Consultation outcome

Automatic enrolment: alternative quality requirements for defined benefit and hybrid schemes being used as a workplace pension

Updated 25 February 2021

Applies to England, Scotland and Wales

1. About this call for evidence

1.1 Who is this call for evidence aimed at?

The call for evidence is aimed at:

• employers
• employee representatives
• pension industry professionals
• scheme administrators
• actuaries
• independent financial advisers
• employee benefit consultants
• any other interested parties

1.2 Purpose of the call for evidence

The Department for Work and Pensions (DWP) is required to carry out a statutory review of the operation of regulations made under Section 23A(1) of the Pensions Act 2008.

Regulations made under Section 23A(1) set out the alternative quality requirement for defined benefit pension schemes that are used for automatic enrolment. The requirements allow for simpler alternative tests to be used so that a scheme can demonstrate that it is of sufficient quality to be used by employers to fulfil their automatic enrolment duties. This call for evidence aims to ascertain whether or not the government’s policy intentions in this area are continuing to be being achieved, in particular how the simplifications and flexibilities introduced under the test work in practice, and whether any new issues have arisen since the last triennial review in 2017.

1.3 Scope of the call for evidence

This call for evidence applies to England, Wales and Scotland.

1.4 Duration of the call for evidence

The call for evidence begins on 22 September 2020 and runs until 21 October 2020.

1.5 How to respond to this call for evidence

Email your response to automaticenrolment.consultation@dwp.gov.uk

Alternatively, you can post your response to:

Department for Work and Pensions
Automatic Enrolment Policy Team
1st Floor, Zone C
Caxton House
6-12 Tothill Street
London
SW1H 9NA

Please ensure posted responses are sent in time to arrive by 21 October.

When responding, please state whether you are doing so as an individual or as a representative of an organisation. If you are responding on behalf of an organisation, please make it clear who the organisation represents, and where applicable, how the views of members were canvassed.

Send any queries about the subject matter of this call for evidence to automaticenrolment.consultation@dwp.gov.uk

1.6 Government response

We will aim to publish the government response to this call for evidence on GOV.UK. The report will also set out the conclusions of the statutory reviews into the alternative quality requirements conducted by the department.

2. How we consult

2.1 Consultation principles

This call for evidence is being conducted in line with the revised Cabinet Office consultation principles published in March 2018. These principles give clear guidance to government departments on conducting consultations.

2.2 Feedback on the consultation process

We value your feedback on how well we consult. If you have any comments about the consultation process (as opposed to comments about the issues which are the subject of the call for evidence), including if you feel that the call for evidence does not adhere to the values expressed in the consultation principles or that the process could be improved, please address them to:

DWP Consultation Coordinator
Legislative Strategy Team
4th Floor, Caxton House
Tothill Street
London
SW1H 9NA

Or email caxtonhouse.legislation@dwp.gov.uk

2.3 Data Protection and Confidentiality

For this call for evidence, we may publish responses except for those where the respondent indicates that they are an individual acting in a private capacity (for example, a member of the public). We will remove email addresses and telephone numbers from published responses.

More information about what we do with personal data is available in DWP’s Personal Information Charter.

3. Alternative quality requirement for defined benefit and hybrid schemes

3.1 Why are we carrying out a review now?

The Secretary of State is under a statutory duty to review the regulations made under the powers in Section 23A(1) of the Pensions Act 2008, which introduced the alternative quality requirements for UK defined benefit schemes. These reviews must take place at no more than three-yearly intervals ^{[footnote 1]} and the last review concluded in 2017.

The overarching aim of the review is to test to what extent the regulations are operating as intended, including whether there are any unintended consequences, and to what degree the provisions are continuing to deliver simplifications and efficiencies for employers and pension schemes.

3.2 Background

Automatic enrolment into workplace pensions was introduced in 2012 to enable more people to save for their retirement and to make saving the norm for most people in work. The law requires employers to enrol all their eligible ^{[footnote 2]} workers into a qualifying workplace pension scheme and pay pension contributions.

Employers who choose to use a defined benefit or hybrid pension scheme to meet their automatic enrolment duties must ensure their scheme meets the minimum quality requirements ^{[footnote 3]} set out in the Pensions Act 2008 and the accompanying secondary ^{[footnote 4]} legislation.

Up until 6th April 2016 a defined benefit scheme with its main administration in the UK could meet the quality requirements for a workplace pension scheme by:

• being contracted out of the State Second Pension (also known as the Additional State Pension)

• or meeting the test scheme standards (TSS) provided for in legislation and statutory guidance ^{[footnote 5]} which allow defined benefit schemes to demonstrate they meet the minimum necessary standard.

The ‘test scheme’ is a hypothetical defined benefit scheme and, in simple terms, a scheme satisfies the TSS if it provides pension benefits broadly equivalent to those of the ‘test scheme’. Following the abolition of contracting-out, on 6 April 2016, only those defined benefit schemes that satisfy the TSS in relation to all relevant jobholders ^{[footnote 6]} could be used as a qualifying workplace pension scheme. The TSS remains an option for employers.

In straightforward cases, DWP guidance sets out how employers can certify that their scheme meets the TSS. In more complex cases, the scheme actuary will need to certify the scheme.

In a public consultation in 2013 ^{[footnote 7]} (followed by a further consultation in 2014 ^{[footnote 8]}), DWP invited views on whether there was a less onerous way for defined benefit schemes to demonstrate the quality requirement for the purposes of automatic enrolment. The majority of respondents expressed the view that the TSS was unnecessarily complex and employers would benefit from the flexibility to use an alternative, simpler test.

