New Act introduces S2P and strengthens role of Ombudsman
The second major piece of legislation in the space of a year to affect pensions has received Royal Assent. The Child Support, Pensions and Social Security Act 2000 reforms the state pension system through the introduction of the state second pension (S2P) to replace the state earnings related pension scheme (SERPS) from April 2002. In addition to the fundamental reform of the additional state pension, the Act introduces further changes affecting occupational and personal pensions. There are sections on the selection of trustees, the winding-up of schemes, the purchase of annuities, combined pensions forecasts and measures affecting the Pensions Ombudsman. This feature describes the contents of the Act and highlights the major amendments made to the Bill (OP, February 2000).
THE STATE SECOND PENSION
Introducing the Bill to the House of Commons for its Second Reading, Secretary of State for Social Security Alistair Darling summarised the Government's intention to overhaul the way the additional state pension is provided: "The current system - SERPS - was designed to supplement the basic state pension, but it does not do enough for the low-paid, and it does nothing for many carers or disabled people with broken work records." (Hansard (HC), 11 January 2000, col. 161). The S2P uses formulas based on SERPS to calculate the additional pension and because of this the Government claims to have honoured its manifesto commitment to retain SERPS, even if it is radically reformed.
Getting to grips with the S2P requires an understanding of SERPS. Under SERPS, individuals accrue a pension of 20% of their earnings between the lower earnings limit (LEL) and the upper earnings limit (UEL). The S2P aims to double SERPS for those with earnings below £9,500, the low earnings threshold (LET). According to Jeff Rooker, Minister of State for Social Security: "The state scheme will generally be the right vehicle for low earners who do not have access to a funded occupational pension scheme because funded pensions are unlikely to be cost-efficient for them" (Hansard (HC), Standing Committee F, 7 March 2000, col. 718). There will be three earnings bands between the LEL and UEL. Band one will be from the LEL (£3,432) to the LET (£9,500). Band two will be from the LET to £21,600. Band three will be from £21,600 to the UEL (£26,000). For those who are contracted-in and earning up to £9,500, the accrual rate of 20% will be doubled to 40% and low earners will receive an S2P top-up as if they were earning £9,500. Carers and disabled people will also be assumed to have earnings of £9,500 for S2P purposes. On earnings band two the accrual rate will be 10% and on earnings band three it will be 20% (figures are all in 1999/2000 terms and will be revalued as described in the box on p.6). The aim is to ensure that low earners are much better off, those in earnings band two are better off, although to a decreasing extent the more they earn, and those earning over £21,600 are no worse off.
The two phases of S2P
The S2P is to be introduced in two phases, starting in April 2002. In the first phase, which is expected to last five years, or however long it takes stakeholder pensions to become established, it will be an earnings-related pension. In the second phase it will be converted to a flat-rate scheme. The earliest this could happen is 2006, but it is more likely to be 2007 so as to coincide with the five-yearly review of contracting-out rebates. The Government indicated that a report would be submitted to the House of Commons on when to move to the second phase and that the Social Security Committee would be involved to some extent. It was not willing to be more precise than that, saying it would be obvious when stakeholder was established.
In the second, flat-rate phase of S2P, there will continue to be 40% accrual on earnings up to the LET, but S2P will not accrue on earnings above this. Employees who are contracted-out will receive rebates above the LET to the UEL, strongly encouraging those with earnings above band one to contract out.
The contracting-out method
The Bill entered Parliament with critical decisions on the operation of the contracting-out regime still to be taken. Among the major changes required to the Bill as a result of the way in which rebates are to be calculated was the introduction at Committee Stage in the House of Commons of Schedule 4 to replace clause 29 of the Bill dealing with the calculation of the S2P. The Government had delayed announcements on the rebate option that was to be used for S2P to allow for consultation with the pensions industry. The rebate option subsequently chosen (OP, March 2000) was picked largely because it does not require schemes to alter their benefit design. When making the amendments at Committee Stage Jeff Rooker explained that Schedule 4 "amends the Pension Schemes Act 1993 to enable a different rebate structure to be implemented using secondary legislation" (Hansard (HC), Standing Committee F, 7 March 2000, col. 720). It also "means that the calculation for those who are contracted-in and those who are contracted-out will be dealt with in one place". The Government Actuary is currently consulting on Orders setting out the new rebate levels (OP, October 2000), and these are due to be laid before Parliament by 5 April 2001, to become effective a year later.
