, but which do not meet the clarified definition. That will ensure that their members are protected.

In particular, these regulations amend Section 84 of the Pension Schemes Act 1993 to provide an alternative method for trustees or managers to revalue certain types of benefits known as cash balance benefits. The cash balance method allows the sum available for a cash balance benefit for a deferred member to be revalued by any method that is applied to the benefits of active members where it cannot be calculated by reference to the salary.

The regulations also include decisions made by the board of the Pension Protection Fund that relate to benefits affected by the clarified definition as matters that are reviewable under Schedule 9 to the Pensions Act 2004. That will ensure that during the transitional period, where the board has exercised discretion as to whether to treat benefits as money purchase benefits, that decision can be challenged and subject to a formal review process.

The Government have worked closely with the pensions industry to identify the type and number of schemes that will be affected by the clarified definition of money purchase benefits. The majority of schemes will be hybrid schemes—that is, they will contain a mixture of money purchase and non-money purchase benefits. Hybrid schemes make up about 2% of the estimated 40,000 private occupational schemes in the UK which include money purchase benefits—that is, approximately 800 schemes.

I commend the Pensions Act 2011 (Consequential and Supplementary Provisions) Regulations 2014 to the Grand Committee and ask its approval to implement them.

[Lord Kirkwood of Kirkhope (LD)]

My Lords, I am pleased to have the opportunity to contribute to this technical debate. I declare an interest as chairman of the defined benefit superannuation scheme of the General Medical Council, so unfortunately I know nothing about money purchase schemes. I did try, honestly—I took home the 36-page judgment of the noble and learned Lord, Lord Walker, and read it carefully until Germany scored the second goal. I still do not understand the noble and learned Lord’s reasoning, but I am sure that it is sound.

I hope that the Minister can help me. I understand that we are dealing with two sets of statutory instruments. The department deserves credit for taking on board the suggestion made by the Secondary Legislation Scrutiny Committee of teasing out the negative from the affirmative. That is always good practice. However, I do not know where the transitional regulation, Regulation 1711, comes from. I assumed that it would have been sensible to have taken these together because they talk about the same thing and are all part of a piece. However, I may have missed something and the Minister might be able to put me right on the procedure that is involved.

This is a small but important issue and anyone who looks at it will be reminded of the ineffable complexity of our pensions system. I have to say that although this is the right thing to do and I am content with the regulations, they form another layer of complexity—because they have to. If money purchase is not defined in this way, it would leave a terrible amount of uncertainty. If people do not understand a valid, watertight description of money purchase, chaos will ensue. Lots of schemes could get into even greater difficulties in the future.

We always have to be careful about retrospective provision. These regulations go back to 1 January 1997. I understand perfectly why and, in the circumstances, that is justified, but, as I say, we must always be careful about retrospective provision. However, I think this is the right tactic. It is not perfect because retrospection never is, but the stated case is accepted, certainly as far as I am concerned. Clarity is the order of the day, as much as we can achieve it in pension provision.

I have a couple of questions for the Minister. Some of these things are imponderable because the data are not available in money purchase schemes to the same extent as in defined benefit schemes, but the number of affected schemes has been listed as being around 800. Is there an update on that figure and is there now a better definition? Has the number gone up or down since these matters started to be drawn up by the department? I also want to try to understand what the costs of non-compliance would amount to. What is the worst that could happen? If everything that can go wrong does go wrong, what would happen to hybrid schemes such as these which involve money purchase in a way that we have to change through these regulations?

As the chairman of a superannuation scheme myself, the key and overriding priority of a trustee is to protect the members’ benefits. Are there any circumstances where benefits afforded to members could be prejudiced by these changes? I have looked at the very helpful Explanatory Memorandum. Paragraph 19 explains the provisions of,

“transitional measures to assist affected schemes in three ways”.

The first bullet point talks about,

“retrospective protection so that schemes do not have to revisit past decisions”,

and goes on to conclude that,

“there is very likely to be no detrimental material impact on member benefits”.

