Pensions changes: protecting defined benefit pension schemes
The Pension Schemes Act 2021 brings in a range of measures, from new criminal offences to tighter funding rules, designed to strengthen the powers of the Pensions Regulator and ensure the security of defined benefit (DB) pensions. We are told both that it is “revolutionary” and that it will not “change commercial norms or accepted standards of corporate behaviour”. The reality is no doubt somewhere in between.
The new Act takes a three-pronged approach: more severe penalties for weakening financial support for a scheme, including new criminal offences; increased information powers, backed by more penalties; and new rules on scheme funding. It also builds on two strategies: engagement and self-assessment by corporates and trustees on both transactions and funding; and strengthened supervisory powers for the Pensions Regulator in the form of sanctions and investigatory powers.
The new criminal offences are attention grabbing. It is an offence, punishable by up to seven years imprisonment or an unlimited fine, for any person to be party to a transaction (by act or omission):
- that intentionally avoids, compromises, reduces an employer debt to a scheme or prevents recovery of such a debt without a reasonable excuse; or
- which they knew or ought to have known would be materially detrimental to the likelihood of accrued scheme benefits being received without a reasonable excuse.
The offences almost matches the existing grounds for contribution notices but a key difference is that the criminal offences can be committed by persons who are not connected with the employer and indeed, as secondary liability, by advisers. As an alternative to prosecution, the Pensions Regulator can impose a financial penalty of up to £1m. There are also two new grounds for contribution notices based on snapshot tests of the resources available to meet or the recoveries that could be made by the scheme in respect of a hypothetical employer debt at the time of the transaction.
The offences are broad and may in principle catch any course of dealing that reduces the resources available to fund the scheme or the scheme’s recoveries in a default scenario. This could include a wide range of ordinary business activities. This is subject to whether the person has a “reasonable excuse”. Much therefore turns on what may constitute a “reasonable excuse”.
The Pensions Regulator, as primary prosecutor, has issued a policy on its approach to investigating and prosecuting the new offences. This sets out three factors for determining whether a person has a reasonable excuse: whether the impact on the scheme was incidental; whether there was adequate mitigation to offset any detriment to the scheme; and whether there was a viable alternative which would have avoided or reduced such impact.
The key point is that harming the funding of a DB scheme may be an offence even for persons who otherwise have no duties to the scheme.
To support the Pensions Regulator in policing this, its information powers are extended to cover the administration of the employer’s business, its assets and any decisions on change of ownership. The Pensions Regulator may request documents, summon individuals for interview or carry out “dawn raids”. Failure to comply, including failure to attend an interview or answer a question, without a reasonable excuse, is a criminal offence and can result in financial penalties, including daily fines.
In short, anyone involved in a corporate transaction affecting an employer with a DB scheme, including shareholders, lenders, counter-parties and advisers, may be called for interview, asked for documents or have their premises searched.
To ensure the Pensions Regulator has awareness of such transactions, employers and connected persons are required to give notice to the Pensions Regulator prior to negotiating or agreeing material transactions under the updated notifiable events regime. Thereafter, they are required to give detailed reports to the Pensions Regulator and to the trustees on the main terms of the transaction, its impact on the scheme, how any impact is to be mitigated, engagement with the trustees and any changes or termination of the transaction. Relevant transactions are the sale of assets of the employer representing 25% of annual revenue or gross assets or the grant of security, including fixed and floating charges, over its assets.
These provisions are not yet in force. They will require corporate groups to engage in advance both with the Pensions Regulator and the trustees on corporate transactions or refinancings. Failure to comply may lead to financial penalties of up to £1m for the employer, connected entities and their directors and other managers. Provision of incorrect or misleading information, even by omission, may lead to criminal prosecution punishable by up to two years’ imprisonment or a fine, or financial penalties.
The expectation is that the notifications and resulting engagement with the trustees and the Pensions Regulator will ensure the scheme is protected as a creditor.
The third limb of the strategy is the new rules on scheme funding. These are not yet in force but they will require a higher funding target to be adopted reflecting the intended long term investment strategy: more risky assets will require bigger buffers on top of the funding of the liabilities or “technical provisions”. The rules avoid mandating the investment strategy or the size of the buffers but will set principles. The trustees are required to take ownership of the strategy, periodically reflecting on experience and how to respond, and reporting such reflections to the Pensions Regulator. It is a flexible but demanding structure that does not usurp the trustees’ powers but holds them to account. It avoids a one-size-fits-all, too tight for some and too loose for others, and that might create concentration risks in asset markets.
The Pension Schemes Act 2021 protects DB schemes as creditors, creates an unnerving range of offences for executives and advisers who fail to protect the scheme, gives the Pensions Regulator visibility on material transactions and adds new buffers to scheme funding. The combination should persuade corporate groups to get these schemes fully funded and transferred to insurers.