The full mechanics of the S2P are explained in the box above. The implications for members of contracted-out occupational schemes were explained by Mr Rooker: "The S2P top-up will do two things for low earners in occupational schemes. First, because the rebate will remain unchanged, it will deliver the difference between the 20% rebate on their actual earnings and the 40% accrual rate in the S2P. Secondly, it will pay the full 40% accrual on the boost between their actual earnings of, say, £6,000 and £9,500." Moderate earners are also catered for because "the top-up payment will reflect the extra help given in the S2P, with the payment tapering away on earnings between £9,500 and £21,600." The Government's intention is clearly to make contracting-out the obvious choice for people earning over £9,500; this will be particularly clear in the second phase.
Other changes to state pensions
The most heated debate on the Bill's passage through Parliament concerned s.39, which delays the 50% reduction in inherited SERPS rights until 6 October 2002 (OP, October 2000). It makes provision for redress for those who were misinformed about their SERPS rights and also allows for Regulations to be made concerning how these people will be identified.
The self-employed are to be excluded from access to the S2P. Where an individual is part employed and part self-employed, their class 2 contributions are currently taken into account when calculating the amount of surplus class 1 contributions on which their entitlement is based. Under S2P, only class 1 contributions will be taken into account. However, the Government indicated during the Committee Stages that it might be prepared to reconsider this at a later date.
Among the other changes made to this part of the Bill were minor amendments affecting the revaluation of earnings and the calculation of benefits where a person has both contracted-in and contracted-out employment in the same year.
The Act makes two changes affecting the Government Actuary that were not included in the Bill. First, the actuary's report on rebates will have to take into account that, under S2P, those contracting out are not necessarily giving up all rights to S2P. The second new clause requires an annual report on what the cost would be to the National Insurance Fund of uprating the basic state pension in line with earnings.
OCCUPATIONAL AND PERSONAL PENSION PROVISIONS
The provisions relating to the selection of trustees, the winding-up of schemes and other measures affecting occupational and personal pensions are contained in Part II, Chapter 2 of the Act.
Member-nominated trustees (MNTs), or, in the case of a corporate trustee, member-nominated directors (MNDs), are dealt with in ss.43-46 of the Act. As explained in our article written when the Bill was first introduced to Parliament (OP, February 2000), the new legislation reforms the current system for the nomination and selection of MNTs and MNDs. At present, the employer can propose an "alternative arrangement" that can permit the scheme to opt out of the MNT or MND provisions entirely, always provided the membership does not reject the proposal under the statutory consultation procedure. In future, provided the scheme is not exempt, at least one-third of the trustees or directors in all cases must have been nominated by, or on behalf of, the members.
Removal of MNTs
The Government made one important amendment to the Bill during the House of Commons Committee Stage. A consultation paper issued by the DSS last year (OP, December 1999) had proposed that MNTs and MNDs could be removed from office if they changed their category of membership, ie went from an active member to a deferred pensioner or from an active member to a pensioner.
At present, an MNT or MND who remains a member of the scheme cannot be removed from office without the agreement of all the other trustees. This gives the MNT or MND some measure of protection against being dismissed by an unscrupulous employer for the sole purpose of removing him or her as a trustee. But the rule causes genuine difficulties for many reasonable employers. For example, an MNT who had been nominated and selected while an active member of the scheme, but who then left that employment to go and work for a competitor, could become a deferred pensioner in the scheme. Many employers would feel very uncomfortable at that prospect and this has in fact been a major reason for employers deciding to propose an alternative arrangement. The eventual arrangement may well involve 50% of the trustees or directors being nominated by the members but, because they are not MNTs or MNDs as defined in the Pensions Act 1995, this statutory prohibition on the removal of a trustee or director who has been nominated by the members and who remains a member does not apply.
