It`s the end of the (DB) - Bath Actuarial Consulting

March 2015
It’s the end of the (DB) world as
we know it and we feel…
The Pensions Act 2014 confirmed that
contracting-out will end in April 2016 and
companies will be able to amend their
schemes unilaterally to offset the impact of
higher National Insurance (NI) contributions.
Finally, more than 8 months after its
consultation closed, the DWP has confirmed
the workings of this statutory override power.
Whether this leaves companies feeling
“fine” about the end of contractingout depends upon whether they have
already started the process of reviewing
benefit design. Those with a contractedout defined benefit (DB) scheme open
to future accrual have a year to decide
on their strategy, consult with members
and implement change. If companies
want to be ready for April 2016, this
gives them very little slack (see possible
timeline overleaf). In this Pensions
Perspective, I examine the statutory
override power and how it will work,
before considering the choices and the
timescales which companies face in the
run-up to the end of contracting-out.
Statutory override power
In a nutshell, an employer can increase
member contributions or reduce the
value of future pension accruals under
its scheme from 6 April 2016, provided
an actuary certifies that the impact of
these changes across the whole of
the relevant membership is not more
than the increase in the employer’s
NI contributions. This limit is 3.4% of
NI band earnings, which are earnings
between the Lower Earnings Limit
and Upper Accrual Point (£5,824 and
£40,040 respectively in 2015/16), or
about £1,000 a year for an employee
earning £35,000. In many schemes the
extra NI contributions will be equivalent
to around 2.5% of overall pensionable
pay. For the purpose of assessing the
reduction in the value of future pension
accruals, the actuary is to use the
scheme’s technical provisions basis.
This employer power overrides any
restrictions in a scheme’s amendment
rule, most commonly the need for
trustee agreement, although it does not
apply to so-called “protected persons”,
who are employees from former
nationalised industries.
Employer’s control
The employer controls three aspects of
the calculation/certification process for
the statutory override and these could
be helpful in ensuring that a company
which chooses to use the override gets
the best return from it. It is the employer
who:
•appoints the actuary to provide
the necessary certificate. It would
seem odd for the employer to want
to appoint the scheme actuary
and this is certainly not the DWP’s
expectation. Having discussed this
with the actuarial profession, the
DWP noted that the scheme actuary
is unlikely to be able to advise the
employer on the type of amendments
being made because that would
create a conflict of interest
•chooses the calculation date. The
calculations are based on a one
year period from the specified
calculation date, which can be
any date after 31 December 2011.
The choice of calculation date is
relevant in two ways – it affects
the contracted-out membership on
which the calculations are based
and it also determines the relevant
technical provisions basis, since
this is the basis used at the most
recent actuarial valuation on/before
the calculation date (albeit it needs
adjusting to market conditions at the
calculation date)
house views on what constitutes a
best estimate assumption.
So the choice of actuary could be
material to the end result.
Member consultation
•instructs the actuary to adjust
any assumptions in the technical
provisions basis to remove margins
for prudence (i.e. convert the basis
from prudent to best estimate).
This is crucial for the company
because using a prudent basis will
reduce the scope for reductions in
pension benefits (for example if, on
the technical provisions basis, the
accrual rate could reduce from 1/60th
to 1/66th, on the corresponding best
estimate basis it might be possible to
reduce it to 1/68th or 1/69th).
Actuary’s judgement
Although the calculation process is
clearly specified, there will inevitably
be aspects which reflect the judgement
of the chosen actuary and/or firm.
In particular there may be some
subjectivity in:
•updating the technical provisions
basis to the calculation date
•the adjustments made to remove
margins for prudence, given that
some actuarial firms have different
Despite arguments to the contrary, the
DWP has confirmed that employers
choosing to use the statutory override
power will still need to carry out a formal
consultation with members about the
proposed changes. This must run for at
least the usual 60 day minimum period.
However, making the business case for
change should be more straightforward
than usual as, by definition, it is to
recoup some or all of the additional
employer’s NI contributions.
Of course, members will also pay
additional NI contributions after 5
April 2016 (1.4% of NI band earnings
compared with the employer’s 3.4%),
so the consultation will need to flag
that their take-home pay will reduce as
a result of the extra 1.4% NI but their
scheme contributions/benefits will also
increase/reduce respectively to allow
the employer to recoup its extra 3.4%
NI contributions. This will not be an
easy message to communicate! The
DWP estimates that, even if members
in effect foot the bill for both lots of
additional NI contributions, around 85%
of members who reach State pension
age in the 20 years beginning 2016 will
So the choice of actuary
could be material to the end
result.
still be better off once their improved
State pension is taken into account.
