With 2023 now well and truly behind us, we take a look at some of the key issues for pension scheme trustees and sponsoring employers in the year ahead.
DB Funding Code
Expectations are high that 2024 will finally see new DB funding regulations and a new Funding Code brought into force which will require trustees to adopt a long-term strategy for providing members' benefits on a low employer-dependent basis by the time their scheme reaches significant maturity. This will require schemes to re-evaluate their funding strategies at their next actuarial valuation. The proposed April timeframe, however, is looking increasingly unrealistic given the need for the regulations and Code to reflect lessons learned from the recent gilts crisis and the Chancellor's policy objective that schemes should be investing a greater proportion of their assets in long-term, illiquid assets, such as UK infrastructure projects.
Many trustees have set their scheme's long-term strategic objective as buying-out members' benefits with an insurance company and, with the sharp rise in gilt yields over the last 15 months, some trustees have reached, or are close to reaching, the point where they can realise that objective much sooner than anticipated. Trustees should be discussing with employers whether to take steps to lock-in the gains they have made to facilitate a buy-out.
This improvement in funding means 2024 is likely to see demand for buy-ins/outs being at an all-time high, stretching insurers' operational resources. It looks likely, however, that the year will see several new market entrants, providing much needed additional capacity. Attractive pricing and the high volume of schemes looking to buy-out means that there is more reason than ever for schemes to get themselves insurer-ready, in particular ensuring they are clear as to the benefits they need to secure. Incomplete or inaccurate data and uncertainties about the effectiveness of scheme benefit changes or the interpretation of scheme rules are issues which should be addressed well ahead of approaching the market. Even where schemes are not targeting buy-out in the near to medium term, trustees should be confident that they are calculating and paying benefits on the correct basis, so reviewing a scheme's data and rules is something which should be on all trustees' agendas.
Historic benefit issues
Last June's Virgin Media case brought an additional complication to scheme buy-in/outs, ruling that certain historic benefit amendments affecting contracted-out benefits built-up after 5 April 1997 were invalid, where they hadn't been subject to an actuarial confirmation. The issue is due to be considered by the Court of Appeal in August and, in the meantime, several organisations are attempting to persuade the DWP to make legislative changes to overcome the effects of the judgment. Any scheme rule review will need to consider if the case has implications for the scheme's benefits.
After many years where all the talk has been of scheme deficits, more schemes are now finding themselves in the enviable position of having a surplus. Quite how that surplus can be used will depend on how the scheme's rules are framed and whether the scheme is looking to buy-out, or run on, but in most cases, trustees will need to consider both members' and employers' interests. This is an area where trustees need to be particularly careful with several actions having been brought recently by pensioner groups, unhappy that surplus has not been used to provide full inflation protection for their pensions.
Employers should also be thinking about whether they should be taking steps to prevent surpluses arising in the first place, as any return of surplus to them will be subject to tax. The rate is currently 35%, dropping to 25% on 6 April 2024. Typical contingent funding mechanisms include escrow accounts and asset-backed contribution arrangements.
Employer access to surplus in ongoing schemes is also something the Government has stated it wishes to make easier, with the intention of boosting investment in UK productive finance. A consultation is expected later in the year.
From a trustee and member perspective, a buy-out has the advantage of bringing members' benefits within the protection afforded by insurer capital requirements and the Financial Services Compensation Scheme. From an employer perspective, funding risks are removed as well as the time and costs of managing the scheme. However, there can be downsides. Members' benefits will be fixed, and member service levels could be poorer. Both members and employers will also lose the ability to use scheme assets to generate a scheme surplus.
Trustees and employers of schemes which are well funded and have a strong employer covenant should consider if there is benefit to adopting a strategy of running-on a scheme with agreed arrangements for generating and sharing surplus between members and employers, with appropriate triggers to move to buy-out, if circumstances change.
The end of 2023 also saw the first superfund deal between Clara and the Sears Retail Pension Scheme. This is good news for schemes which otherwise may be unable to reach buy-out. The deal took place under the Pensions Regulator's interim regulatory framework and the Government has said it will bring in legislation formalising the framework when time allows.
