Jane Marshall takes a look at some of the changes and objectives brought about by the Pensions Act 2004
The Pensions Act 2004 - much of which came into effect on 6 April 2005 - introduces far-reaching changes for company pension schemes, particularly those administered on a final salary or defined benefit basis. These changes have a direct impact on both sponsoring companies and pension trustee boards.
The Act is extremely complex, extending to 325 sections and 13 schedules, and will be supplemented by regulations and codes of practice. The 2004 Act is much more radical than the Pensions Act 1995, itself enacted to improve pension fund security following the disappearance of £600 million from pension schemes operated by the Mirror Group.
Regulator
The new Act creates a Pensions Regulator with significantly increased powers than those enjoyed by the Occupational Pensions Regulatory Authority, the original regulator set up in the earlier legislation.
The increased powers have been given to the new regulator with three objectives in mind. The principal objective is to protect the benefits of members in company schemes. The second objective is to reduce calls in relation to a new compensation scheme, the pension protection fund (PPF) established under the Act.
The PPF will meet part of members' benefits where an insolvent employer is unable to meet its pension liabilities by virtue of an under-funded defined benefit scheme. Accordingly, the regulator is given powers designed to ensure that companies do not attempt to transfer their liabilities to the PPF (for example, by restructuring so as to avoid the statutory debt that becomes payable on a scheme wind-up). The third objective of the regulator is to promote good administration.
The regulator's new powers are:
The PPF protects private sector defined benefit scheme members whose employers become insolvent with insufficient assets to pay promised benefits.
The PPF is partly paid for by levies to be imposed on the trustees, managers or other prescribed persons of other company pension schemes. The first is the 'initial levy', which will apply for approximately a year following the introduction of the PPF, and which is to be calculated by reference to the number of members. The second are 'pension protection levies' that can be either risk-based or scheme-based. In addition, the Act introduces both an administration and a fraud compensation levy.
Concern has been expressed that, depending on the number of plans that become eligible for PPF protection, there might be insufficient funds within the PPF to provide the promised benefits. There is no underlying government guarantee within the PPF, although it is doubtful that the public at large appreciates this. The cost of the levy is expected to rise in the longer term.
The Act also introduces a financial assistance scheme, a publicly funded arrangement designed to compensate scheme members whose underfunded schemes do not fall within the PPF - for example, because the relevant scheme was already in wind-up at the time the legislation came into force.
The 1995 Act had introduced a funding standard called the minimum funding requirement. This was criticised for its inflexibility, and because a minimum became for many schemes an inadequate maximum.
Therefore, the Act introduces a new 'scheme-specific' funding requirement or 'statutory funding objective' (SFO). Broadly, the trustees and employer have to agree on an appropriate funding rate. If they are unable to do so then the new regulator can set a contribution rate.
Trustees will have to take actuarial advice to meet the SFO by choosing from a range of calculation bases. Where a valuation discloses a failure to meet the SFO, the trustees must agree a recovery plan with the employer and provide this to the regulator.
The Act imposes new statutory obligations on trustees to be 'conversant with', and have 'knowledge and understanding' of, certain matters. They must demonstrate that they have the necessary understanding of scheme-specific matters, such as their scheme documents and statements of investment and funding principles. They will also need to have demonstrated knowledge and understanding of pensions law in general.
Moral hazard
Concern about the viability of the PPF and the fear that it might become financially overstretched are the reasons underlying some of the regulator's new powers. These are what have been loosely termed the 'moral hazard' provisions of the Act.
They enable the regulator to issue a contribution notice where the regulator believes that companies are deliberately trying to avoid debts due to the pension scheme. Legislation extends the regulator's powers to connected and associated persons as defined in sections 249 and 435 of the Insolvency Act 1986 respectively.
As a result of the new provisions, a wide range of persons who are not named employers in the pension scheme documents could become liable to contribute. There are clear implications for corporate transactions, for purchasers of employers and connected or associated persons. The possibility of being faced with a contribution notice is a fundamental concern in relation to company sales where there is a defined benefit plan.
The regulator has a separate raft of powers to require companies to secure financial support for the scheme, and can issue a financial support direction if it determines the value of the scheme employer's resources are such that it is unlikely to be able to meet a proportion of a legal debt due to the scheme. Again, the definition extends to associated and connected persons.
The Act makes a wide range of changes to the law relating to the calculation and treatment of employer debts due to a pension scheme where an employer becomes insolvent or where a scheme begins winding up. The new regulator is given broad powers to wind up pension schemes, impose freezing orders and make restoration orders where schemes have suffered a transaction at an undervalue or a transaction to defraud creditors.
The regulator will now be responsible for the appointment of independent trustees, and insolvency practitioners will have new obligations with the provision of information to the PPF, the regulator and the scheme trustees.
Sections 259 to 261 introduce the first pensions-specific consultation on sponsors of company schemes and on employers who operate direct pay arrangements for employees who are members of personal pension schemes.
In addition, a number of changes have been made to the law protecting past service rights. Certain 'high level' amendments to pension schemes will, for example, require member consent and only after the trustees have complied with prescriptive notification requirements.
Jane Marshall is a partner at the London office of Hammonds. She is a co-author of Pensions Act 2004: A Guide to the New Law, published in April by Law Society Publishing and available from Marston Book services, tel: 01235 465656
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