Yet when the Bill appeared, that change, despite having been set out in the consultation paper, had not been made. It looked as if the Government had changed its mind.
But in February, Jeff Rooker moved two amendments to "correct an accidental omission". The effect is to restore the policy intention so that the legislation includes a provision for MNTs or MNDs to stand down automatically if they change their category of membership. If an active member leaves to take up employment elsewhere and becomes a deferred member, the rules of the scheme can insist that that individual ceases to be a trustee. The Minister said: "The power is permissive. Such a rule will not be adopted without a conscious decision by the trustee or the employer. If such a rule is adopted, a trustee required to stand down will, of course, have the opportunity to stand for reselection, and the members may decide whether they want the person to serve as a member-nominated trustee. Such people will still be members of a scheme, although their category has changed. It is reasonable to give the membership the opportunity to decide whether they want a deferred member who was originally nominated when an active member to continue, or whether they want to nominate someone else." The amendments were unopposed.
Nomination by representative bodies
The Government also moved a further amendment to make it clear that, under the new scheme-specific route, employers can provide that organisations representing the interests of the members can make nominations for MNT or MND positions. Nominations by representative bodies may be in addition to, or instead of, nominations made by the members. Mr Rooker suggested that organisations such as trade unions and pensioner bodies would be included under the Regulation-making power inserted by the amendment to define which bodies could act to nominate MNTs and MNDs.
Winding up
Central to the measures contained in the Act that are designed to accelerate the winding-up process is the new requirement for those responsible for the process to make periodic reports to the Occupational Pensions Regulatory Authority (OPRA). Many of the details of the time limits for these reports will be set out in future Regulations. However, the Minister of State, during the House of Commons Committee Stage, explained that the first report would be required when a scheme has been winding up for three years or more, as had been proposed in the earlier consultation paper (OP, July 1999). However, there are many existing scheme wind-ups currently in progress and the Government wants OPRA to concentrate on the oldest cases first. As a result, the requirement to provide reports will have to be phased in, as summarised in the table, right.
Regulations will set out the information to be contained in the reports, which will include action already taken and a plan of future action. Mr Rooker commented: "The purpose of the requirement is not to provide an essay on what has happened in the past, but to ensure that there is action in the future." OPRA will have the power to extend the period if it is important to do so and if a delay would enable OPRA to receive more up-to-date information and more comprehensive details - for example, when the outcome of a course of action by the trustees would be known shortly after the next report is due. The Regulations will allow the period for follow-up reports to be varied if the default period of 12 months is inappropriate.
Directions from OPRA
Government amendments were also made in Committee to make it clear that OPRA can direct that information relevant to winding up should be provided to persons involved with the administration of a scheme as well as, or instead of, the trustees or managers. The Government considers that it may be more appropriate for those people to have the information if they are actually carrying out most of the work connected with the winding-up of a scheme. Regulations will list other persons to whom OPRA can direct that information must be provided and will also enable OPRA to direct action on grounds other than that reports from the scheme are due.
Index-linked annuities
On 22 March, the Government announced that it would be relaxing the current indexation rules for money-purchase pension schemes (OP, May 2000). Such schemes would be allowed to offer investment-linked annuities to any members who might wish to choose this option as an alternative to a traditional indexed annuity. An investment-linked annuity enables the annuitant to benefit from growth in a range of underlying investments after retirement, but at the same time exposes them to the risk of possible falls in pension income if investment performance is poor. As a result, the Government tabled an amendment to the Bill (which has become s.51 of the Act) that will have the effect of allowing funds in occupational schemes, subject to the limited price indexation (LPI) requirement, to be used to purchase an investment-linked annuity. Protected rights, however, are not covered by the amendment.
