The key legal issues for pension schemes in 2023

Pensions dashboards

At the top of the list for many lawyers consulted was the forthcoming introduction of pensions dashboards. As well as connecting to dashboards by their staging deadline, schemes must act on ‘find requests' and ‘view requests' relating to individuals, and provide members with information about their pensions.

They should also co-operate with the Money and Pensions Service (Maps) and report information to The Pensions Regulator (TPR) and Maps.

With the largest schemes being required to connect by the end of the year, there is a lot that schemes can do to prepare now, says Pinsent Masons pensions partner Tom Barton. He notes that devising an action plan around their connection deadline and working on improving data quality and their data matching policy will go a long way for schemes who want to get ahead. He notes: "We can also expect an increase in transfer requests; on seeing their pensions in one place for the first time, members may want to consolidate their savings. Schemes will need up-to-date processes and well-trained staff to handle more queries and process more transfers whilst also protecting members from scams."

Hogan Lovells counsel knowledge lawyer Jill Clucas adds that schemes need to ensure they have member data in good order, as they will be expected to respond to ‘find' and ‘view' requests within tight timescales.

"Defined contribution (DC) schemes must disclose the member's accrued and projected income and fund value. Defined benefit (DB) arrangements face more complex obligations, including to provide the revalued amount of a deferred member's pension," says Clucas. "This is not currently required under the existing disclosure regime, and, in practice, most administrators revalue deferred benefits only when the member retires.

"Much of the work will be done on trustees' behalf by their administrators and IT specialists: ensuring administrator capacity is expected to be a challenge, and administration agreements are likely to need revising to reflect the additional requirements."

LDI issues

The market turmoil following the Truss/Kwarteng Mini Budget in September exposed vulnerabilities in the leveraged nature of liability-driven investment (LDI) funds, says Burges Salmon litigation partner Suzanne Padmore. She says the collateral calls were far more than what had been seen previously, and there was huge variation in the abilities of schemes and employers to deal with them. Padmore notes: "They now face greater exposure to movements in interest rates and inflation, and a greater cost of returning to the hedged positions they held before the Mini Budget - due to greater market instability being factored into the cost of LDI products."

The trustees of schemes who fared worst from the crisis will likely be considering whether they could be in line for a claim. "Where a scheme's hedging position was not what it was understood to be, the question for these schemes is whether the level of the hedge was managed and if so, how effective was that management during 2022?" continues Padmore. "Where hedge levels had drifted, there may be scope for claims if, as 2022 wore on, that approach presented a level of risk not properly understood or accepted by trustees."

Schemes which invested in pooled LDI funds may also have suffered, as some pooled funds did not accept cash to meet collateral calls. "Some are rumoured not to have had the resource to process the calls, whereas others may have taken that approach believing that treating all investors in the same way would be fairer than a fragmented approach," says Padmore.

It will be interesting to see how the recent crisis will affect the Department for Work and Pensions (DWP) or TPR's approaches to DB funding, adds Hogan Lovells' Jill Clucas, noting that, while the House of Commons inquiry is yet to report, evidence from pension experts was important.

"It was suggested that regulators did not sufficiently monitor the cumulative impact of individual schemes' investment and funding decisions and the potential for systemic disruption when many schemes faced collateral calls at the same time," continues Clucas.

"The lack of information held by TPR about the level of leverage in schemes was also criticised, with recommendations that this be addressed in future scheme returns."

Regulation and legislation

Many regulatory developments are expected come to fruition this year, the first of which will be TPR's new DB funding code, the second consultation on which was launched last month. DLA Piper partner Matthew Swynnerton says the new code is expected to be operational from September and will propose "twin-track approach to valuations, under which schemes will be able to choose between a bespoke route or a more prescriptive fast-track option".

Other regulatory developments coming into force this year will include scheme funding regulations, says Linklaters senior associate Claire Collier. She says these will require schemes to have a "long-term objective of full funding on a low dependency funding basis, propelling trustees and employers towards fully funding their schemes on a buyout or self-sufficiency basis".

TPR's notifiable events regulations will also materialise this year, says Collier - rules that will change employers' reporting obligations so that trustees and the regulator will be alerted about financial decisions which could impact the scheme at an earlier stage.

DLA Piper's Matthew Swynnerton says schemes should be aware that draft regulations on this issue had been issued in 2021 - draft regulation that would affect areas such as the sale of a material proportion of the sponsoring employers' business or assets, as well as the granting or extension of relevant security that would rank ahead of the scheme.

Swynnerton explains: "Depending on how the final regulations are drafted, the implications for corporate activity could be significant, with trustees potentially being given a seat at the table in relation to corporate transactions and reorganisations."

He added that, as things currently stand, the obligation to notify is triggered before the event has occurred adding that "the final regulations and, hopefully, the clarity they will bring, are eagerly anticipated by trustees and employers alike".

SH Legal senior knowledge lawyer Julia Ward and partner Stephen Richards agree - saying the new requirements mean "sponsors will need to consider the impact of corporate activity on their DB pension schemes, put in place sufficient mitigation and actively involve the trustees in the process".

DLA Piper's Matthew Swynnerton also says schemes will also need to be aware of the progress of the EU Retained Law (Revocation and Reform) Bill, which means the majority of retained EU law will expire at the end of this year. He explains: "This could have significant consequences for schemes in respect of issues such as discrimination and Pension Protection Fund compensation levels."

Swynnerton additionally notes the DWP's review of the conditions for transfers regulations will be published by May 2023.