However, getting into a discussion
about the level of a member’s State
pension is probably best avoided due
to the individual complications that will
arise.
Who is the employer?
When the regulations talk about the
employer, they include the principal
employer for a multi-employer scheme.
Usually the principal employer will mean
the person who has been nominated
by the employers or by the rules of
the scheme for the purposes of the
scheme funding regime. However,
if no such nomination has taken
place, the regulations provide for the
principal employer to be chosen by
the employers to act on their behalf
specifically for the use of the override
power.
What will companies do?
There are three options for companies
with a contracted-out DB scheme in the
run-up to April 2016:
•do nothing and simply pay the extra
3.4% NI contributions
•use the statutory override to recoup
the extra NI contributions
•make more radical changes to
contributions and/or future service
benefits (and perhaps to the link
between past service benefits and
future salary increases) and possibly
close to future accrual, but this
will require the agreement of the
scheme’s trustees.
...the end of contractingout after 38 years provides
a clear opportunity to make
changes.
Whatever a company’s attitude to its
pension costs, the end of contractingout after 38 years provides a clear
opportunity to make changes. Given
the DWP’s tardiness in finalising the
statutory override regulations, many
companies have yet to take a final
decision on precisely what they will do
(indeed a recent survey suggested that
almost half of companies have yet to
properly consider the issue!)
For some companies, whose scheme
has a restrictive amendment power or
whose trustees are unlikely to agree
to a change in member contributions/
benefits, the statutory override will
be an attractive way of recouping the
additional 3.4% NI contributions.
However, many companies will want to
do more than this, particularly given the
further reductions in bond yields since
the summer of 2014 which will have
pushed up the cost of future accrual
significantly. The new DC flexibilities
which arrive in April 2015 make DC
more attractive and so may lead some
employers to propose closure to future
DB accrual when they would not
previously have contemplated going
that far. For a discussion of how to
close a scheme to future accrual as
smoothly as possible, see my Pensions
Perspective, “Taking the sting out of
final salary closure”.
Timescales
For companies who are at the start of
considering how to respond to the end
of contracting-out, there is still enough
time to implement changes from April
2016, but only just.
A possible timeline is shown in the chart
below, split broadly into the four main
stages of a pension change exercise (for
a description of what’s involved in each
stage, please see bac’s brochure on our
pension change services).
The timeline includes the best part
of three months for feasibility work
which may all be needed if the
employer wants to do more than use
the statutory override and there are
potential complications, for example
awkward trustees or the need to review
members’ contracts. If contracts do
need changing, a 90 day employment
law consultation will be needed instead
of the 60 day pension consultation.
Perhaps the stage in the overall pension
change process that has the most
potential for variation is the last, i.e.
the implementation. If a company is
using the statutory override to change
member contributions and accrual
rate, implementation may only involve
updating payroll and administration
processes and so take at most a couple
of months. However, if a company
proposes to close its DB scheme to
future accrual and switch all employees
to DC going forward, there is a
significant amount of additional member
communication needed after the end of
the consultation process, i.e. to explain
the new DC contribution and investment
choices and obtain members’
responses. In the latter case, it will be
tight timing indeed to implement the
changes within the four months shown,
especially if a new or amended DC
arrangement is needed for the former
DB members.
The last word
Whatever a company’s views on its
future pension design, the end of
contracting-out in April 2016 is a clear
trigger for change. So what should
companies be doing? It is critical that
feasibility work kicks-off very soon
(if it has not already started), so that
companies can take initial decisions by
early summer, 2015.
For more details about how BAC can
support you cost-effectively in reviewing
your plan design and implementing any
changes at April 2016, please contact
one of our senior team. You can find our
other Pensions Perspectives on pension
change on our website.
Possible timeline
March - May 2015
– feasibility
June - August 2015
– planning
September November 2015
– 60 day consultation
and follow-up
December 2015 March 2016
– implementation of
new design
Andrew Udale-Smith | March 2015
Copyright © 2015 Bath Actuarial Consulting
Bath Actuarial Consulting Limited
PO Box 5110 | Bath | BA1 0QY |
+44 (0) 1225 481450 |
info@bathactuarial.com |
Registered Address: 37 Great Pulteney Street, Bath BA2 4DA | Company Registered in England & Wales Company No. 07975135
This Pensions Perspective gives general information only and should not be taken as an authoritative statement of the law. Opinions, estimates and projections contained in this Pensions Perspective constitute the current
judgement of Bath Actuarial Consulting as at the date of this Pensions Perspective and are subject to change without notice. You should not take any action on the basis of this Pensions Perspective and Bath Actuarial
Consulting does not accept any liability to anyone who does rely on its content.