Combined benefit statements
The clause in the Act (s.52) that deals with combined benefit statements differs substantially from the original clause in the Bill. The recasting of the measure was necessary because of data protection issues. The redrafting means that state pension information can be passed to employers and pension scheme providers, unless employees indicate that they do not want such information to be disclosed. Under the law as it stood at the time of pilot tests being carried out by the Prudential and Sainsbury's (OP, June 2000), the individual consent of every employee was needed if state pension information was to be passed on. It was realised that this would have made the proposal for combined statements unworkable.
Pensions Ombudsman
Two sections of the Act concern the powers of the Pensions Ombudsman, although the original Bill contained only one clause. This original clause is now s.54 of the Act and introduces measures needed to prevent the Ombudsman's jurisdiction being reduced following the ruling of the Court of Appeal in the Edge v Pensions Ombudsman case (OP, September 1999). The Court of Appeal had said that the Ombudsman should not make directions that would affect the interests of those not directly involved in a complaint. This was because those not directly involved are currently not able to make representations to the Ombudsman and so would not be bound by his determination. Section 54 rectifies the problem by allowing the Ombudsman to appoint a person to represent a group of members with the same interests in any complaint or dispute.
The move represents a strong endorsement of the role of the Pensions Ombudsman by the Government after his mauling by the judiciary. Jeff Rooker, in discussing the present Ombudsman in the Committee Stage of the Bill said: "He also ruffles feathers, for which I pay tribute to him, because it means that he is genuinely doing the job of an Ombudsman." However, there is no party political division on this issue. The Opposition leader on the Standing Committee, Jacqui Lait, said: "I put firmly on the record the fact that we welcome the clause's effort to correct the difficult position that the Ombudsman was placed in by the case that stopped class actions."
The second section dealing with the Pensions Ombudsman, s.53 of the Act, deals with changes to his jurisdiction. It was introduced as a new clause during the Bill's Committee Stage and implements measures originally set out in the December 1998 consultation paper Strengthening the pensions framework (OP, February 1999).
Under s.53 the Ombudsman is allowed to consider five new types of case. First, it allows independent trustees to take complaints or disputes with other trustees or former trustees of the same scheme to the Ombudsman. If independent trustees discover that the actions of previous trustees were in breach of trust, their only options at present are to try to take the trustees to court, spending what may be limited scheme resources, or to persuade a member to make a complaint to the Pensions Ombudsman on their behalf. They may in future do so directly.
Second, at present when scheme rules are unclear on an issue, the trustees may have to go to court to obtain a ruling on their meaning, particularly when a scheme is winding up and the rules cannot be changed. The costs of doing so have to be met from the fund. In future, s.53 will allow the trustees to ask the Ombudsman for clarification if at least half the members of the trustee board agree to do so, with no cost to the scheme. The requirement that half or more of the trustees have to agree is in place because the Government did not want to overturn the principle that the majority view of the trustees should prevail.
The third new type of case the Ombudsman will be able to accept concerns complaints about an employer in connection with personal pensions. Currently, a personal pension holder can complain about the actions of the trustees or administrators, but not those of the employer. In the light of the new legislation in the Welfare Reform and Pensions Act 1999 enforcing the payment of contributions to personal pensions (including, of course, stakeholder pensions when these are legally established as personal pensions), employers will have an increasing role to play in personal pensions.
Also, divorcing couples concerned about the level of charges or the implementation of the pension share will be permitted to raise these issues with the Ombudsman. The Government wishes to ensure that those with pension credits awarded in a pension sharing case should be able to complain if they feel the pension scheme mishandled the pension sharing process.
Finally, a scheme member may raise an issue concerning their pension scheme with another authority, such as an employment tribunal. Currently, if they do so, even by mistake, the Ombudsman cannot later accept the case, but now s.53 ensures that he can accept the case if it has been referred to court or tribunal but has subsequently been discontinued.