That is a nuanced subordinate clause, and perhaps it has to be so. I would rather have the truth than be given a more definitive statement that was easier to understand and more reassuring. However, that is a key question for me. If I could be given some reassurance on that point, I would be even happier than I am at the moment.

Finally, I think that the consultation was exemplary. I looked at the document very carefully and the department did everything it could. The consultation was responded to well and those who did respond are experts who know the exact consequences of these changes. For me, that has lifted a great deal of concern and apprehension about the effects of these changes. These regulations reflect circumstances that no one could have foreseen and the Government have responded to them in the best way they can. The situation is still a bit fuzzy at the edges, but I hope that the Minister will give us an assurance that the appropriate officials who understand these things will monitor the position so that we can be assured in the fullness of time that the assumptions we are making of very little or no loss of benefit to individual members are found to be what happens in practice in the future.

[Baroness Drake (Lab)]

My Lords, I declare my interests as a trustee of both the Santander and Telefónica pension schemes.

This statutory instrument has been on a rather interesting journey. In part it supersedes draft regulations published in May, which were withdrawn and subsequently divided into two in order to separate provisions required to go through affirmative procedure from those required to go through negative procedure. It has therefore been a little confusing to try to anticipate the affirmative provisions to be relaid in the form of a pared-down instrument, as this SI was not laid until last Thursday. Having said that, I appreciate that dealing with the uncertainties and complexities that flow from the Supreme Court decision in Bridge cannot have been straightforward for the Government. I compliment the drafters of the Explanatory Memoranda and the impact assessment, who tried to provide clarity as to what the Government intend and why, in what to most normal people would seem a rather dense and complex set of requirements.

The two regulations have separate Explanatory Memoranda, but they share a common impact assessment, so one can assume that certain key assumptions and conclusions underpin both orders. I refer in particular to the fact that, having considered the consultation responses, the department has changed its policy on retrospection for non-compliant schemes. Decisions taken by schemes between 1 January 1997 and the coming into force of Section 29 will be validated, except in two limited circumstances that relate to winding up and employer debt, where there is a risk to members’ benefits.

The department has been persuaded that it would therefore be unduly burdensome to require schemes to revisit past decisions, which could give rise to expensive administrative costs that could deplete scheme assets and therefore the ability to fund members’ benefits—that is the argument put by the Government—and that the impact of members’ benefits of revisiting past decisions since July 2011 would be negligible. In summary, the Government are persuaded that with two exceptions, Section 29 will come into force only with prospective effect; there will be retrospective protection for schemes and past decisions will be validated.

However, in coming to that view and giving that retrospective protection to decisions made, the department is unable to quantify the impact of the regulations on schemes likely to be affected. There are no data available at an industry-wide level. The consultation did not elicit sufficient data at scheme level to allow the department to produce reliable estimates of the impacts on schemes and on members—and indeed, on employers. The department engaged further through the pensions regulator’s annual survey and the wider pensions industry to enable some quantification of costs and benefit. However, insufficient information was forthcoming.

A question must be, therefore: are the Government right to be persuaded, and indeed confident, that except in the defined limited circumstances that they have identified, there is negligible risk to members’ benefits in validating decisions taken by schemes before the coming into force of Section 29? Should there be more exceptions to the retrospective validation? How do the Government give themselves the level of confidence they need to give that retrospective validation? I will illustrate my concern with reference to a couple of examples.

The very important rules which govern any attempts to change pension rights or entitlements are detailed in Section 67 of the Pensions Act 1995, popularly referred to as “Section 67 rights”—an often quoted phrase because of its protected nature. During the course of the consultation on the regulations arising from the Pensions Act 2011, stakeholders advised the department that there could be schemes which had inadvertently changed their benefits from non-money purchase to money purchase; for example, by removing a guarantee from a cash balance scheme because of their interpretation of the law in force at the time. In doing so they may not have secured the members’ consent as is required.

