Abolition of DB contracting-out: actions to take as the final countdown approaches

Issue

Details

Action

GMP increases in
payment

GMPs accrued post-1988 are required to be increased by inflation up to a maximum of 3%. GMPs accrued pre-6 April 1988 do not have to be increased, but the state pension prior to the abolition of DB contracting-out is structured in such a way that it effectively provides these increases. Members who retire after the abolition of DB contracting-out and receive the single tier pension will no longer receive these increases via their state pension in the same way.

Some
scheme rules provide for GMP increases only to be paid by the scheme in
relation to GMPs accrued post-1988. Members of such schemes may see their
pension decrease after the abolition of DB contracting-out, because neither
the state nor their scheme will fund increases on their pre-1988 GMPs. Scheme
rules that do not limit the position in this way may find the scheme having
to increase pre 6 April 1988 GMPs after the abolition of DB contracting-out,
given that the state pension will no longer provide these increases. Scheme
rules should be checked to determine the position. Booklets and member communications
should also be checked to ensure they communicate the position on GMP
increases accurately.

Check
how scheme rules deal with GMP increases.

Update
member communications appropriately.

GMP revaluation

An issue has arisen for schemes that have chosen to use fixed rate revaluation for GMPs and the scheme rules provide that this will happen at the end of contracted out service, or where the scheme rules specify that fixed rate revaluation will apply from the end of contracted-out service. Schemes in this situation will find that fixed rate revaluation will start from the abolition of DB contracting-out on 6 April 2016, when all contracted-out service will end, rather than from the end of pensionable service. To change the position so that fixed rate revaluation starts from the end of pensionable service an amendment to the rules prior to 6 April 2016 is likely to be required.

The DWP has legislated to provide for a statutory modification power allowing trustees of schemes affected by this to modify their rules so that fixed rate revaluation will apply from the date pensionable service ends for members who ceased contracted-out employment on 6 April 2016, rather than from the date their contracted out service ends. The modification power has to be exercised before 6 April 2017.

The power will allow this change to be made retrospectively to 6 April 2016, and can be exercised unilaterally by the trustees.

Review scheme choice on revaluation for GMPs and amend if required – which may involve using the statutory modification power.

Reference scheme
test (RST) underpins

The legislation provides for the RST to fall away from 6
April 2016 on the abolition of DB contracting-out, but a saving provision
means that it will continue until 6 April 2019.  Schemes that simply refer to the
legislative provisions for a RST underpin will therefore have this preserved
until 2019. Some pension schemes may ‘hard-code’ the RST into their rules by
setting out the legislative requirements. In which case, this will continue
until the rules are amended.  Schemes
in this situation need to consider whether they wish to amend the rules.

Where a defined contribution scheme has a RST underpin,
regulations make it clear that the requirement to provide this underpin for
contracted-out employment will continue after 5 April 2016. A question has
arisen as to whether the underpin must be revalued going forward in relation
to salary as at 5 April 2016, or whether it should be linked to final
pensionable salary. Affected schemes that do not wish the RST underpin to
link to final pensionable salary, should check their rules to ensure the
wording does not provide for this. The government has stated in its response
to a consultation where issues about the RST underpin in DC schemes were
raised, that it requires more time to develop solutions. In the meantime it
is saving the current provisions until April 2019.

Check scheme rule provisions on RST underpins and consider
whether changes required.

Transfers

The current regulations that will apply in relation to the
end of contracting-out mean that, from April 2016, member consent is required
to transfer contracted-out rights to a scheme which was not previously
contracted-out on a salary related basis. This means it will not be possible
to establish new pension schemes to receive bulk transfers without member
consent after 6 April 2016. This could cause significant difficulties for a
number of potential transactions. We understand that the DWP is aware of this
issue and has agreed to consider it, although is unlikely to take action
before the 6 April 2016.

Consider any implications for merger/demerger activity

Trivial commutation

The current GMP trivial commutation provisions no longer
work adequately.  The DWP is expected
to consult on further legislative changes in this area.