Legal experts have reported that schemes caught by the recent change in the definition of money purchase are trying to amend their benefits structures to remove the additional risk of guarantees.
However, advisers have said making the switch will be subject to legal restrictions and may be difficult to sell to the membership, if beneficial options are being removed.
From July 24, schemes that could develop a funding deficit were classified as defined benefit rather than money purchase, under section 29 of the Pensions Act 2011. The government estimates around 800 of 40,000 schemes have been affected by the change.
We will target a rate of return and every year we will apply that real money to your AVC pot, but if at any time the scheme goes bust … you have no right to it
Andrew Powell, Squire Patton Boggs
Andrew Powell, consultant at law firm Squire Patton Boggs, said at least three of his clients, which were redefined as DB schemes, were looking to remove the investment guarantees provided to members in order to escape the funding requirements they will now face.
One of the schemes is a legacy arrangement, offering a guaranteed investment return to members on their additional voluntary contribution pots, he said.
“A particular return they’re guaranteed is the better of a certain sum of money, 5 per cent per annum or alternatively the return on something like 30 per cent over the local government return index,” Powell said.
There could be problems with leaving newly redefined schemes as they are. “The first problem is, are you then faced with having to revalue the benefits?,” said Powell.
Since schemes now classified as DB are covered by the Pension Protection Fund, if the scheme were to go bust, members may see some of the AVC pot they have built up “spread across the deficiency of the scheme”, Powell said.
“[That would be saying] we will target a rate of return and every year we will apply that real money to your AVC pot, but if at any time the scheme goes bust … you have no right to it,” he said, adding this means there would always be a match between the amount the scheme holds and its liabilities.
Gaining member consent
Trustees and employers seeking to make changes to benefits must consult members at least 60 days before the intended change, under the Pensions Act 2004.
Schemes must gain member consent in order to make any changes to past service benefits, since they are deemed protected modifications under section 67 of the Pensions Act 1995.
Mark Howard, partner at law firm Clyde & Co, said communication on the issue could be difficult if schemes are mixing consent and consultation. "To try and explain it to members why you are doing this is going to be a tricky communication exercise," he said.
Rosalind Connor, partner at law firm Taylor Wessing, said making the change from money purchase to DB would not be as difficult for schemes that set up a money purchase section once they closed their DB scheme to future accrual.
“What they have often done is set that up as a new section of the same scheme,” Connor said.
Legal experts agreed schemes may explain to members via the consultation that the redefinition is a technical change that was not¹ intended when the scheme was set up.
Howard said: “It might be that you’d want to provide some incentive [to members] to go back to money purchase.”
Anne-Marie Winton, partner at law firm Nabarro, said the additional at-retirement flexibility afforded to defined contribution scheme members by this year’s Budget may persuade some members to consent to the switch back to money purchase.
“With the Budget changes people might think that’s what they want because they’re going to take their benefits as cash," said Winton.
Additional reporting by Ian Smith
¹The original version of this article read "a technical change that was intended when the scheme was set up". This has been updated.
