Clause 12 - Revaluation of accrued benefits

Pension Schemes Bill – in a Public Bill Committee at 2:00 pm on 28th October 2014.

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Question proposed, That the clause stand part of the Bill.

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

Clause 12 itself is relatively uncontentious. It says only:

Schedule 2 contains amendments about the revaluation of benefits.”.

It sets up the long, detailed schedule 2, which deals with the issue of bringing pension rights built up in the past up to present day values. There are a range of ways in which that can be done. The Bill has to work out the right mechanism for revaluation in this new world of pension schemes.

When a member stops being an active member of a scheme prior to retirement, the accrued benefits are required to be revalued, so that when the member reaches the scheme’s normal pension age, the value of those benefits has a measure of inflation protection over the period of the deferral. Sections 83 to 86 of and schedule 3 to the Pension Schemes Act 1993 set out the procedure for revaluation based on benefit type. Clause 12 and schedule 2 of the Bill contain amendments about the revaluation of benefits, to ensure the appropriate revaluation method applies to collective benefits and to benefits accruing after the new scheme categories in part 1 of the Bill come into force. The key point to bear in mind is that existing methods of revaluation will still apply. With the introduction of the new scheme categories in part 1 of the Bill, it is important that everyone is clear how the revaluation requirements apply to the benefits they provide. Revaluation requirements apply to benefits in both occupational and personal pension schemes. I am tempted to indulge in a short quiz at this point, because currently there are four methods for revaluation set out in schedule 3 to the 1993 Act. I will take any interventions from anybody who wishes to name any of them. I will come back to that later.

Following commencement of the new definition of money purchase benefits in the Pensions Act 2011, we introduced another one, a cash balance method, which may be used for cash balance benefits where the available  sum is not calculated by reference to final salary. To reveal the answer to my quiz, the four different methods of revaluation are the final salary method, the average salary method, the flat rate method, and the money purchase method, which is a favourite of mine.

The average salary, flat rate and cash balance methods essentially aim to ensure that those who leave the scheme prior to retirement—deferred members—are treated in the same way as those who remain in the scheme until retirement. The revaluation method to be applied in the case of any benefit depends on the benefit type and not the scheme category. As I noted this morning, the Bill sets up categories of schemes—DB, DA and DC—but some of these measures relate to benefit types, not scheme types.

In terms of revaluation, the final salary method will no longer be the default. The clause and schedule change the revaluation provisions so that they work with the new scheme categories and take account of collective benefits. They update provisions written in a world of final salary schemes, and enable revaluation to apply to new scheme types in a more appropriate way. The requirements will continue to apply at benefit level, and will require little or no change for current schemes.

A default revaluation will apply, to ensure that deferred members’ benefits are revalued in any way in which they would have been revalued had they not left the scheme. The default revaluation method will apply except in the following cases: for money purchase benefits, which will continue to be revalued—surprisingly enough—by the money purchase method; salary-related benefits, which will be revalued by the final salary method, unless they are average salary benefits, in which case trustees and managers will continue to have the option of revaluing by the average salary method; and flat-rate benefits, unless the trustees or managers of the scheme decide that the final salary method is more appropriate. Personal pension schemes, which include non-money purchase benefits, will be required to apply the relevant revaluation method to those benefits.

This approach is a change from the current provision, whereby the default for non-money purchase benefits is the final salary method, with the ability for trustees and managers to use a different method in certain cases, if the trustees consider it appropriate to do so.

Just to clarify, existing schemes can carry on as they are now, so this change better reflects the greater variety of benefits and pension scheme structures that exist now and will continue to develop in the future, but it will not have an adverse impact on existing schemes, which will continue to be able to carry out revaluation as they currently do.

Finally, there will no longer be any need for a separate revaluation method for cash balance benefits. Amendments that a revaluation requirement made by the 2011 Act and the Pensions Act 2011 (Consequential and Supplementary Provisions) Regulations 2014 introduce a new method of revaluation for certain cash balance benefits. The changes introduced by the clause mean that we will no longer need a separate method for cash balance benefits. The default method will apply unless the trustees or managers think that the final salary method is more appropriate for a salary-related cash balance benefit. A transitional provision ensures that any trustees or managers using the cash balance method can continue to do so.

I hope that that has been helpful in setting out the thinking behind clause 12, and I commend the clause to the Committee.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions)

I thank the Minister for setting out the Government’s position. Let us get down to brass tacks. For a member of the public thinking about, or perhaps in the future becoming a member of one of the schemes as defined in this Bill, what does clause 12 mean in reality?

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

I thank the hon. Gentleman for his question. Essentially, what it means is that in many cases the status quo will continue to prevail. For example, if someone is already in a defined-benefits final salary pension scheme, the way that their existing rights are revalued will be the same way that they are currently revalued. However, where a brand new scheme is invented—a scheme with collective benefits—the default will not be the indexation or revaluation method used for final salary pensions. It will be the default method set out in schedule 2.

I must admit that when I saw there were four different methods of revaluation, my first question was, “What are they?” If it would be helpful, I will just explain what the four different methods are.

The final salary method says that where the amount you have built up is salary-related—that is to say, raised to your final salary—and where an amount in this case is added to the deferred pension to take account of inflation between leaving pensionable service and retirement in line with the annual revaluation order, which is something we will debate each year, potentially as an annual regulation that affects inflation.

The average salary method is where salaries have to be revalued in the same way for active and deferred members. Then, there is the flat-rate method, whereby benefits, as opposed to salaries, for active and deferred members have to be revalued in the same way. Finally, there is the money purchase method, where investment, yield and any bonuses have to be applied in the same way for active and deferred members.

There are all those different ways, and as I said earlier we introduced a fifth one for cash balance and we no longer think we will need a separate one. But the basic idea is that there is a rational method whereby if someone is a member of these new types of pensions and they leave, their money is not only left purely to be devalued by inflation but there is a method appropriate to that kind of pension scheme to bring it up to date, to the point at which someone draws it.

I did not get terribly close to lay terms there, did I? However, I hope that that response gives the hon. Gentleman a sense of what we are trying to achieve with this clause.

Question put and agreed to.

Clause 12 accordingly ordered to stand part of the Bill.