UK Pensions Law Update - February 2024

The Code applies to governing bodies of occupational, personal and public service pension schemes, and specific modules specify how the obligations may apply differently for certain types of schemes. While the Code is not a statement of law and there is not usually a direct penalty for non-compliance, it sets out TPR’s expectations of how governing bodies should comply with their legal duties (even where they have chosen to delegate specific tasks to another party). When determining whether the legal requirements have been met, relevant terms of the Code must be taken into account by a court or tribunal.

TPR also published its final response to the consultation on the Code, which noted some major changes from the previous draft, as noted below.

Own risk assessment

It is a legal requirement for many pension schemes to establish and operate an effective system of governance (“ESOG”), which must be proportionate to the size, nature, scale and complexity of activities of the schemes. Any such applicable schemes with 100 members or more need to document an “own risk assessment” (“ORA”) as part of the ESOG.

Having received feedback that the originally proposed timescale was too onerous, TPR relaxed the requirements in the updated Code. The first ORA must now be documented (a) within 12 months beginning with the last day of the first scheme year that begins after the Code is issued; or (b) if later, (i) within 15 months beginning with the date on which the trustees are next required to obtain an actuarial valuation; or (ii) by the date on which the trustees are next required to prepare an annual statement regarding governance. The ORA should be completed every three years.

The ORA needs to include consideration of the effectiveness of, and risks arising from the following elements: (a) policies for the governing body, (b) risk management policies, (c) investment, (d) administration, and (e) payment of benefits. While the ORA does not need to document the steps taken to mitigate identified risks, the governing body should maintain appropriate records of mitigation as part of its ordinary risk management processes.

TPR, in its consultation response, noted that they do not have current plans to produce guidance on completing the ORA, or produce a template for the ORA.

Investment

For schemes subject to the ESOG with 100 or more members, an earlier draft of the Code was very prescriptive on the limit of unregulated investments that may be had by the governing body. Having received feedback about the negative impact this may have on well-governed schemes that hold such assets, TPR in the updated Code now provides that governing bodies of applicable schemes must invest “mainly” in regulated markets.

Rather than the prescriptive requirements for quarterly monitoring of scheme investments and performance in the earlier draft, the updated Code now requires this to be done “regularly”. Environmental, social and governance (“ESG”) factors need to be part of the investment-decision making process. The Code has been updated in light of the statutory requirements around the Task Force on Climate-Related Financial Disclosures (“TCFD”) since the draft code was published for consultation.

Diversity of the governing body

The Code has been updated to include references to diversity and inclusion, while TPR’s work in this area is ongoing. The membership of the governing body should be reviewed regularly to ensure it is well-balanced and diverse, with members demonstrating varied skills, knowledge and experience. The governing body is also encouraged to consider good practice approaches to ensure that its recruitment practices (including member-nominated trustee arrangements, where applicable) are inclusive.

Remuneration and fee policy

TPR has clarified in the Code that a scheme’s remuneration policy should only cover the costs of activities that the governing body is directly responsible for – TPR appreciated from the feedback that scheme costs are often paid by sponsoring employers, and are not under the governing body’s control. TPR also noted in the consultation response that the policy does not need to set out the levels of remuneration paid. The expectation to publish the remuneration policy has been removed in the Code, as TPR acknowledged the feedback that such publication requirement would add little value to members, and might become a source of criticism.

The ‘lump sum allowance’ is a cumulative limit on the tax-free element of lump sums at the point of retirement (and has been set at £268,275 – i.e. 25% of the current standard lifetime allowance). So, for instance, if a member took a pension commencement lump sum of £100,000 at the point of retirement from one scheme, his remaining lump sum allowance (e.g. for pension commencement lump sums from other schemes) would be reduced to £168,275.

The ‘lump sum and death benefit allowance’ is a cumulative limit on the total amount of the tax-free element of lump sums and lump sum death benefits payable (this has been set at £1,073,100 – the level of the current lifetime allowance). Benefits which would count towards this allowance include a member’s pension commencement lump sum, the tax-free element of a serious ill-health lump sum and the tax-free element of an authorised lump sum death benefit. Any excess is subject to income tax.

Those with LTA protections will maintain their higher allowances but they will be frozen.

Changes since the previous draft legislation put forward in July include:

• The ‘new’ allowances will not now be reduced by the payment of a trivial lump sum or winding up lump sum, saving some administrative burden.
• The July draft legislation allowed schemes to pay taxed lump sums beyond the usual tax-free allowances, but this has been addressed in the latest draft Bill. A new ‘pension commencement excess lump sum’ has been added, which can only be used when all of the member’s lump sum allowance has been used.
• Although previously announced, it has been confirmed that the proposal to tax defined contribution benefits on death before age 75 is not going ahead.

As we noted in previous updates, the previous draft regulations did not appear to align with the draft DB Funding Code in a number of areas. The draft DB Funding Code had set out a more flexible and scheme specific regime than contained in the 2023 draft regulations. The Government has addressed this issue in its consultation response and has stated that the final draft regulations now align with the draft DB Funding Code to “anchor the [scheme specific] flexibilities described in the draft code.”

More specifically, there have been various significant revisions to the draft regulations to take account of the views/concerns raised in response to the consultation. These concerns included that:

• the measure of scheme maturity created too much uncertainty given its sensitivity to market conditions;
• the definition of ‘low dependency asset allocation’ would limit the types of assets in which schemes can invest, i.e. a loss of the flexibility that should apply to the specific circumstances of each individual scheme;
• the draft regulations did not fully reflect the circumstances of opens schemes as the regulations would prevent open schemes from taking account of new entrants and future accrual and thus de-risking sooner than necessary and increasing Technical Provisions.

