Purchase scheme not working as intended

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Now let us just take a step back and make it clear that for the vast majority of money purchase schemes there is no question that they are not money purchase schemes. Contributions are paid in by the employer and/or employee, these are invested and at some later date the value of the investments is used to provide retirement benefits which may take a variety of forms. This issue applies to the tiny minority of money purchase schemes, perhaps some 2 per cent, that also contain an element of defined benefit. These are ‘hybrid’ schemes.

This question has been the subject of a number of court cases. The reason for such legal activity is not uncommon as the legislation does not do ‘what it says on the tin’. The current legislation, and in particular the definition of money purchase, does not work as it was intended to by the department for work and pensions. The DWP believed, along with most people, that a scheme could not be a money purchase one if a funding deficit could arise.

The most recent case concerned the Imperial Home Décor Pensions Scheme and was filed by Bridge Trustees, the trustee company, in 2006. The pension scheme was winding up with a deficit of £40m and the trustees were seeking to clarify a number of points, particularly section 73 of The Pensions Act 1995 which applies to salary-related benefits but not money purchase benefits. The scheme was originally a DB scheme but following a restructure some members became money purchase members but with two non-money purchase aspects:

* At retirement the trustees pay a pension from the scheme (a pure money purchase scheme would utilise the scheme assets to buy an annuity).

* The return on members’ money purchase funds was the value of these funds or a fund using a specified guaranteed rate if higher.

This was a ‘hybrid’ arrangement as it was possible for either of the above two points to lead to the scheme having a funding deficit. Based upon the definition in section 181 of the Pension Schemes Act 1993 the government believed that the members would be fully protected as the scheme would not fall into the category of a money purchase scheme. This was not how the high court interpreted the legislation in 2008. As a result the DWP took the case to the court of appeal and, following its judgement in 2010, subsequently appealed to the Supreme Court. The latter dismissed the DWP’s arguments on 27 July 2011.

It may be useful to take a brief look at the key aspects that the Supreme Court considered when arriving at a decision that perhaps went against common understanding of the legislation. The Supreme Court’s press summary of the judgement is useful here. One of the main reasons for the judgement concerned, as we would expect, the definition of money purchase schemes in the legislation. The court explained that “the statutory definition makes no express reference to investment return”. The court decided that “the equilibrium of assets and liabilities is not a requirement of the statutory definition of a money purchase scheme (and similarly for money purchase benefits)”. The judgement also considered internal annuities, as opposed to the purchase of annuities from a life office, and found these not to be incompatible with money purchase benefits. The court of appeal had earlier pointed out that both methods were very similar as both used annuity tables based on actuarial calculations when the member retires to convert a lump-sum into an annuity. The deputy judge said that “the distinction would produce insupportable anomalies”.

The DWP was unhappy with the judgement as it meant that schemes with similar benefits would be classified as money purchase schemes even though the benefit structure could lead to them being underfunded. As a result the scheme would not be subject to the statutory funding regime and members’ benefits would not be protected by the Pensions Protection Fund in the event of insolvency. The government announced, on the same day as the judgement, that it would amend the legislation to make certain the position and thereby negate the judgement. Retrospective amendments, effective from 1 January 1997, were made in section 29 of the Pensions Bill 2011 but the implementation of the changes was left to be introduced at a later date since the government wished to enact transitional arrangements to prevent unintended consequences of backdating the change.

The government has now published the keenly awaited draft secondary legislation – Pensions Act 2011 (Transitional and Consequential Provisions) Regulations 2014 – by way of a consultation document. The consultation will be open until 12 December 2013. As with most legislative changes it is the transitional arrangements that will be the most complicated. Meeting every set of circumstances that already exist, or that have already been dealt with, is going to be difficult and hence why the government seeks to obtain the input of interested parties. A total of 51 questions are asked in the consultation and I am sure there will not be a shortage of responses.

Assuming the amendments to the Finance Act 2011 (for example section 29) are shortly implemented we will in fact be back to where we thought we were in the first place. On to the next question I say.

A final point to note that this is a specialised area and expert opinion should be sought before any action is taken. This article is intended to give a flavour of the issues at play in considering and answering this important question.

Colin Batchelor is a freelance pensions consultant

Amendments to the Finance Act 2011

The amendments provide that:

* A benefit (other than a pension in payment) will be treated as a money purchase benefit where: “its rate or amount is calculated solely by reference to assets which (because of the nature of the calculation) must necessarily suffice for the purposes of its provision to or in respect of the member”; and

* Pensions in payment will only be treated as a money purchase benefit where they are secured by way of an annuity contract or insurance policy taken out with an insurer and where “at all times before coming into payment” the benefit fell within the meaning of a money purchase benefit set out above.

Key points

Defining a money purchase scheme has significant ramifications for how a scheme is managed, regulated and governed

Defining money purchase schemes has been the subject of a number of court cases

The government has now published the keenly awaited draft secondary legislation by way of a Consultation document