Offsetting costs from the end of contracting-out

Some employers, especially those with schemes closed to new joiners and a declining population of active members, are deciding simply to leave things as they are and absorb the additional NI cost. 

For those wishing to offset the loss of the NI rebates, the options are to:

• close their scheme to future accrual and offer future pension benefits through an alternative – most likely defined contribution – arrangement;

• amend their scheme to reduce the cost of future benefit accrual; or

• increase member contributions – remembering that employees face their own increase in NI contributions from April 6, with an individual earning £43,000 or more facing a reduction in take-home pay of around £40 per month.

Types of schemes

Private sector employers may use a statutory amendment power, available until April 2021, to offset the higher NI costs by increasing member contributions, reducing future benefit accrual, or a combination of the two.

Whichever path is used for amending the scheme, the affected members must be consulted and given at least 60 days to respond

An actuary’s certificate will be needed, to confirm that the value of the changes does not exceed the employer’s increased NI costs.

The statutory power may be used more than once, provided the total value of the amendments made falls within the upper limit.

Trustees must provide any information ‘reasonably requested’ by the employer in connection with using the power.

It should be pointed out that the statutory power may not be used in respect of public sector schemes, nor in relation to ‘protected members’ from certain former nationalised industries. 

For non-segregated multi-employer schemes, the power may be exercised by the principal employer, nominated under the rules, or by the sponsoring employers, to act on the employers’ behalf.

Benefit accrual changes

When calculating the value of a reduction in future benefit accrual, the actuary must use the methods and assumptions used in the most recent actuarial valuation for valuing the technical provisions, updated if necessary to reflect market conditions. 

However, the employer may instruct the actuary to remove the element of prudence included in the technical provisions calculation meaning that, effectively, the reduction is valued on the cash equivalent transfer value basis. 

The CETV basis often results in lower values than the technical provisions basis, so removing prudence from the assumptions can allow a greater reduction in future benefit accrual.

Having obtained an actuary’s certificate, the employer must consult the trustees about an appropriate amendment date.

Changes to future benefit accrual or member contributions can also be made under the scheme’s amendment power, though this will often require trustee consent. 

Actuarial calculations are not required, although some trustees may ask for evidence of the value of any reductions they are being asked to consent to.

Some amendment powers restrict amendments to future service benefits – in such cases the statutory amendment route is likely to be more useful.

Whichever path is used for amending the scheme, the affected members must be consulted and given at least 60 days to respond. 

Member communications will need to be carefully drafted and disclosure requirements complied with.

Auto-enrolment tests

Salary-related contracted-out schemes were automatically ‘qualifying schemes’ for the purposes of the auto-enrolment requirements. 

From April 6, the benefits these schemes provide must pass one of a range of tests for qualifying schemes if they are still to be used to meet the employer’s auto-enrolment obligations.

Where relevant, employers should ensure that any reduction to future benefits will not take their scheme outside the criteria for being a qualifying scheme.

Duncan Buchanan is president of the Society of Pension Professionals and partner at law firm Hogan Lovells, and Jill Clucas is counsel at Hogan Lovells