Contracting out - some recent changes

The Government (and indeed everyone else!) believes that contracting-out needs to be simplified. Therefore regulations went out to consultation in the summer of last year looking at simplification of contracting-out. This resulted in The Occupational and Personal Schemes (Contracting-out) (Miscellaneous Amendments) Regulations 2002, which came into force on 6 April 2002. In addition to making some minor corrections and dealing with certain inconsistencies between the treatment of guaranteed minimum pensions (GMPs), protected rights and Section 9(2B) rights, the regulations introduce some useful changes to the contracting-out regime.

The key points to note are as follows:

The legislation covering the content of notices of intention which need to be issued to relevant employees as part of the election procedure to obtain a contracting-out certificate has been overly prescriptive. This is partially because a number of the provisions are already adequately covered within the disclosure regulations. The regulations therefore delete some of the provisions which need to be included when issuing a notice. However, it should be noted that the National Insurance Contributions Office (NICO) of the Inland Revenue are in the process of updating practitioner manuals and so it could be some time before new specimen notices become available.

A similar exercise has also taken place in the case of elections for the issue of a contracting-out certificate. Revised elections (CA 7300, CA 7301 and CA 7302) will be produced.

More significantly the regulations dispense with the need for a triennial reassurance test, the process whereby NICO obtained confirmation that a scheme continued to meet the requirements of the reference scheme test. The former DSS acknowledged that the regime was "overly bureaucratic" and that dispensing with the process would not present a risk to the security of members' benefits. The regulations have also dispensed with the need for a solvency statement (a Certificate T) to be signed off by the actuary once the first MFR valuation has been completed.

Before the Pensions Act, provisions were already in force for the payment of protected rights and GMPs to be suspended in cases of serious mental incapacity. The benefits would not be lost or forfeited but would be payable upon the member becoming capable of handling his own affairs, to a dependant, or upon the appointment of an individual to take responsibility for the maintenance of the member. Such provisions have now also been put in place for Section 9(2B) rights. However, these provisions will only apply if scheme rules are amended accordingly.

Under the Welfare Reform and Pensions Act 1999, provisions were put in place for the mandatory payment of Contribution Equivalent Premiums (CEPs) to the state to enable a member who has completed less than 2 years contracted-out employment to be reinstated in the state scheme. These regulations set out the timing and manner of the payment of CEPs.

Section 62 of the Occupational Pension Schemes (Contracting-out) Regulations 1996 sets out the fixed rate annual revaluation percentages which apply to GMPs for periods of service terminating before 1988 and subsequently. The new regulations set out the rate which should be applied where service terminates on or after 6 April 2002 - a reduction to 4.5% to reflect low current inflation.

Until the passing of the Child Support, Pensions and Social Security Act 2000, NICO only had power to provide information on the liabilities that schemes may have for GMPs. The regulations now enable NICO to provide information on any Section 9(2B) rights, protected rights or safeguarded rights (following pension sharing on divorce) liabilities that a scheme may have.

Before the Pensions Act regime, it was possible to transfer contracted-out rights into a scheme which had ceased to be contracted-out for active members but had still retained contracted-out liabilities. The former DSS took the view that there was little demand for such transfers to take place. However, it has become evident that there is a need for such a provision and the ability to make such transfers has now been reintroduced.

It is now possible to transfer pre-6 April 1997 protected rights and GMPs to overseas personal pensions and other similar arrangements. Before the regulations were made it was only possible to transfer such rights to an occupational pension scheme. This provision is likely to be useful for transfers to Australasia and Canada where personal pensions are a popular form of pension provision.

Members with protected rights derived from pre-6 April 1997 pensionable service have been required to purchase a survivor's benefit without being able to take account of their marital status. However, post-6 April 1997 protected rights can provide for a single life annuity where the member is not married at the time that the annuity is purchased. The amending regulations now provide that a single life annuity can be purchased in such circumstances for protected rights from pre-6 April 1997 service.

Under a contracted-out money purchase scheme a spouse could inherit contracted-out rights but only if a number of qualifying conditions were satisfied under the scheme rules. However, no statutory right to inherit such rights has been in place. This was inconsistent with the treatment of salary related schemes and, therefore, the regulations have now introduced a statutory right for contracted-out rights to be inherited under a contracted-out money purchase scheme.

Equivalent Pension Benefits (EPBs), governed by the National Insurance Act 1965, accrued under the former state graduated retirement benefit scheme which ceased in 1975. The value of EPBs tends to be very low and as a result provisions have been introduced to allow the commutation of such benefits. This will be of particular relevance for older schemes which are winding-up. However, it should be noted that member consent to the commutation will be required.

It would be nice to think that following the outcome of the Pickering review we may see further moves towards simplification of the contracting-out regime.

For further information on this issues, please contact Nigel Moore at [email protected] or on +44 (0)20 7367 3405.