UK government plans to revamp holiday pay calculation for part-year workers
Out-Law Analysis | 11 Feb 2021 | 3:50 pm | 8 min. read
As trustees of master trusts prepare for their first board meetings of 2021, several high profile issues are set to dominate agendas.
We expect several of these issues to become substantive agenda items as the defined contribution (DC) pension market continues to consolidate and trustees become subject to more stringent reporting obligations.
Robust governance processes will be crucial to mitigating the risk of challenge; providing evidence of reasons for a particular decision or course of action; and ensuring that trustees' work and decisions stand up to public and regulatory scrutiny.
Perhaps the most pressing action for trustees is to start embedding the climate governance requirements. The government has confirmed that trustees of authorised master trusts will need to comply with Task Force on Climate-related Financial Disclosures (TCFD) governance requirements by 1 October 2021, and publish a TCFD report within seven months of the end of their scheme year underway on or after 1 October 2021.
Increasingly, we are seeing employers initiating transfers between master trusts to benefit from lower costs and consolidate pension providers across their workforce
Trustees need to ensure their entire governance framework integrates climate-related risks and opportunities (CRRO), which goes to the very heart of how trustees govern and run their master trust. This includes setting the roles and responsibilities of sub-committees, working groups, investment advisers and fund managers; setting climate-related metrics and targets, including parameters for reporting; and carrying out scenario analysis based on specific CRRO for all their default arrangements. Trustee approaches will be scheme-specific and depend on how they invest. For example, trustees of vertically integrated trusts investing through an insurance policy need to manage their indirect role in the investment chain and face different challenges to those trustees investing directly or through segregated mandates.
Trustees' knowledge and understanding requirements (TKU) now extend to identifying, assessing and managing climate change risk. We expect that trustees will need to establish a formal training programme to meet this statutory duty. They need to understand the purpose and outputs of activities such as conducting scenario analysis and calculating emissions-based metrics, and incorporate these activities into their new climate risk management processes.
Given levels of transfer activity, both in and out of master trusts, towards the end of 2020, trustees will need to review their on-boarding processes to ensure they are fit for purpose.
Increasingly, we are seeing employers initiating transfers between master trusts to benefit from lower costs and consolidate pension providers across their workforce. Where employers push for a transfer, they will often be looking to bring as many assets as possible to the new trust in order to benefit from preferential commercial terms - including both 'active' deferreds still employed by the employer; and 'pure' deferreds who are former employees of the employer.
In these circumstances, we are seeing prolonged negotiation between transferring trustees and employers over assets under management, given trustees need to ensure they exercise their fiduciary duties to act in the interests of all categories of member. To minimise negotiation at the transfer stage, we are seeing trusts agree exit terms with employers at the on-boarding stage, subject to certain conditions being satisfied (e.g. positive investment advice). We think exit terms will become a common feature as transfers between master trusts increase and competition continues to intensify.
This year, for the first time, trustees must submit a supervisory return to the Pensions Regulator within three months of their scheme year end.
Trusts will already have a framework for collating the relevant information for all aspects of the supervisory return. The return is, in effect, an annual 'catch-all' report of material changes to the master trust that have not been significant enough to qualify as "significant events". Trustees are required to explain their due diligence and process for ensuring persons remain fit and proper individually and collectively, and for ensuring that any events in relation to their systems and processes have been identified and resolved.
Again, a robust governance framework is critical to enable trustees and their delegated service providers to identify, flag, report and resolve issues. Periodic reviews of the suitability of governance processes should be a standing agenda item – particularly for those trustees with in-house service providers steeped in the FCA-regulated regime, for whom trust-based pension provision is a relatively new concept. There is a risk that significant events are not identified quickly enough, particularly if there needs to be escalation to senior management to determine the materiality of the event. Trustees need to understand, and review periodically, the framework in which their service providers identify potential significant events and material breaches of law.
The government has proposed that trustees need to include net investment returns for their default and self-select funds in the chair's statement from 5 October 2021. Under the proposals, net return reporting will need to cover an initial five years from 2015, increasing cumulatively each year. Given non-compliance with the chair's statement requirements is subject to mandatory regulatory fines, the proposed introduction of net return reporting adds a new layer of complexity to the chair's statement that trustees will need to manage. We recommend that trustees ask their investment advisers - and, if appropriate, fund managers - how they propose to collate the relevant information this year.
Trustees will also need to be aware of the proposed new value for money assessment for DC schemes with total assets of less than £100 million ('specified schemes'). In carrying out a more prescribed assessment, it is likely that specified schemes will need to use master trusts as comparator schemes, using investment return information over the relevant scheme year. Trustees, in conjunction with their providers, will need to start considering how to disclose information to specified schemes, and in what form.