Overseas residents
During the Bill's passage through Parliament, s.55 was introduced to implement European Council Directive 98/49/EC under UK law. Its purpose is to safeguard the occupational pension rights of employed and self-employed workers who move within the European Community. Although UK occupational pension schemes already operate within the spirit of the principle of the free movement of workers, there was nothing in existing UK legislation that placed an obligation on schemes to comply with two specific requirements in the Directive. Occupational pension schemes will therefore be prevented by s.55 from having scheme rules that allow the accrued pension entitlement of members or beneficiaries to be altered because the member or beneficiary wants payment to be made anywhere outside the UK. Secondly, the new clause will allow UK workers who work outside the UK to continue membership of their employer's UK occupational pension scheme. Any such scheme members, and the sponsoring employer, will be able to continue to make contributions to the scheme, subject to Inland Revenue limits.
Anti-franking
The eight steps in the proposed minimum benefit rules that will replace the current anti-franking requirements were set out in our discussion of the Bill (OP, February 2000). Some technical changes to alternative anti-franking rules were made during the Committee Stage. The amendments aim to clarify the legislation so that schemes have a sound basis for apportioning an amount of the overall scheme pension to rights arising from pensionable service prior to 6 April 1997.
In particular, they ensure that, for the purposes of the minimum benefit test, the amended legislation will require an individual's guaranteed minimum pension to be increased in line with earnings until the member leaves salary-related pensionable service or reaches state pension age, whichever is earlier. The original provisions required amendment because they would have permitted the increases to continue after the member had reached state pension age. That would have distorted the amount of statutory minimum pension that the scheme would be required to pay.
SUMMARY OF KEY POINTS
Changes to the Bill during its passage through Parliament ensure that the Child Support, Pensions and Social Security Act 2000:
THE STATE SECOND PENSION
Earnings on which S2P is based
Employees build up entitlement to S2P on earnings between the lower earnings limit (LEL) of £3,432 for 1999/2000 and the upper earnings limit (UEL) of £26,000 (figures rise in line with prices). The LEL serves as the qualifying earnings factor (QEF) for use in calculating S2P entitlement. The earnings factor is then the total of the earnings on which class 1 national insurance (NI) contributions have been paid or treated as paid. This last point applies because where an employee has earnings between the LEL and below the new primary threshold which is just above it, they will not pay NI contributions, but will qualify for the additional state pension.
Deemed earnings factors
When an employee's earnings reach the LEL, the employee is to be treated as if he or she had earnings equal to the low earnings threshold (LET) of £9,500 (this figure is in 1999/2000 terms and will be revalued in line with average earnings) for the purposes of calculating S2P. Entitlement to S2P will be calculated on an annual basis, so having earnings of up to the LEL in one week will not be sufficient to build up S2P entitlement; rather, total earnings over the year will need to reach the LEL.
A person is to be treated as if they had an earnings factor of £9,500 if they received, or were entitled to receive, invalid care allowance throughout the year. This will also apply if they were paid child benefit for a child under six or if they satisfied conditions to be contained in Regulations. Others who are to be eligible for S2P include those who receive income support because they are caring for a sick or disabled person, those who spend 35 hours a week caring for a person who receives attendance allowance and those who receive long-term incapacity benefit throughout the tax year and have paid NI contributions for at least one-tenth of their working life.
Calculation of S2P
This will differ according to whether it is done in the first or second phase.
First phase
Three new earnings bands are created. Band one is between the LEL and the LET. Band two is to be twice the width of earnings band one, rounded to the nearest hundred pounds. Using the 1999/2000 figures, band two is between the LET and £21,600. Band three is from this figure up to the UEL. The upper limit of band two will therefore increase faster than average earnings because while the LET will increase in line with earnings, the LEL will increase in line with prices.
