Issue 14 - November 2006
Final age discrimination regulations published

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On Friday 10 November 2006, the Department for Work and Pensions (DWP) published final regulations to amend the legislation on age discrimination as it affects pension schemes. These regulations had previously been subject to a brief consultation in mid October. Trustees are at last in a position to be able to judge what action may be needed in their schemes to deal with discriminatory rules and practices.

However, they have very little time to do so as the legislation will come into force on 1 December 2006 (the last date permitted by the EU Directive that gave rise to the legislation). There had been considerable demands for a ‘compliance window’ to allow schemes time after 1 December to make the necessary changes to their scheme rules, but the DWP have decided that they cannot provide such a window. Trustees should therefore as a minimum consider the possible risks and costs to their scheme of not having amendments in place by 1 December, and should take legal advice if they have not already done so.

The final amending regulations make some welcome changes to the original regulations published in spring, in particular to the list of rules and practices that are exempt from the legislation. It should now be possible for trustees to close a section of a scheme to new members without being liable to claims of discrimination or having to rely on proof of objective
justification (e.g. where a defined benefit scheme has been replaced with a defined contribution scheme for members joining after a particular date, or where some members joined the scheme as a result of bulk transfer on a different benefit structure to other members). These sections do not need to be formally defined within the scheme rules, but may just be groups of members with historic entitlements to different benefits. In particular, schemes will be able to apply the earnings cap to post-89 members and not to pre-89 members.

Another important change is in the area of early retirement. The original legislation exempted the practice of paying full pension without actuarial reduction on retirement before normal pension age in respect of members or prospective members as at 1 December 2006. However, there is now a further exemption in the case of early retirement on the grounds of redundancy. Enhanced or unreduced early retirement pensions on grounds of redundancy will be exempt from the scope of age discrimination claims, irrespective of whether the member joined the scheme before or after 1 December. However, if a scheme currently allows members between 60 and 65 to retire without reduction but with trustee or employer consent in circumstances other than redundancy or ill-health, there will be no exemption in respect of any new members.

Additional changes have been made relating to death benefits. Originally there was no exemption in place where a dependant’s pension was calculated by reference to the length of the member’s future service and this could potentially have been discriminatory as younger members would be likely to have more future service. The new regulations now exempt such pensions. There is also an exemption where schemes provide a five year guarantee. However, there is no specific exemption for children’s pensions that come to an end before age 23 (the highest age permitted by A-Day legislation). Trustees would need to consider providing objective justification for this or changing their scheme rules.

Finally, the regulations introduce further exemptions for employer contributions to personal pension schemes. It will now be possible to operate a minimum age for entry or a maximum level of pay on which contributions may be calculated. It will also be possible to have both flat rate and age-related contributions provided that the contribution scale for the latter meets the same conditions as for occupational defined contribution schemes, namely that the aim of the scale should be to provide benefits which are “more nearly equal” over “comparable aggregate periods of pensionable service”.

Even though we now have the final regulations, there are still a number of areas where the correct interpretation of the legislation remains unclear. The Department for Trade and Industry (DTI) which then had responsibility for the legislation published guidance in April which was intended to explain the scope of the legislation. However in a number of places the guidance appeared to go further than the legislation itself.We are still awaiting an updated version of this guidance (a draft has just been released for consultation). Areas where we would particularly like clarification are what age-related contribution rates will be deemed to meet the ‘benefits that are more nearly equal’ test and the question of whether it is possible for schemes to require members to leave employment before they can draw their pension.

Pension Protection Fund to raise less thanexpected from 2006/7 levy

The Pension Protection Fund (PPF) has indicated that it expects to collect £324 million in respect of the 2006/7 pension protection levy rather than the £575 million it initially estimated. This is partly because of equity market conditions at the time the levy was calculated and partly because employers took active steps to reduce their levies.We are still waiting to hear how much it expects to collect for the 2007/8 levy. In addition to the pension protection levy which is used to pay compensation to members of schemes admitted to the PPF, the PPF also charges an administration levy to covers its running costs. This is expected to rise by around 50% for 2007/8. For most schemes, the administration levy is likely to be relatively small compared to the pension protection levy.

Queen’s speech announces long-term reform of pensions

The Queen’s Speech on 15 November has confirmed that there will be a Pensions Bill in the new parliamentary session to introduce a long term reform of the pensions system. This will follow on from the proposals contained in the Pensions Commission’s report and in the DWP’s White Paper published in May. The DWP recently published a summary of the responses received to the White Paper and some further reflections on their proposals.

We are expecting the Pensions Bill to cover changes to the state pension system. The DWP has indicated that there will be a further consultation on the scheme of personal accounts in December this year and so personal accounts will not feature significantly in the Pensions Bill this session.

The changes to the state pension system will include increasing the state pension age and a linking of the basic state pension to earnings from a date between 2012 and 2015.We expect the Bill to provide further details on both these areas (although some aspects may be deferred to regulations).

One area that will be of particular interest to the trustees and sponsoring employers of occupational pension schemes is the future of the state second pension (S2P) and the implications for contracting out. The intention is that over time S2P will become flat rate – the White Paper indicated that S2P would become fully flat-rate from around 2030. In a recent speech, James Purnell indicated that he was considering accelerating the speed at which S2P would become flat-rate. The details are rather sketchy, but the proposal appears to be that the part of S2P based on earnings below around £12,000 would become flat-rate from 2012-2015 with S2P based on higher earnings remaining earnings-related for longer.We hope that the Pensions Bill will provide clearer detail on how this will operate.

The White Paper indicated that contracting out would be abolished for defined contribution schemes with effect from 2012-2015. The DWP consulted on some of the practical implications of this decision in September/October 2006. Concerns included how existing protected rights funds would be dealt with and how the administration of the change should take place. The consultation did not address the particular problems of those defined benefit schemes that are contracted out on a protected rights basis.

Contracting out in a defined benefit scheme will be much harder to remove and there are no immediate proposals to do so. The Pensions Commission recommended that the option for a defined benefit scheme to opt out should be removed from 2030, but the White Paper indicated that the DWP would make no long-term proposals at this stage, but would keep the future of defined benefit contracting out under continuing review. It is not clear whether this proposal might now be changed given the plans to accelerate the flat-rating of S2P. In addition, the DWP has indicated that it proposes to allow schemes to convert their guaranteed minimum pension (GMP) into ordinary scheme benefits – but we do not have any details of how this would operate or whether their proposals will clarify the thorny issue of how to equalise GMPs for men and women.

For the trustees and employers of contracted-out occupational schemes, this is therefore a time of uncertainty.We hope that the Pensions Bill will provide clarity on some of these issues.

Other recent developments

Code of Practice on Modifications to Subsisting Rights:
The Pensions Regulator has laid its tenth (and for the time being final) code of practice before parliament. The code covers the procedures trustees should follow when making changes to benefits that have already built up in defined benefit schemes.

Pensions Regulator Consultation on Defined Contribution Schemes:
The Pensions Regulator has issued a consultation on how it plans to regulate defined contribution schemes. It will proceed by publishing good practice guidelines to improve scheme governance and by intervening where poor practice exists (for example, by naming and shaming particular organisations).

DWP Report on Speeding Up Winding Up:
The DWP has published a report indicating that a scheme wind-up should normally be completed within two years. Any wind-ups that have already commenced should also be completed within two years.

For further information please contact your usual Punter Southall contact.

© 2006 Punter Southall Group Ltd. All rights reserved. This bulletin is intended to provide a brief summary of current issues and action should not be taken as a result of this bulletin alone.