Standard Life ezine - The Cutting Edge..with John Lawson – Standard Life Ezine

Standard Life newsletter for advisers

Issue 2: Nov 2006

Those who were involved in pensions 15 years ago will have the words ‘Barber’ and ‘Guardian Royal Exchange’ etched on their memories. This case centred on a European Court of Justice (ECJ) ruling that said it was unlawful to prevent a man from getting his (in this case early retirement) pension from the same age that a woman could. The case spawned a rash of test cases exploring the boundaries of what did and did not amount to sex discrimination in the context of pensions. The result was a hurried move on the part of pension schemes to equalise normal retirement ages for men and women.

The shockwaves registered by Barber versus GRE reverberated around the pensions industry throughout the 1990s. If pensions had a Richter scale, this event would have registered about six.

Age Discrimination
The reason for this brief history lesson is that another pensions earthquake is brewing. In this case, the cause is age discrimination. More worryingly, the shockwaves felt in the pensions world from this one are likely to register eight.

From 1 October 2006, employers must not discriminate against employees based upon their age. At least not until they reach age 65. This means that employees have the right to choose when to retire (up to age 65), even if their normal retirement age (NRA) is, say 60.

How does this impact on pensions? Take an employee in a final salary scheme. If they choose to work after NRA, they will be entitled to another 60th or 80th for each extra year. And, is it reasonable to expect that an actuarial increase will apply to benefits accrued up to NRA but taken later than that?

Or can future benefits after NRA be accrued in a different scheme? For example, can the employer insist those people that were in a final salary scheme with a NRA of 60, accrue future benefits in a money-purchase scheme if they work on beyond 60?

The new rules also affect the way employers plan succession. Back in the 1990s (and even in the early 2000s), employers tried to encourage older staff to leave by promising no actuarial reduction to their pension because they ‘retired’ early. These new rules insist that the pension benefits of those retiring early must be actuarially reduced unless that person is in ill health. Note also that employers can’t get around this by crediting extra years of service for early retirees; that practice is banned as well. So employers can no longer use this tactic to encourage staff to go early.

Employers already making changes
These examples only represent the tip of the iceberg and it is apparent that the new rules have the greatest impact upon final salary schemes. The issues are so complex for trustees and scheme managers, that the government granted a stay of execution. The age discrimination rules for pensions only will now come into force on 1 December 2006.

Some big employers are already making changes to their pension schemes. For example, some are using the new age discrimination rules to justify an increase in NRA from 60 to 65 for future benefit accrual.

Age-tiered money purchase schemes
The tremors emanating from this legislation might also hit age-tiered money purchase schemes. Although the Department of Trade and Industry tried to be super helpful to pensions when they interpreted the European anti-discrimination directive, many pension lawyers think that they have gone too far. In other words, even although the UK law says that it is OK to have age-tiered schemes, the European law says otherwise. And European law overrides UK law.

In this case, the European law does permit age-tiered payments but only if the differences are actuarially justifiable. But the question is, ‘can payment rates chosen arbitrarily, such as 3% for those in their 20s and 7% for those in their 50s, be actuarially justified?’ I would venture not, because there must be an aim in setting different payments rates, for example, to provide the same target level of benefits at age 65.

Even the DTI is cautious about this. Whilst the regulations do permit age tiering, the guidance for pension schemes that goes along with it suggests that 10 tiers are needed. But it doesn’t say whether this is 10 tiers for men and another 10 tiers for women.

If age-tiered schemes are ultimately declared unlawful by the ECJ, then employers will be forced to make good the underpayments to younger employees backdated to 1st October 2006. If this judgement happens to be in 2010, then employers would have to make good four years worth of underpayments in one fell swoop. If I were an employer with an age-tiered scheme, I would be seeking a swift exit strategy now.

Opt-outs
The legislation provides lots of opt-outs but only for occupational pension schemes. As mentioned before, the DTI has perhaps been over-generous in granting some of these opt-outs. So don’t regard them as a get-out-of-jail-free card, as they could be tested in the European courts.

A few examples of these opt-outs are:

It is OK to close a scheme and open a new one for new employees;
It is OK to set a minimum or maximum age of admission to the scheme; and
It is OK to pay different rates of pension payment or benefit if this relates to differences in pensionable pay.

Remember that these opt-outs don’t apply to Group Personal Pensions (GPPs) or Group Stakeholder Pension Plans (GSPPs) set up under personal pension legislation. This is significant. For example, setting a minimum entry age for a GPP would appear to be discriminatory. DTI guidance says that employers with GPPS should drop the entry age to 16.

If an employer decides to close their GPP and open up a new, less generous scheme, then it would appear that the employer can be challenged under indirect discrimination rules if the new workers (who only have access to the new scheme) are on average younger or older than those employees with access to the old GPP. Changing the scheme might still be acceptable if the new workers are all junior (in role rather than age) than the existing workers are, but that is unlikely.

Risk benefits also become prohibitively expensive for workers over age 65. For example, permanent health insurance, life cover and so on. In some cases, cover is not available at all. Employers who receive requests from employees to work on beyond age 65 may decide to decline these requests because the cost of employing those over 65 is just too much. This would be contrary to the general aim of encouraging later working.

To help get to grips with this, a good place to start is the DTI guidance, which can be found on the DTI website.

The two-month delay to the implementation of age-discrimination rules for pensions is to allow schemes more time to make changes. It will also allow government to consult with the industry to iron out some of the remaining glitches. However, any amending legislation will have to follow, probably next year.

Queues are already forming here in the UK for employment tribunal hearings. Court cases emanating from this legislation, both here and in Europe, will be numerous for years to come. Advisers should prepare now for what is sure to be a seismic event.

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