The S2P differs from SERPS in applying different accrual rates to each of the above earnings bands. Under SERPS, anyone retiring after 6 April 2009 would have had one accrual rate of 20% on their earnings between the LEL and UEL. This follows reductions made to SERPS that cut the accrual rate from 25% to 20% and the earnings to which it applies from the best 20 years' service to an average across a person's working lifetime.
Under S2P, individuals will have an accrual rate of 40% on band one, 10% on band two and 20% on band three. Earnings within each of the three bands are to be revalued every year to maintain their earnings-related value. To calculate a person's S2P, the revalued figures in each band are multiplied by the appropriate percentage figure, the totals for each year are added together and the sum divided by the number of years in work. Transitional arrangements are to be implemented for people retiring before 6 April 2009 to reflect the accrual rate that they would have received if they had remained in SERPS.
Second phase
Regulations are required to bring in the second phase. Low earners, carers and disabled people will continue to earn entitlement to S2P as if they had an earnings factor of £9,500. Those with earnings above £9,500 will receive an S2P entitlement only on earnings up to the LET. Entitlement accrued under the first phase will be preserved.
Contracted-out employment
Once S2P has been introduced, the rebates paid to members of contracted-out salary-related (COSR) and contracted-out money-purchase (COMP) schemes will continue to reflect the current SERPS accrual rates. Rebates will be based on actual earnings, not the notional figure of £9,500 used for calculation of S2P. According to the consultative note on NI rebates issued by the Government Actuary's Department (OP, October 2000): "Members of COSR and COMP schemes earning below £21,600 (in terms of 1999/2000 earnings) will receive an S2P top-up from the NI Fund. This will be based on the difference between what their state second pension (based on the low earnings threshold if they earn less than that) would have been and what their SERPS entitlement would have been, if they had not been contracted-out." The top-up is to be paid with the state pension.
For individuals contracted-out through appropriate personal pensions (APPs), rebates will be based on accrual under the earnings-related phase of S2P. Those with an APP who earn below the LET will receive an S2P top-up from the NI Fund based on the difference between the LET and their actual earnings.
Other cases
Paragraph 9 of Schedule 4 provides for Regulations to be made dealing with cases where a person's circumstances change during the course of a year. This could be a change from contracted-out to contracted-in employment or from a salary-related scheme to an APP.
It will then be necessary to work out how much is required in respect of each type of employment. Regulations will aim to provide a top-up from the state scheme if someone who is contracted-out would have received more from the S2P than the amount they are treated as receiving in respect of their NI rebate.
Revaluation
The LET is to be revalued in line with rises in average earnings, calculated to the end of September of the preceding year. Earnings factors are also to be revalued in line with national average earnings, so maintaining the value of people's earnings over their working lifetime. In the S2P these percentages will be applied to the surpluses in a person's earnings factors in each of the three bands.
The annual revaluation of earnings factors is to cover the year to the end of September rather than December. This amendment is to ensure that revaluation figures taken from the Office of National Statistics are available for employers in good time as well as providing consistency with the revaluation of the LET.
The clause on the modification of earnings factors (s.38) is a consequential amendment that allows new Regulations to be made concerning the calculation of additional pension using part-years.
MISCELLANEOUS AMENDMENTS
The whole of what has become Part I of Schedule 5 to the Act was nodded through Parliament without amendment. The changes made by Part I of Schedule 5 are summarised below.
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REPORT DATES TO OPRA FOR SCHEMES IN WIND-UP |
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Start date of wind-up: before to OPRA |
First report due |
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January 1990 |
April 2002 |
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January 1993 |
April 2003 |
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January 1996 |
April 2004 |
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January 1999 |
April 2005 |
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January 2003 |
April 2006 |
OUR RESEARCH
This feature is based primarily on the Child Support, Pensions and Social Security Act 2000, the Child Support, Pensions and Social Security Bill, the Explanatory Notes to the Act and the official reports of debates in the House of Commons and the House of Lords.