Since 2015, trustees have been required to seek member views and feedback on matters relating to their master trust. Historically, trusts have struggled with low levels of member feedback and how to increase member engagement. Without engagement, contribution levels remain low, leading to inadequate retirement savings. However, the government's recent drive towards a zero carbon economy by 2050 and focus on integrating environmental, social and governance (ESG) factors has led to an industry-wide increase in member engagement.
While this is good news for pensions as a whole, it leaves trustees with the delicate issue of how to integrate member views and feedback into investments while acting in their best financial interests. To date, many trustees have opted to regard members' views as non-financial factors and relevant to the range of self-select funds only, as this is the way in which the law is currently positioned. But the landscape is changing: ShareAction has proposed a responsible investment bill to allow trustees to consider the wider effects on the economy and the environment as part of the 'best interests' duty, and the lines between financial and non-financial factors are converging. Climate risk is a clear financial reason to include ESG components into default arrangements, and trustees need to ensure their views on climate risk are properly reflected in their investment decisions.
Most master trusts offer "net pay" tax arrangements rather than relief at source (RAS). Employers must use only one of these methods for their employees, leading to trusts favouring the net pay system. But a net pay scheme means low earners miss out on tax relief, and will have to pay 20% more for their pension.
Increasingly, we are seeing trusts considering how to offer both net pay and RAS arrangements, particularly those trusts with a significant proportion of their membership below the income tax threshold. There are a number of possible options. A small number of providers have set up a separate RAS trust, but the requirement for authorisation adds a layer of complexity and cost to this approach. While it is unlikely that offering a RAS arrangement will become mandatory, master trusts may look to consider other options, such as paying a 20% 'top-up' to lower earners in net pay schemes to reflect the difference in treatment. A call for evidence was published in July 2020 to address this issue, and the Treasury is currently analysing the feedback received. Trustees will need to keep track of developments, given the commercial implications of any changes to the existing system.
Contribution monitoring will remain a key theme for 2021. Master trusts will need to ensure they continue to receive accurate employer contributions and payroll information for members on furlough or with periods of part-time work due to Covid-19.
Trustees should continue to strengthen data validation processes where there is scope to do so, to limit the risk of employers using the wrong pay figures. Responsibility for inputting pay data lies with the employer, and trustees should review existing contractual documentation to ensure employers' obligations are documented clearly.
Schemes with members who are resident overseas will have considered the potential impact of Brexit on the payment of benefits to those members. Some banks have decided to close accounts in countries where they no longer wish to operate following the loss of passporting rights - previously, these rights allowed banks to provide services to customers in other European Economic Area (EEA) states without having to get direct and separate authorisation in those states. Where EEA-based members receive payments into a UK bank account, they may need to review the arrangement to ensure that they can continue to receive payments.
Master trusts are leading developments in 'at retirement' and decumulation solutions. Increasingly, we are seeing companies with large workforce seeking to partner with master trusts to offer decumulation options at retirement, including financial advice, as a part of their benefit package. Typically, companies are driving the selection process for the drawdown services and then offering them to their trustees, who will want assurance over the selection criteria and due diligence process.
We expect decumulation to become a significant source of new business for master trusts as employers seek a holistic retirement package for their workforce and employees look to benefit from the flexibility of these services. Last year, the PLSA called for a new DC decumulation regulatory framework and proposed a statutory requirement for schemes to support members when making decisions about how to access their pensions. We can expect continued focus on the 'at retirement' journey as the year progresses.
The issue of 'small pots' has returned to the front of minds with the DWP's Small Pots Working Group. One of the key issues facing the industry is dealing with the administrative challenges of mass transfer and delivering consolidation systems at scale.
Although automated large scale consolidation solutions are the current priority, pensions dashboards could form part of the wider solution. A successful dashboard would allow members to view all their pots with different providers in the same place, potentially leading to member-led consolidation which would complement an automated large-scale approach. The industry-led Pensions Dashboard Programme proposes to start building, integrating and user testing a dashboard this year. Providers will need to connect to the service from 2023. With both small pots and pensions dashboards, data flows and employers' contractual obligations to provide complete and accurate data will be key. Contracts may need to be revisited to ensure that they are fit for purpose.
Master trusts are well placed as a test case for exploring and testing potential solutions, including member exchange. We expect to see further developments as the Small Pots Working Group continues scoping and feasibility work in 2021. Trustees should track developments with small pots and the pensions dashboard throughout 2021.
Co-written by Helen Murphy of Pinsent Masons.
28 Jan 2021
09 Oct 2020
UK government plans to revamp holiday pay calculation for part-year workers