Issue 7 September 2005
Consultation on Age Discrimination Regulations

The Department for Trade and Industry has now published draft regulations on the subject of age discrimination. These regulations, which will implement the age discrimination requirements of the European Employment Directive, are due to come into force in October 2006. Overall, these are wide-ranging regulations that will have a substantial impact on employers’ recruitment, promotion and retirement policy. However, there are extensive exemptions for occupational pension schemes, which mean that, in practice, most pension schemes will be able to carry on as before.

All occupational pension schemes will be treated as if their rules included a nondiscrimination rule and trustees will be given the power to alter scheme rules in order to comply with the non-discrimination rule. Whilst trustees are still subject to the general requirement not to discriminate on the grounds of age, the regulations exempt a large number of practices common in occupational pension schemes. These include providing different schemes for members of different ages (such as a money purchase scheme for members aged under 40 and a defined benefit scheme for those aged 40 and over) or paying different rates of employer contribution depending on the member’s age. It will also be possible for occupational pension schemes to continue to have fixed normal pension ages and minimum and maximum ages for joining pension schemes and to use age-related factors when calculating members’ early or late retirement pensions. The exemptions are much wider than many in the industry had been expecting.

Even where a scheme’s practice is not covered by the list of exemptions, there will still be an option for the trustees or employer to provide objective justification of the practice, for example on the grounds that it encourages or rewards loyalty. The exemptions given in the regulations only relate to occupational pension schemes, but it is likely that group personal pension schemes would be able to use the objective justification approach, for example to justify practices like age-related contribution rates.

In addition, there will be a national default retirement age of 65 (although employers will be able to make use of a lower retirement age if they can demonstrate that it fulfils a legitimate aim and is appropriate and necessary). Members will be able to request that they are allowed to continue working after that age and the employer will have a duty to consider this request following a procedure set out in the regulations. However, this retirement age only relates to retirement from employment; it is entirely possible (although probably impractical) for pension schemes to have a normal pension age that differs from the default retirement age for retiring from employment.

New Rules on Member-Nominated Trustees

The Pensions Regulator is now consulting on a draft code of practice on member-nominated trustees and at the same time the Department for Work and Pensions has issued draft regulations on the same subject. The regulations confirm that new employer opt-outs from the member-nominated trustee requirements will not be possible from April 2006, although existing opt-outs may continue in force until they expire (which for many schemes will be April 2007) or until 31 October 2007, if earlier. The consultation on the regulations also confirms the Government’s intention to increase the proportion of member-nominated trustees from a third to a half in 2009.

The code sets out procedures for the nomination and selection of member trustees, which are much less prescriptive than the existing rules. Member trustees must be nominated in a process in which all active and pensioner members (or groups representing them) are eligible to participate. The selection could involve a full ballot of all members or could be decided by a selection panel or a member representative committee. The Pensions Regulator envisages that the process of nomination and selection would normally be completed within 6 months.

Details of the Pension Protection Levy

The Pension Protection Fund (“PPF”) has also contributed to the flood of consultations over the summer. Gone are the days when July and August were quiet months in the world of pensions! The PPF has issued a 92 page consultation document on its plans for the pension protection levy for 2006-7 and future years. This levy will be used to fund the compensation payments payable by the PPF. 20% of the levy will be ‘scheme-based’ and calculated as a percentage of the scheme’s total PPF liabilities. PPF liabilities are essentially liabilities in respect of the benefits that would be provided to scheme members by the PPF if the scheme were to enter the fund. The remaining 80% of the levy will be calculated in accordance with ‘risk-based’ factors.

The ‘risk-based’ levy will be calculated taking into account the level of underfunding in the scheme and the risk of insolvency on the part of the sponsoring employer. The level of underfunding will be calculated as the difference between 105% of the scheme’s PPF liabilities and the scheme’s assets. This figure will be subject to a minimum of 1% of the scheme’s PPF liabilities. The risk of insolvency will be calculated by dividing employers into ten risk bands each of which will have an assumed probability of insolvency attaching to it. The PPF has appointed Dun and Bradstreet to assess the insolvency risk for each employer. For example an employer with an AAA credit rating would be in risk band 1 and would have an assumed probability of insolvency of 0.13% in the next year whereas an employer with a B credit rating would be in risk band 8 and have an assumed probability of insolvency of 6.6% in the next year. The risk-based levy will then be calculated by multiplying the level of underfunding by the risk of insolvency and the percentage of the levy to be risk-based (80%).

However, although the consultation document explains how the levy will be calculated, it does not provide enough detail to enable schemes to determine how much it will cost them. This is because the PPF does not yet know how much money it will need in total to pay compensation to members of affected schemes. Initially, it was suggested that the levy would need to raise £300m, but recent estimates suggest the figure required will be much higher than that. The PPF will publish its estimate for the total levy by the end of November. Scaling factors will then be applied to the scheme-based and risk-based levies calculated as above so that, when added together, the levies will raise the correct total. Although there will be a limit on the risk-based levy (of 3% of the PPF liabilities if the scaling factor is 1), for many schemes the levy will be much higher than anticipated, especially for those whose sponsoring employers have low credit ratings. Whilst it is technically the responsibility of the scheme to pay the levy, in practice the trustees will be asking the employers for additional contributions to cover the cost of the levy.

Other Recent Developments

Code of Practice on Scheme Modifications: The Pensions Regulator has issued a code of practice for trustees on making changes to past service benefits. Some changes (such as switching from defined benefit to defined contribution or reducing a pension in payment) can only be made with member consent, but others can to be made so long as an ‘actuarial equivalence’ test is met. The code provides guidance on how trustees should go about fulfilling these requirements.

Debt on Withdrawal of Employer: Under new regulations, the debt on a solvent employer withdrawing from a pension scheme will now be calculated on a full buy-out basis unless an arrangement approved by the Pensions Regulator is put in place. Under such an arrangement, the debt can still be paid at MFR level so long as there is a guarantor prepared to pay the rest of the debt if the scheme winds up or is left without a solvent employer.

Scheme Funding: The DWP and the Pensions Regulator have announced that the regulations on scheme funding will be delayed until 31 October 2005. Any valuation carried out after 31 October 2005 with an effective date on or after 23 September 2005 must be carried out in line with the new scheme funding requirements.

Seminar on Managing Investment Risk within Closed Schemes: Our sister company PSolve is giving a seminar on managing investment risk in closed schemes in London on 11 October 2005. Please contact helen.davies@psolve.com for further details.