The Government is also expected to develop its thinking on the PPF becoming a consolidation vehicle for DB schemes which are unlikely to be able to achieve buy-out or access private sector superfund solutions.
Our focus so far has been on the end point for schemes. Many schemes of course will have many years ahead of them with a myriad of issues needing to be addressed by their trustees and employers.
A key issue which is likely to face schemes in 2024 is complying with the requirements of the Pensions Regulator's General Code, which we expect to be finalised and come into effect in the first half of this year. Central to the Code are the Regulator's expectations as to the features of a well-run scheme. Effective governance has always been critical to a pension scheme delivering for its members and trustees should be looking to incorporate a review of their scheme's policies and processes into their 2024 business plan. As an initial element of any review, trustees should consider if they have the necessary experience and resources for effective decision making and implementation.
Equality, diversity and inclusion
The effectiveness of a scheme's governance and the service delivered to members can benefit from having a diverse trustee board, enabling the scheme's running to take into account a wide range of viewpoints and experience. Trustees should consider, as part of any governance review, what steps they can take to facilitate such a board.
The Lifetime Allowance (LTA) on pension savings will be abolished on 6 April 2024, although the tax charge for exceeding the LTA was withdrawn a year earlier. A new limit, however, will apply to the amount of pension which members can exchange for a tax-free lump sum. Broadly, this will be 25% of the value of a member's pension, or if lower, 25% of the member's LTA as at 5 April 2023.
There is also a new cumulative Lump Sum and Death Benefit Allowance, equal to the value of a member's LTA as at 5 April 2023, which will apply to the aggregate of the retirement cash sums and lump sum death benefits paid to or in respect of an individual under all registered pension schemes. Any excess benefits will be subject to income tax at the recipient's marginal rate of income tax.
Trustees should check that their scheme Rules, administrative processes and member communications reflect the changes to the pensions tax regime. Employers may also need to revisit benefit arrangements agreed with employees who had previously reached their LTA.
A weakness in many employer, trust-based DC pension schemes, is the lack of options for members to turn their investment account into a benefit – known in industry jargon as "decumulation". To address this, the Government intends to legislate to impose a duty on trustees to provide decumulation options with the Pensions Regulator providing supporting guidance. Its policy aim is to push trustees and employers towards moving members into schemes of larger providers with the resources to offer a wider range of options and better member service.
2024 is likely to require trustees and employers to review their scheme's decumulation options and consider whether they and scheme members would benefit from a transfer to a larger Master Trust.
Enhancing retirement outcomes
There is an increasing recognition that individuals aren't saving enough to deliver the standard of retirement to which they aspire. While cost of living pressures mean that some individuals simply cannot increase their savings, others do not have a good enough understanding of the standard of living they are likely to obtain from a given pension pot and the amount they will need to save to have a comfortable retirement. With compulsory retirement of employees at a fixed age not an option, this is likely to result in employers increasingly finding themselves with an ageing workforce which is unable to retire.
Employers may wish to consider enhancing the resources made available to their employees to help them with their retirement planning, drawing on initiatives such as the Pensions and Lifetime Savings Association's Retirement Living Standards materials.
The FCA and Government are also consulting on how further support on retirement planning can be provided to individuals, without organisations crossing the line into the area of providing regulated financial advice.
We end our new year thoughts on a slightly Rumsfeldian note, that life, especially in terms of the behaviour of financial markets and pensions policy, is inherently uncertain. Trustees should check that they have appropriate processes in place to identify and control key risks and are able to react quickly in the event of the occurrence of an unknown unknown.
A risk which is increasingly likely to materialise for many schemes is that of a cyber-attack, typically on a scheme's outsourced administrator. Our experience is that many trustees' response plans are untested and when they are, reveal considerable weaknesses in their operation. War gaming a hypothetical cyber-attack could be something trustees and employers usefully undertake in 2024.
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