The department has taken the view that schemes should not be required to revisit these decisions and that it would deem that the requirements of Section 67 of the Pensions Act 1995 had been satisfied where the actuarial equivalence requirements were met before such a scheme modification took effect. But those actuarial equivalence assumptions may not hold good over the longer term, and the issue remains that a guarantee or some other right has been removed without consent. The Section 67 requirements have not been met and the beneficiaries may be worse off.

--- Later in debate ---

[Lord Bates]

My Lords, a number of questions have been asked. I have counted 19, which compares to the five that were asked when these regulations were scrutinised in the other place. I am sure that that is a reflection of the quality and expertise, if not the viewing habits, of the members of the respective committees. I confess that at one point last night I was not sure whether the scoreline reflected the football match I was watching or the judgment of the Supreme Court which happened to be open on my lap at the same time.

[Lord Kirkwood of Kirkhope]

That was 4-1.

[Lord Bates]

At half time.

There are many questions and I want to try to address as many of them as possible to get the responses on the record for people to scrutinise. First, my noble friend Lord Kirkwood asked how many schemes were affected by the clarified money-purchased benefits definition. It has not been possible to quantify the exact number of the affected schemes as trustees and scheme managers are only required to make detailed reports to the pensions regulator on benefits that they consider to be non-money purchase. Schemes are not required to provide detailed reports of benefits that they consider to be money purchase, so any information held by the regulator here is self-reported by the scheme on a voluntary basis.

We consulted extensively on this point, and the regulator has also tried to secure additional data. However, stakeholders have been unable to share with us the detailed scheme-level data because that information is sensitive and restricted. A small number of consultation responses indicated the size of the scheme and the potential costs involved. However, the information is not representative of all the schemes affected, and cannot be reliably used to produce an aggregate estimate. The DWP continues to work with the regulator to identify and communicate with effective schemes to establish more comprehensive data on how many schemes are to be affected.

My noble friend Lord Kirkwood also asked whether with the new definition the Government are adding costs and increasing the administrative burden on the schemes. I can assure my noble friend that that is not the case. Although the clarified definition is retrospective to 1 January 1997, in most cases the regulations modify the retrospective application of regulatory legislation so that schemes will not need to look back at events where benefits could fall into a category affected by the Bridge judgment or the clarified definition in Section 29. The clarified definition will mean that the member benefits are protected. The transitional measures will bring schemes into compliance, are proportionate and bear in mind the risks and the burdens on members, schemes and employers. We believe that that is the sensible approach, precisely because the Government want to minimise the additional requirements on schemes without jeopardising the protection of the scheme’s members.

My noble friend also asked why the Government insisted on a change of definition, and asked whether the Supreme Court decision was wrong. The Supreme Court judgment concerned two specific scheme benefit types: benefits which provided a guaranteed pot, otherwise known as cash balance benefits, and pensions in payment from schemes derived from money purchase benefits, both of which the court decided could be money purchase. The decision meant that some guaranteed benefits from outside the regulatory regime conflicted with the Government’s view of what constituted a money purchase benefit.

Why are the regulations not together? The department’s advice was that both sets of regulations would be debated together subject to the affirmative procedure. However, following comment from the Joint Committee on Statutory Instruments, the department decided to split the regulations. However, we expect that because both sets are closely linked together, the discussion will encompass transitional arrangements for both regulations.

I have addressed the question of why there are two separate regulations, but I will add one additional point. It has been necessary to divide regulations in that way because the primary legislation under which the regulations have been made—Section 33 of the Pensions Act 2011—provides a different parliamentary procedure for regulations which amend primary legislation. I appreciate that that procedural requirement has not made discussion and debate in this area easier, but I am happy for this debate to encompass both sets of regulations, as it has already done. On why the clarified definition of money purchase benefits is retrospective to 1 January 1997, the Government have decided on retrospection to that date so that the effect of the clarified definition coincided with the inception of key pension protection legislation. Provisions of the Pensions Act 1995 largely came into force in April 1997, hence the chosen date, but retrospection was set up on 1 January 1997 as the financial assistance scheme eligibility began for schemes which started winding up from that date. However, since the Pensions Act 2011 was passed, we have no evidence that any of the schemes in this position would have been affected by the Bridge Trustees judgment or Section 29.