He says: "The regulations were designed to address the issue that where a member has a statutory right to transfer, trustees were required to comply with the request even if they had concerns in relation to pension scams and give trustees greater powers to stop transfers where there are scam concerns and to direct members to guidance from MoneyHelper when scam warning signs are identified."

Swynnerton notes, however, there is uncertainty surrounding the amber flag relating to overseas investments and the red flag relating to incentives - but says the upcoming review should address this.

TPR is also expected to finalise its single code of practice, in which ten codes will be merged into one, in early 2023, says Burges Salmon pensions practice development lawyer Catrin Young.

She expects, however, that parts of the code derived from the EU Institutions for Occupational Retirement Provision (IORP) II Directive could be removed or watered down because of the retained EU law bill.

Young explains: "The IORP II requirement to establish and operate an effective system of governance now sits in section 249A of the Pensions Act 2004 and will not, under the bill, automatically fall away on 31 December 2023." But she says it is uncertain whether DWP will amend s249A or Occupational Pension Schemes (Governance) (Amendment) Regulations 2018.

Pinsent Masons pension lawyer Helen Hanbidge says the new code of practice is timely, especially given the recent rise in inflation and the LDI crisis - which she says have shown the importance of schemes reviewing their investment decision-making processes, and their ability to respond to economic turbulence. She explains: "Where elements of the code are not compulsory for some schemes, TPR believes they model best practice and are a starting point for ‘a thorough review of the processes and procedures of any scheme'."

DC consolidation

Fieldfisher pensions partner Jeremy Harris believes 2023 will see pressure for the consolidation of DC schemes increase further. "The increasing regulation of DC occupational schemes tends to make it uneconomic to continue to operate such a scheme of modest size," he says. "A particularly onerous requirement is to carry out a value for members assessment and to document that assessment and a review of the scheme's governance arrangements in an annual chair's statement."

Harris says DC master trusts tend to make more economic sense and provide lower per member administration costs, higher standard of governance and administration, economies of scale, and wider range of investment and decumulation options - saying this is likely to mean 2023 will see the continuation of the trend of smaller DC schemes transferring to larger master trusts.

De-risking

Recent increases in gilt yields have led to an improvement in the funding position of UK DB pension schemes - with Burges Salmon pensions partner Michael Hayles saying the funding ratio of DB schemes on a full buyout basis increasing over the last year, from 73.7% to 79.2%, meaning an increasing number are closer to the funding levels required to de-risk or fully buyout their pension obligations.

Hayles points towards a recent Lane Clark & Peacock de-risking report that estimates this funding increase will translate to a potential demand of over £200bn for transactions over the next three years but says schemes need to ensure they are prepared to go to market and are sufficiently attractive to insurers.

He says to become market-ready and more attractive to insurers, schemes must cleanse data to remove gaps, consider marital status write-outs, produce an accurate benefit specification, and codify trustee discretions for benefits which exist under scheme rules.

Hayles says they should also form a joint working party between trustees and the sponsor to promote efficient decision-making as well as analyse whether the scheme has capacity and power to enter into the bulk annuity contract, and consider merging group schemes, or approaching the market on a collective basis.

"Where schemes have the benefit of interest from multiple insurers, trustees should also be prepared to spend time to understand the relative strength of the insurers, not only from a pricing perspective, but considering member experience, legal terms and covenant - as this may be the biggest decision that trustees will ever make," adds Hayles.

The value of longevity swaps is also expected to grow further in 2021, say Eversheds Sutherland partner Hugo Laing and associate Ellie Legg - who say such swaps can mitigate longevity risk without the cost of a full buy-in or buyout.

"The benefit of longevity swaps as opposed to buy-in transactions is that there is not a full upfront payment of premium," say Laing and Legg. "Longevity swaps can therefore mitigate longevity risk without the cost of a full buy-in or buyout but it does mean that the investment risk is retained by the scheme."

Inflation

Osborne Clarke pensions partner Jonathan Hazlett says the impact of continuing high levels of inflation in 2023 will impact various schemes differently.  He says: "For example, any scheme with uncapped index-linked pension increases will be more exposed than those subject to the statutory caps, and schemes with nil increases for benefits accrued before 6 April 1997 may face calls from pensioners to apply an uplift."

Hazlett says trustees need to consider how pension increase and revaluation provisions operate. He asks: "Is there an obligation on trustees and/or employers to periodically review pensions in payment? Is there a sole or joint power to provide discretionary pension increases and if so, what factors should trustees consider? How would trustees respond to questions from members (consider whether discretionary increases have been paid in the past and what members may have been told) - would it help to agree a set of standard answers to send to members who ask about increases?"

Trapped surpluses

Fieldfisher's Harris says that, with an increasing number of schemes already in a position to buy-in or buy out their liabilities, sponsoring employers will be increasingly concerned about trapped surpluses.

He says trustees and employers will need to have a dialogue about how scheme surplus will be treated under the scheme rules and in view of the statutory restrictions on surplus refunds. He adds suitable arrangements will also need to be made for scheme expenses to be paid in a way which minimises surplus.

Diversity, equality and inclusion

Also expected on TPR's agenda is an increased focus on equality, diversity and inclusion following the publication of its ED&I action plan in September, says Pinsent Masons pensions partner Christina Bowyer - noting the watchdog is expected to be encouraging recruitment of more diverse trustee boards and a more inclusive scheme culture.

"TPR reveals few schemes have been collecting trustee diversity data and even fewer plan to do anything with that information. [It] wants greater diversity to reduce the risks of knowledge gaps, entrenched ideas and poor decision-making," says Bowyer, adding that schemes should look to the new single code and separate guidance for support.