Abolition of DB contracting-out: DWP publishes regulations

The DWP has now published a response to its consultation on rules for formerly contracted-out schemes in light of the abolition of DB contracting-out next year.

5 August 2015

On 16 July the DWP published its response to the consultation on the rules which will be put in place for formerly contracted-out schemes when contracting-out is abolished for defined benefit (DB) schemes in 2016. The associated regulations were laid before parliament on the same day. This follows the publication in March this year of the finalised regulations in relation to the override power which will allow contracted-out schemes to be amended in certain respects to deal with abolition.

Contracting-out for DB schemes will be abolished with effect from 6 April 2016. After that date accrued contracted-out rights will be protected in DB schemes as guaranteed minimum pensions (GMPs) or section 9(2B) rights. There is therefore a need to amend the existing legislation to protect those rights. The government has also agreed to make changes to mitigate the impact of abolition on employers. Since May 2014, the DWP has been consulting on two sets of draft regulations: the Occupational Pension Schemes (Power to amend schemes to reflect abolition of contracting-out) Regulations 2015 (the “Override Regulations”) and the Occupational Pension Schemes (Schemes that were contracted-out) Regulations 2015 (the “Rules Regulations”).

The Override Regulations
In March of this year the DWP published its response to the consultation on the proposed Override Regulations and a finalised form was laid before parliament on 4 March. The Pensions Act 2014 allows an employer to amend a scheme in order to take account of the increases in national insurance contributions (NICs) which arise as a result of the abolition of contracting-out. The Override Regulations provide a framework for the exercise of this power.

The power may only be used to recover the increase in NICs though adjustments to the members’ future accrual or future contributions - subsisting rights cannot be adversely affected by the changes. Amendments cannot however be made to benefits for “protected persons” formerly employed in nationalised industries. An actuary will be required to certify that the amendments comply with the legal requirements. The employer is not permitted to use the override power to take over the discretion or decision-making in respect of a matter which is currently exercised by the trustees (eg. discretion to permit early retirement).

As with a normal amendment under a scheme’s rules, the consultation requirements will apply to any change which is made using the override power. Where the employer seeks to make changes to deal with the end of contracting-out by using the normal amendment power under the rules, the DWP recommends that trustees should obtain the employer’s written agreement that they will not subsequently use the override power to make further changes.

The Override Regulations provide further guidance on the manner in which an actuary is to carry out the calculation and provide the certification. It should be noted that the DWP advises that the scheme actuary should not be asked to carry out this calculation and a separate actuary should be appointed by the employer in order to prevent any conflict of interest arising.

The Rules Regulations
The Rules Regulations set out the rules which a formerly contracted-out scheme will need to follow after abolition. As part of this, many of the provisions contained in the Occupational Pension Schemes (Contracting-out) Regulations 1996 will be revoked with effect from the abolition date (6 April 2016). Some provisions are, however, to be retained with amendments designed to protect section 9(2B) rights and GMPs.

Taken together, the Rules Regulations and the Pensions Act 2014 will require DB schemes which were formerly contracted-out to continue to meet the legislative requirements relating to GMPs and Section 9(2B) rights. This will include, amongst other things, the protection of benefits for surviving spouses and civil partners and revaluation requirements. It is, however, unclear how this will impact on certain DC schemes which have integrated the existing contracting-out legislation into their rules. For example, it is not clear how this would be applied for members with money purchase benefits who currently benefit from a reference scheme underpin. As a short-term solution, the DWP has proposed to preserve the provisions relating to the reference scheme test immediately following abolition but this issue will have to be revisited at a later date. 

The Pension Act 2014 (Savings) Order 2015
The Pensions Act 2014 (Savings) Order 2015, coming into effect on 6 April 2016, will also preserve a number of provisions contained in the Pension Schemes Act 1993. The preserved provisions are intended to allow pension scheme trustees and HMRC to carry out all necessary activity relating to contracted-out employment prior to 6 April 2016. This will include matters relating to the issue and surrender of contracting-out certificates and the application of earnings factors for early leavers who left contracted-out employment before 6 April 2016.

The Override Regulations came into effect on 6 April 2015. This is intended to give employers sufficient time to amend their schemes, carrying out the associated consultation process, prior to the abolition next year. Employers should therefore be considering now whether any amendments are required in order to mitigate the financial impact of abolition.

The Rules Regulations and the Savings Order come into effect on 6 April 2016. The DWP has, however, confirmed that it will consult further on issues relating to the Rules Regulations later in 2015 and we can expect to see further changes being made as a result. In particular, changes will be needed to deal with uncertainty surrounding the reference scheme underpin.

Trustees and their advisers should be reviewing their scheme’s rules with a view to identifying any benefits which are currently calculated by reference to existing state pension benefits, which will change from 6 April 2016. Trustees should also seek confirmation from the employer as to what amendments, if any, are being considered and, more generally, how contracted-out benefit are to operate under the scheme in the future.