Issue 10 March 2006
Consultation on draft EU directive on Portability of Supplementary Pensions

Now that the requirements of the 2003 EU Pensions Directive (such as the new scheme funding regime) are finally in force, it may be an appropriate moment for us to look forward to another EU Directive which could also have significant implications for the UK.

In October 2005, the European Commission proposed a directive that is intended to improve the portability of pension rights within the EU so that workers can move from job to job without significant reductions in their pension benefits. The directive (which is currently only a draft) only covers supplementary (occupational) pension provision, and does not apply to state schemes. In January, the Department for Work and Pensions (DWP) published a consultation paper on the possible impact for UK pension schemes if the directive is implemented in its present form.

This consultation demonstrates that, as so often with European legislation, what sounds a good idea in principle may have unwelcome consequences in practice for the UK. It is worth remembering, however, that this is still only a draft directive. Part of the purpose of the DWP consultation is to obtain evidence to support them in their negotiations with the EU, and so the directive may still be amended. As it stands, the directive covers three key areas: acquisition of pension rights, preservation and transfer of pension rights and provision
of information.

Under the draft directive, the maximum waiting time a scheme can impose before allowing an employee to join a scheme would be limited to one year. In addition, it appears that it would not be possible to set a minimum age for entry higher than 21. These provisions could have significant implications for some UK schemes: recent surveys suggest that around 10% of UK pension schemes would be affected in each case. The directive also requires members to be given pension rights within the scheme after no more than two years’ service, but this is already a requirement in UK law. A refund of contributions must be provided where the member has not yet completed this minimum period, but this is unlikely to have a significant effect in the UK. From April 2006, schemes must offer either a refund or a cash transfer sum for periods of service between 3 months and 2 years and, in any case, most schemes already offer a refund of contributions even for periods less than 3 months.

The draft directive also requires workers to be able to request a transfer from one scheme to another. This may mean that all schemes would be required to accept incoming transfers.

At present, many schemes do not accept transfers in. The directive also requires that the terms on which the transfer is calculated must not penalise the member. In theory, this could prevent an underfunded defined benefit scheme reducing transfer values.

The directive also sets minimum standards for the provision of information to members. As there are already substantial disclosure requirements in the UK, it is unlikely that this will lead to major consequences for UK schemes.

We will now have to wait to see what success the DWP has in negotiating with the EU to mitigate the impact of the directive on UK pension schemes. Once the directive has come into force, the UK must implement it by 1 July 2008.

Cross-border schemes

The Pensions Regulator has now issued revised guidance on schemes that wish to operate cross-border. This covers UK schemes which receive contributions in respect of members working in other EU states and sets out the arrangements for the authorisation and approval of such schemes. Cross-border schemes have to meet more stringent funding requirements than other schemes. A scheme will not be classed as cross-border where the only members working in other EU states are seconded for a limited period and are expected to return to the UK or to retire at the end of the period. The latest guidance indicates that the Regulator does not wish to specify any particular period as a ‘limited period’ (previously 5 years was mentioned) and that it will be up to the trustees to determine whether members working in other EU states meet the definition of seconded workers.

Employers required to consult members on changes to scheme rules

Final regulations have now been published that will require employers to consult members on changes to scheme rules made after 6 April 2006. The requirements will be introduced on a phased basis and will cover employers with more than 150 employees from April 2006, employers with more than 100 employees from April 2007 and employers with more than 50 employees from April 2008. Even if scheme rules enable trustees to change future service benefits, they will be prohibited from making the change until the employer has followed the consultation process.

Consultation is only required where certain prescribed changes are made. These include increasing the scheme’s retirement age, closing the scheme to new members, replacing a defined benefit scheme with a defined contribution scheme and reducing or ceasing future accrual. Increasing the rate of member contributions will also count as a prescribed change as will reducing the rate of employer contributions to a defined contribution scheme. In practice, this list covers most significant changes that an employer might want to make.

Consultation does not give members the right to veto any change. Employers must provide written information about any change and its likely implications to members and their representatives and give them at least 60 days to respond. There are no firm prescriptions about how the consultation should be conducted, but the regulations specify that the employer and the persons consulted are ‘under a duty to work in a spirit of co-operation, taking into account the interests of both sides’.

Other recent developments

Internal Dispute Resolution Procedure (IDRP)
The Government had originally intended to replace the existing two-stage requirements for IDRP with a simpler one-stage process. The proposal has now been abandoned on the grounds that it would not have achieved the intended simplification.

Modification Regulations
Barely 6 weeks before A-Day, HM Revenue and Customs finally published regulations which set out modifications that will apply to scheme rules for a transitional period until 2011. The effect of these regulations is to enable schemes to continue to rely on the old taxation regime until they are ready to implement the new regime. However, the regulations are complex, and there are still questions remaining about how they should be interpreted.

‘Recycling’ Tax-Free Cash
In his pre-Budget report, the Chancellor indicated that he would prevent scheme members using their tax-free cash from a pension scheme to make a contribution back into a scheme (thereby benefiting from tax relief). HMRC have now published draft guidance on this issue, which will apply a very complex procedure to test whether recycling has taken place.Where the
lump sum is greater than £15,000 and a contribution is made of more than 20% of its value and this is significantly higher than the member’s normal pattern of contributions, HMRC will
deem that recycling has taken place. There has been extensive criticism of these proposals, which could have significant implications for pension schemes paying out lump sums.

PPF Levy
The PPF has produced its final determination on the form of the levy for 2006/7. This is essentially unchanged from the draft published in December 2005 (see our last Technical Bulletin).

Contracted out rebates
The government has announced the contracted-out rebates to apply from 2007. Despite the recommendation of the Government Actuary’s Department that a rebate of 5.8% should apply to defined benefit schemes (5.8% was a revised figure following heavy criticism of its initial recommendation of 5.2%), the DWP has set a rate of only 5.3%. They explain the reduction as arising from a ‘need to sustain the affordability of the rebate’ and the fact that the DWP is ‘considering the shape of future reform’.

Good news on trustee knowledge and understanding
The Pensions Regulator has published a revised draft code of practice on trustee knowledge and understanding.Whilst the broad principles are the same, the Regulator has attempted
to allay concerns that the requirements are very onerous by including more examples of exactly what they may mean in practice.

For further information please contact your usual Punter Southall contact.