Abolition of DB contracting-out: response to consultation and final regulations on statutory override

Introduction

On 4 March 2015, the DWP published a response to the consultation on the Occupational Pension Schemes (Power to Amend Schemes to Reflect Abolition of Contracting-out) Regulations (“the Response” and “the Regulations” respectively), together with a final version of the Regulations.

In this Alert

• Key points
• Background
• Why is DB contracting-out being abolished?
• Statutory modification power
• How can the power be used?
• What do the Regulations do?
• Consultation
• Will employer’s contributions reduce?
• Next steps

Key points

• DB contracting-out will come to an end with effect from 6 April 2016.
• The Pensions Act 2014 provides employers with a unilateral power to amend their schemes to take account of the increase in their NICs resulting from the abolition of contracting-out.
• The Regulations set out the detail of how the statutory power may be used.
• Sponsors of schemes providing DC benefits with a DB underpin will not be able to use the power to reduce DC benefits.

Background

The current state pension system comprises the BSP, the additional State pension (commonly known as S2P but formerly SERPS) which is linked to earnings, and the pension credit (a means tested benefit).

It is possible for employers to “contract-out” of the additional State pension by providing an occupational pension which meets certain statutory requirements (these have changed over the years).  The aim of these requirements is to ensure that employees will become eligible to receive a pension in their contracted-out scheme which is broadly equivalent to the additional State pension to which they would otherwise have been entitled.

In return for the employer providing a pension meeting the statutory minimum, both the employer and employee pay reduced rates of NICs.  Employer contributions are currently reduced by 3.4% and employee contributions by 1.4%.

Why is DB contracting-out being abolished?

With effect from 6 April 2016, the Government intends to replace the current State pension system with a flat rate single-tier pension (see our Alert for details).  A key consequence of this is that employers will cease to have the option to contract their employees out of the additional State pension on a salary-related basis.  DB contracting-out will therefore also cease to exist from the same date.

Statutory modification power

One of the most significant implications of abolishing DB contracting-out is that both employers and employees will need to start paying the standard rate of NICs.

The Government recognises that this additional cost will be a blow for the sponsoring employers of the remaining open DB schemes.   It has therefore provided employers with a unilateral power to amend their schemes, in relation to some or all of the members, to take account of the increase in the employer’s NICs.

How can the power be used?

An employer may only use the statutory power to recoup the increase in its NICs by either adjusting members’ future pension accrual or future contributions.  It may not be used in a way which would or might adversely affect the subsisting rights of a scheme member, or a survivor of a scheme member.

The Regulations will prevent employers using the modification power to redesign DB schemes to provide DC benefits instead.  As a result, sponsors of schemes providing DC benefits with a DB contracting-out underpin will not be able to use the power to reduce DC benefits.

In addition, employers may not use the power to make amendments which would remove a power to determine any matter from the hands of a scheme’s trustees.  For example, this is intended to prevent an employer amending the scheme rules so that it is the employer, rather than the trustees, who consents to members taking early retirement.

What do the Regulations do?

The Regulations set out the detail of how the statutory power may be used, in particular, how the (employer appointed) actuary should calculate and certify that the value of the proposed amendments is not greater than the increase in the employer’s NICs.

The DWP’s view is that amendments which do not comply with the Regulations would be void.  However, there is no provision in the Regulations which makes this clear.

Multi-employer schemes

In a multi-employer segregated scheme, where there is only one employer in each section, each employer will be able to amend the rules for their section.  In non-segregated multi-employer schemes and segregated schemes with multi-employer sections the “principal employer” will exercise the modification power.

Following consultation, the definition of “principal employer” has been revised.  It now means:

• a person nominated by the employers, or by the scheme rules, to act on behalf of the employers to agree scheme funding matters, or
• where there is no such nominee, a person nominated by the employers to act on their behalf for the purposes of the use of the power.

The Government considers that this new definition strikes a reasonable balance between making the power workable for multi-employer schemes and protecting the position of individual employers.

Different rules for different members

Some schemes have different levels of benefits or different rates of contributions for different groups of members (referred to as different sections).  In the original draft of the Regulations, the Government included a provision which aimed to prevent cross-subsidy between sections.  This has been removed following consultation.  In the Response, the Government states that it would expect employers to explain clearly to employees, as part of the consultation process outlined below, how different groups of employees are affected by the proposed amendments.

Provision of information

Employers will need access to scheme and individual membership data to be able to make the amendments.  Consequently, the Regulations will place a duty on trustees to provide information to employers in connection with the use of the power.  The data must be supplied within “such reasonable period as agreed with the principal employer or employer as applicable”.  Civil penalties will apply where the trustees fail to take “all reasonable steps” to comply with this requirement.

There is no provision in the Regulations to assist the principal employer in obtaining information from other employers.  The Government considers this unnecessary.

Consultation

Although employers will not be required to consult about DB contracting-out coming to an end (as this will happen automatically via legislation), the use of the statutory modification power by an employer to reduce members’ future pension accrual or to increase contributions will be a “listed change” and so the employer will need to consult with affected members in advance.

In addition, the Regulations now include a requirement for the employer to consult the trustees about the timing of the amendment(s), following the issue of the actuary’s certificate.

Will employer’s contributions reduce?

Some respondents to the consultation queried whether employers should be given a power to reduce their contributions in light of any adjustment to members’ future accrual or contributions.  The Response makes clear that employers may not use the amendment power to directly reduce their contributions to the scheme.  The timing of any employer reduction in contributions will depend upon the circumstances of the scheme, the decisions made by the trustees and sponsor, and where the scheme sits in the scheme funding cycle.

However, once the amendment power has been used, the trustees should consider revising the schedule of contributions to reflect the change.

Next steps

The Regulations will come into force on 6 April 2015, with the aim of allowing employers time to commence any modification exercise sufficiently in advance of 6 April 2016.

The DWP intends to publish the consultation response to the Occupational Pension Schemes (Schemes that were Contracted-out) Regulations in the summer.  These regulations will set out the rules with which schemes that were contracted-out on a DB basis immediately before 6 April 2016 will need to continue to comply, on and from that date, in respect of accrued contracted-out benefits.