Guest comment: DC consolidation - beware the legal pitfalls

The Pensions Regulator’s annual DC Trust report confirms the ongoing trend towards DC consolidation. The number of schemes with 12 or more DC members declined by 12 per cent last year. Membership of DC master trusts continues to grow with savers now invested in 38 authorised master trusts holding nearly £38.5bn in assets.

However, in the rush to master trust, trustees are failing to spot the legal hurdles that can arise and may be at risk of future claims from members. In this article, we highlight the issues.

To facilitate the consolidation of small occupational DC schemes, amendments were made to the Preservation Regulations in April 2018 to simplify the transfer process for ‘relevant money purchase benefits’ to authorised master trusts.

Previously, bulk DC transfers required actuarial certification. Under the amended legislation, members’ accrued DC benefits can be transferred without consent as long as the transfer is to an authorised master trust.

However, some trustees mistakenly believe they can bulk transfer legacy DC benefits that have certain guarantees, such as a guaranteed annuity rate or investment return, many in with profits policies.

These benefits are not ‘relevant money purchase benefits’ so cannot be transferred without individual member consent. The options for dealing with such ‘guarantees’ are currently limited and often result in savers’ benefits being moved into a deferred annuity contract to facilitate wind-up, but these policies tend not to attract ongoing investment.

In its consultation on the Future of Trusteeship and Governance, the regulator sought respondents’ views as to how to overcome this hurdle.

Of the three options under consideration, assignment of policies to individual savers without crystallising their benefits was the preferred option. The regulator and the DWP intend to investigate the possibility of assignment to a new trust, with any with profits or other guarantees remaining with the existing insurer.

If a scheme can transfer all accrued benefits to a master trust, another issue is whether any of the transferring members have pre A-day protections.

Those protections are the right to a protected pension age (broadly, the right to receive their pension before age 55) and the right to take more than 25 per cent of their savings as tax free cash. To ensure those protections are not lost on a transfer, the transfer must be a block transfer within the meaning of Schedule 36 of the Finance Act 2004.

Legal advice should always be sought on whether a transfer is a block transfer, but some key points include: the transfer must relate to the member and at least one other member; the transaction must be made under a single agreement for a single transfer; partial transfers (e.g. transfers of DC benefits in a hybrid scheme or AVCs in a DB scheme) will not constitute a block transfer; and before the transfer is made, the member cannot have been a member of the receiving scheme for more than 12 months.

As the DC market consolidates, the fourth condition could create issues as, given the reducing number of master trusts, members could already have benefits within the receiving scheme. We may see calls for a removal of this condition in time.

Another obstacle to DC consolidation is where DC benefits are subject to a DB underpin, typically in the form of a Guaranteed Minimum Pension (GMP) underpin or a Reference Scheme Test underpin.

While it is legally possible for underpinned benefits to be transferred to a master trust (by obtaining an actuary’s certificate) it is unlikely that a commercial master trust would accept them.

Alternatives include: transfer out the members’ benefits with their consent - consideration would need to be given to the other requirements under the contracting-out legislation and the Code of Practice on Incentives Exercises. However, a GMP would not need to be provided in the receiving scheme.

Additionally, separate the underpin benefits from DC benefits - a calculation would need to be made at a point in time to ascertain if the benefit exceeds the underpin and, if so, by how much. If the underpin bites, trustees could secure the DB benefits with an insurance company. If the underpin does not bite and there are additional DC benefits, the benefits could be separated out, although splitting benefits can affect A-day protections; take out a deferred annuity contract: each member’s total benefits (the underpin and any additional top up) could be secured with an insurer.

Finally, transfer to a DB superfund: an alternative future option may be to transfer the underpinned benefits to a DB consolidator. It is still uncertain when one or more models will receive regulatory clearance but discussions could be held in the meantime.

Trustees considering DC consolidation need to take early legal advice on the potential obstacles to their plans. Getting it wrong can result in significant losses for members.

Trustees who complete a bulk transfer without consent do not receive a statutory discharge of liability so the importance of obtaining advice on what is likely to be the most significant decision for any DC trustee (and the possible need for indemnities or the amendment of scheme rules to give protection) should not be underestimated.

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