The noble Baroness, Lady Drake, asked whether there was a pre-existing requirement to have benefits valued consistently with legislative requirements in the past. Some schemes may have valued in a way that was not consistent with those requirements. Evidence from the consultations showed that members’ benefits which here are affected by Section 29 and the regulations might have been revalued by the application of notional interest or investment return. It is possible that this would have been less than revaluation in accordance with statutory requirements. However, we had to balance the protection of members against avoiding administrative complexity for schemes. Evidence suggested that the cost of applying revaluation arrangements would outweigh the benefit to members.

The noble Baroness, Lady Drake, also asked what the new cash balance method was. The new cash balance method is based on an existing flat rate method, which requires deferred members to receive any increases that they would have received if they had still been active members of the scheme. She also asked why there is no requirement to revisit the scheme if it is wound up. If the scheme is still being wound up at the time that the regulations come into force and is underfunded, trustees will be required to revisit an employer debt before the regulations come into force. If the scheme has completed winding up when the regulations come into force, there is no scheme in existence to unwind; all the assets of the scheme have been dispersed. The regulations therefore do not require a scheme that has completed winding up to be unpicked.

A question was asked about why schemes newly eligible for the Pension Protection Fund will not be treated as such until 1 April 2015. That date marks the beginning of the first full levy year after these regulations are planned to be in force. The delay will allow the schemes time to correctly determine whether they are eligible for the fund and to carry out the necessary valuations on which the first levy bill will be based. It also ensures that schemes will not be required to pay the levy in respect of past periods. It would not be fair to other levy payers to provide protection for an earlier period for a scheme that has not paid any levy.

The noble Baroness, Lady Drake, raised the question of flipping. The department’s consultation exercise did not identify any scheme that will become newly eligible for the Pension Protection Fund that has a sponsoring employer likely to become insolvent in that small window of time. If such an event does occur, the Government will give consideration to the most appropriate way of protecting scheme members. It would therefore not be fair to other pension protection levy payers to protect the members of a scheme in respect of a period of time when the scheme had not paid into any levy.

The noble Baroness, Lady Drake, asked whether once the regulations are in force it would still be possible to change the scheme benefits without member consent from one form of non-money purchase arrangement to another with a lesser benefit promise. A change of this nature—a detrimental modification under Section 67 of the Pensions Act 1995—would still be subject to a requirement that the value of the members’ rights or benefits was not less than before the change. If this requirement were not met, the change would be subject to being made void by the Pensions Regulator.

The noble Baroness also suggested that there were insufficient data for the Government to be able to conclude that there will be a negligible effect. Section 67 will continue to apply except in very limited circumstances where schemes have changed benefits from cash balance to money purchase. This circumstance is catered for in the negative set of regulations, which require the actuarial calculation between cash balance and benefits collected in the money purchase schemes to be maintained. In addition, the trustee approval and reporting requirements must have been satisfied.

The point was made that retrospection makes these regulations too complex. The clarified definition, when in force, will be retrospective to 1 January 1997. Retrospection to January 1997 is needed to protect the position of schemes that had taken decisions in accordance with the clarified definition in Section 29—that is, not in accordance with the Supreme Court’s judgment—but for schemes that have acted in accordance with the judgment, these regulations modify the application of regulatory legislation with retrospective effect and for the transitional period where necessary. The regulations cover the many different types of pension arrangements that currently exist and which could have been affected by the judgment of the Supreme Court in respect of Section 29.