The Pensions Act, perhaps Robert Maxwell's most enduring legacy, received Royal Assent on 19 July 1995.
It is designed to put pensions on a more secure, equal and sustainable footing for the coming century but how will it affect the providers of financial services in the future?
The first part of the Act is concerned with strengthening the security of funds held by company pension schemes. The protection depends on three factors: the minimum funding requirement (MFR); the requirement for one third of the trustees to be elected by the members; and the Pensions Compensation Scheme.
The minimum funding requirement (MFR)
From April 1997 all final salary pension schemes will be subject to the MFR – the requirement that the value of assets is at least equal to their liabilities.
Trustees will have to obtain an actuarial valuation at intervals of no more than three years and obtain annual certificates to check on the funding position in between.
In the certificate the actuary must state whether the contributions are adequate to meet the MFR. If this cannot be stated, the trustees must get an emergency valuation within six months.
This means that, for the first time, the rate of funding will be subject to external checks and not left to depend on the requirements of the sponsoring employer.
In effect, the Act converts the actuary from being a company adviser to being the trustees' adviser and watchdog for the members.
The trustees will have to maintain a contributions schedule showing the rates of contributions payable by the employer and the members of the pension scheme, and the due dates for payment. Again, it is the actuary who certifies the rates of contributions.
The schedule should be agreed between the employer and the trustees, but if no agreement is reached, the schedule must show the contribution rates which the trustees, advised by the actuary, decide are adequate for the purpose of satisfying the MFR.
This represents an enormous shift in the balance of power to the actuary and the trustees, who will effectively be given the power to decide the employer's contribution rate for the purpose of meeting the MFR.
When contributions are not paid in accordance with the schedule, the trustees must notify the Occupational Pensions Regulatory Authority (OPRA) and the members of the pension scheme. Any unpaid contributions, whether from the employer or the members, will then be treated as a debt due from the employer. Where the trustees believe the MFR is not being met, they must prepare a report. If they do not, they can be removed or fined.
The Government has indicated that there will be a 12-month period for attaining a level of 90 per cent of the MFR and five years for attaining 100 per cent. In addition there will be a five-year transition period from 1997 before the five-year time limit for meeting the MFR takes effect.
Most schemes are already funded at the level required to meet the MFR but about 10 per cent are not. The Government has estimated that the cost to British industry of complying with the MFR is between £300 million and £400 million over a 12-year period. As ever, security has a price.
In addition, the hoary old practice, indulged in by companies teetering on the brink of insolvency, of using members' contributions deducted from pay to finance the business is about to be stopped. If such contributions are not handed over to the trustees within a month, the employer will be guilty of a criminal offence.
The second part of the Act aimed to underpin the security of members' benefits is the requirement that every company pension scheme should have at least one third of the trustees nominated by the members.
For financial services providers, the key issue is that the new trustee board will be handed the power to invest the pension scheme's assets. It is likely the trustees will decide to delegate the power to an investment manager.
If the trustees decide to do this, they will still have to maintain a statement of investment principles. This statement must cover: the kinds of investments to be held; the balance between different kinds of investment; the expected return; and the realisation of the funds. The statement must be drawn up after taking suitable advice and after consulting the employer.
When giving advice the investment manager must have regard to three issues: the need for diversification of the investments; the suitability of the proposed investments; and the suitability of the proposed investment as an investment of that description.
Hopefully, as a result of these discussions the trustees will understand the service an investment manager is meant to provide. In addition, the prospective investment manager will need to explain in words which the trustees can understand what it is he is trying to do. All too often, the language used in investment presentations sounds like it comes from a different planet.
Contrary to many people's expectations, and despite what happened in the case of the Maxwell pensioners, schemes will not to be required to appoint independent custodians to hold their other assets.
Trustees and pension fund members are very concerned about this issue, and it seems likely that there will be a gradual drift towards separate custodianship of assets.
The Pensions Compensation Scheme
The Act sets up the Pensions Compensation Board and Scheme. This will cover schemes, whether final salary or money purchase, where the employer is insolvent and the value of the assets has been reduced because of theft, fraud or dishonest misappropriation; in the case of a final salary scheme, where the value of the assets is less than 90 per cent of the liabilities; and where it is reasonable that members should be compensated.
The amount of compensation must not exceed 90 per cent of the liabilities of the scheme. The board can make payments on account and can recover payments which, with hindsight, should not have been paid.
There are a number of other important areas covered by the Act, including divorce and equalisation.
For those involved in financial services, however, the other significant change introduced by the Act is found in Part III, which deals with personal pensions.
Here the personal pension holder is given the power to defer the purchase of an annuity from the age of 60 to 75 while at the same time being able to draw a specified yearly income from his fund. The specified yearly income must not be greater that the annuity which the member could have bought, or be less than 35 per cent of that amount.
In addition, where a member chooses to defer the purchase of an annuity, income withdrawals from his personal pension fund may be made subject to the following conditions: they must not be made before the age of 50, except where the member is suffering from infirmity or the Inland Revenue accepts that his occupation has a customary lower normal retirement date; they must not be made after the age of 75; the total withdrawals in each year must not be less than 35 per cent or more than 100 per cent of the annuity otherwise purchasable; the fund from which withdrawals may be made is calculated after allowing for the tax-free lump sum; and the date for calculating the annuity otherwise purchasable for the first three years is the date on which the member chooses to make income withdrawals and for each succeeding period of three years is the first day of that period.
The Act allows the member to take his sum either on his normal vesting date if he buys an annuity, or when he decides to make income withdrawals. There are similar provisions about income withdrawals if a dependant's annuity is payable after the member's death.
The dependant can choose to make income withdrawals until the age of 75 or, if earlier, the member's 75th birthday.
Return of fund on death
On the member's death a return of fund is allowed, after allowing for any income withdrawals, as long as: the member was under 75; no annuity had been purchased from him or his dependants; it is paid within two years of his death; tax is payable at 35 per cent on the amount of the refund.
The lump sum death benefit can be paid under the usual discretionary trusts in order to escape inheritance tax.
The new Inland Revenue model rules for personal pensions contain the appropriate provisions to enable the payment to be made to or for the benefit of anyone in accordance with the member's written directions.
After a member has chosen to make income withdrawals, no further contributions or transfer payments can be made. Income withdrawals will be treated as earned income. The Act permits these provisions to be extended to contracted-out money purchase schemes.
The changes being introduced by the Pensions Act will keep those directly involved in the business busy for many years to come. But, as indicated by this article, the Act has important implications not just for pensions' specialists but for those involved in financial services as well.