The Government has addressed these concerns in the final regulations as follows:

Scheme Maturity

The draft regulations require scheme maturity to be measured in years using a duration of liabilities measure. Calculation of duration varies with different discount rates. If the discount rate is high this results in a lower value for the duration. Recognising the volatility created by changing market conditions (e.g. the steep rise in gilt yields in September 2022 caused the proposed significant maturity date to move rapidly by a number of years), the final regulations prescribe a fixed date on which economic assumptions must be based. That date is 31 March 2023.

Low dependency investment allocation

The Government has made changes to the low dependency investment allocation measure that applies after significant maturity. These changes will allow schemes with access to a strong covenant to continue to invest an appropriate proportion of funds in growth assets. In this context, the final regulations no longer contain the requirement after significant maturity for assets to be invested such that cashflow from investments broadly matches pension/benefit payments.

The final regulations make clear that the low dependency investment allocation does not apply to surplus funding.

Open schemes

The Government has addressed the concern that the draft regulations would have forced schemes open to accrual to de-risk unnecessarily. The Government has clarified its intention that open schemes should be allowed to take account of future accrual if they have regard to the employer financial covenant when calculating their significant maturity. This will mean that for some schemes, it will be reasonable to plan and fund on the basis that the scheme will not begin to mature soon. In this context, a new regulation 4(5) will explicitly allow open schemes to make a reasonable allowance for new entrants and future accrual when calculating scheme maturity, subject to the strength of the employer covenant.

No exceptions to low dependency funding basis after significant maturity

One point on which the Government has declined to make any change is on the universal applicability of a low dependency funding basis. This is the principle that all mature schemes should have a low dependency on the sponsoring employer. Some respondents had made the argument that low dependency funding basis should not apply to schemes that still have access to a strong covenant after reaching significant maturity. Whilst declining to allow exceptions, the Government notes that the changes made to the low dependency investment allocation strikes a reasonable balance.

Background

Mr O’Leary had been declared bankrupt, after having misappropriated significant assets belonging to a Mr James Hanson. He had taken advantage of the ill-health of Mr Hanson to dishonestly and fraudulently appropriate assets of some £22 million and had transferred them to Panama for Mr O’Leary’s own benefit.

During bankruptcy, the law generally protects pensions which are not in payment, but pensions in payment may be used to satisfy the bankrupt individual’s debts. Mr O’Leary’s personal pension was not in payment during his bankruptcy so could not be used to satisfy his debts. The Bacci case established, however, that debts incurred due to the bankrupt individual’s fraud survive bankruptcy.

The Court was asked by the applicants in this case, after Mr O’Leary had been discharged from bankruptcy, whether they could access Mr O’Leary’s pension benefits by the Court making an order under section 37(1) of the Senior Courts Act 1981 to help satisfy the debt. These orders can be made if the Court considers it “just and reasonable to do so”. Mr O’Leary argued that he was too impecunious for the order to be made – on the basis his alleged lack of funds would make such an order unreasonable.

Summary

Mr O’Leary had produced evidence of his income and expenditure to the Court, having around £66,000 of outgoings per year which included running a Mercedes, gym memberships, spending nearly £12,000 on medical insurance and legal fees as well as regular trips to Waitrose. This was without having accessed any of Mr O’Leary’s personal pension. There was also evidence that Mr O’Leary and his wife’s income would increase in the coming years.

The applicants argued that this did not demonstrate ‘impecuniosity’. In particular they argued that this showed that: (a) he was considerably more comfortable than a single person living off the State pension, (b) Mr O’Leary and his wife had considerable financial assets including a £800,000 house and (c) given the previous findings of dishonesty Mr O’Leary’s assertions should be treated with scepticism.

The Court found in favour of the creditors.

The Worthington Employee Pension Top-Up Scheme (the “Scheme”), a money purchase trust-based occupational scheme, was established in 2006. The Scheme’s sponsor, Marcus Worthington and Company Ltd (“MWC”), entered administration in September 2019 and was subsequently dissolved in January 2022.

An investigation by the Pensions Regulator (“TPR”) exposed several employer-related loans by the Scheme, including:

• Three totalling around £400,000 to the parent company of MWC; and
• Two totalling around £540,000 to Brockholes Pavilion Trust Fund, a trust-based occupational scheme established for the benefit of Worthington family members.

All Scheme funds were eventually lost, as the loans were converted into another employer-related investment which failed.

Section 40 of the Pensions Act 1995 and the Occupational Pension Schemes (Investment) Regulations 2005 prohibit loans from a scheme to persons connected or associated with the scheme’s employer – with breaches constituting a criminal offence punishable by an unlimited fine and/or imprisonment.

Stephen Smith, a former trustee of the Scheme and finance director of MWC, pleaded guilty to making five prohibited loans at an earlier court appearance, following a prosecution brought by TPR. It was noted that Mr Smith played an integral part in running the Scheme, but was negligent in performing his duties as a trustee and failed to act in the best interests of its beneficiaries. The Judge handed Mr Smith a 10 month jail sentence, suspended for 12 months, and ordered him to complete 150 hours’ unpaid community work and to pay £1,000 in prosecution costs.