Abolition of contracting-out – Revaluation issues

The manner in which legislation has been amended in relation to the abolition of contracting-out may lead to some unintended consequences depending on how your scheme documentation is drafted – amendment may be required.

In February this year, we reported on the implications and steps that may be required as a result of the abolition of contracting-out on a Defined Benefit (DB) basis in April 2016, including in relation to revaluation of Guaranteed Minimum Pension (GMP).

GMP needed to be revalued in accordance with legislative requirements which allow a different, and possibly less generous, basis of revaluation to be applied to the GMP of a member once they have left service with the employer sponsoring the pension scheme and are no longer an active member. For active members, the legislation requires that GMP is revalued in line with average earnings, however once a member leaves service with the employer and becomes a member with preserved benefits there is an option to apply what is referred to as ‘Fixed Rate revaluation’ which is based on a rate set out in legislation

In many schemes, due to the way in which the governing documentation is drafted, this change in revaluation basis is triggered when the member ceases to be in contracted-out service by reference to the scheme. 

Although this was generally intended to trigger the change for employees leaving service with the employer, the abolition of contracting–out in April will effectively trigger this change for all active contracted-out members of a scheme.

An unintended consequence

The Government has recognised that this is an unintended consequence of the approach taken to deal with the abolition of contracting-out. In response, statutory mechanism has been introduced to deal with it.

The Occupational and Personal Pension Schemes (Modification of Schemes – Miscellaneous Amendments) Regulations 2016 (the Regulations) will allow any affected scheme to be amended by a resolution of the trustees taking effect on or after 6 April 2016. This may be passed retrospectively and must be passed before 6 April 2017.

The resolution will allow the trustees to amend the scheme so that any option to change to fixed rate revaluation is triggered when a member leaves pensionable service, as opposed to termination of contracted-out service.

Generally, any amendment impacting on revaluation of deferred benefits is a listed change which requires consultation with the employees. There are also specific regulations preventing amendments affecting GMP. However, the new statutory mechanism provided for by the Regulations allows the amendments to be carried out without a requirement to consult with employees and also without contravening the regulations which protect GMPs. 

First and foremost, employers and trustees will require to review the documentation governing their scheme to assess if amendment will be required.

If you have any questions or would like more information, please contact one of our pensions specialists below.

Author: Vicki Thomas

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

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