Consequently, the framework for alternative quality requirement tests for defined benefit or hybrid schemes was introduced through the Pensions Act 2014 Act (which inserted section 23A into the 2008 Pensions Act). Details of the operation of the alternative quality requirement tests are set out in regulations (made under section 23A(1)).

The policy objective behind both of the alternative quality tests is to provide a simpler mechanism for employers and their advisers to determine if defined benefit or hybrid schemes meet the quality requirements for automatic enrolment. The alternative tests are of particular help to employers with formerly contracted-out schemes (which from April 2016 onwards would otherwise have needed to ensure that their schemes met the TSS).

3.3 The current alternative quality requirements

Since 1 April 2015, there have been two alternative tests of scheme quality available to employers offering defined benefit schemes or hybrid schemes to meet their automatic enrolment duties:

• test one: a test ^{[footnote 9]} enabling schemes, which meet prescribed requirements, to use the money purchase quality requirements – based on meeting the existing quality requirements for defined contribution schemes, for example, a minimum contribution equivalent to 8% of qualifying earnings (Section 20 of the Pensions Act 2008)

• test two: a ‘cost of accruals’ test ^{[footnote 10]} – based on the cost to the scheme of the future accrual of active member benefits

Test one

This is a test enabling schemes which meet prescribed requirements to use the money purchase quality requirements.

In response to feedback from a public consultation in 2014, a test was introduced whereby a defined benefit scheme will be able to use the money purchase quality requirement for defined contribution schemes (Section 20, Pensions Act 2008).

To determine whether the scheme may apply this test, there are a number of conditions that must be satisfied:

a) members’ benefits are calculated by reference to factors which include the contributions made to the scheme by, or on behalf of, the member;

b) the contributions in sub-paragraph (a) are converted, in accordance with scheme rules, as soon as reasonably practicable and no later than a month after receipt, into a right to an income for life;

c) the benefits payable to the member under the scheme become payable no later than the member’s State Pension Age;

d) following the conversion of the benefits in sub-paragraph (a), the amount of the members’ benefits cannot be reduced unless this is at the member’s request;

e) following any actuarial valuation, the trustees or managers have absolute discretion to use any excess funds to increase members’ benefits; and

f) where benefits have been increased using the excess assets referred to in (e), they cannot be reduced except at the member’s request.

Test two

This is the cost of accruals test. The cost of accruals test is based on the cost to the scheme of the future accrual of active member benefits. The test is normally applied at scheme-level and, broadly speaking, a defined benefit scheme (or defined benefit elements of a hybrid scheme) meets the quality requirement for automatic enrolment if ‘the cost of providing the benefits accruing for, or in respect of, the relevant members over a relevant period would require contributions to be made of a total amount equal to at least a prescribed percentage of the members’ total relevant earnings over that period’. In other words, the cost of providing benefits would at least require the minimum levels of contribution rates prescribed in legislation.

Prescribed percentages in relation to members’ earnings are set at a level that broadly represents the cost of providing the benefits under the TSS. To maintain the existing quality standards for schemes, section 23A of the Act provides that the percentage prescribed in regulations cannot be below the 8% total contribution rate required for a qualifying defined contribution scheme.

The cost of accruals test generally applies at a scheme-level. However, where there is material difference in the cost of providing benefits for different groups, the test is applied at a benefit scale level.

4. Active members who have voluntarily chosen to lower their contribution rates

In 2017, the first triennial review included a call for evidence which received several responses in relation to cases where a scheme member had voluntarily opted for a lower benefit scale. The legislative definition of ‘relevant members’ ^{[footnote 11]} does not allow employers to exclude members who have ‘opted-down’ to make contributions below the qualifying rate, from their cost of accruals assessment and this creates a possible risk that a scheme fails to meet the cost of accruals test.

The department does not hold data on levels of opt-down but at the time we anticipated opting down would be less likely in defined benefit schemes as planned increases in phased contributions for automatic enrolment (completed in April 2019) that might have caused individuals to reduce their contributions in defined contribution schemes would not apply.

In 2017, the department wished to avoid adding layers of complexity to the alternative tests, particularly as they seemed to be working for the majority of schemes. In addition, we expected that relative to defined contribution schemes this would be a diminishing issue in the future given the increasing trend for defend contribution pension provision. It should also be pointed out that the TSS was intended for those circumstances where definitions of earnings and calculations of contribution rates remain complex, for example, because they are formed of multiple definitions. We acknowledge, however, that this might continue to be a residual issue for some schemes and sponsoring employers and we therefore invite stakeholders to provide any examples of issues they still face at the current time in this area.

5. Questions

We are seeking evidence and views on the operation of the alternative quality requirements for defined benefit and hybrid schemes.

Please note that we are not seeking views on the transitional provisions for the cost of accruals test in respect of scheme members who had previously contracted out as these ceased to apply in April 2019 ^{[footnote 12]}.

5.1 Public Sector Equality Duty

The Public Sector Equality Duty contained in Section 149 of the Equality Act 2010 states that a public authority must, in the exercise of its functions, have due regard to the need to:

a) eliminate discrimination, harassment, victimisation and any other conduct that is prohibited by or under the Act;

b) advance equality of opportunity between persons who share a relevant protected characteristic and persons who do not share it;

c) foster good relations between persons who share a relevant protected characteristic.

Equality impact analysis will be considered as part of the review and respondents should note that evidence on the operation of the tests in respect of scheme members with different protected characteristics can be submitted in response to question 3.

Question 1

Are the alternative quality requirements for defined benefit and hybrid schemes continuing to deliver the intended simplifications and flexibility for sponsoring employers and pension schemes that are unable to use the TSS?

Question 2

The legislation is not prescriptive about who should apply the alternative quality requirements. In practice, who is carrying out the tests: the employer (i.e. self-certification) or its professional advisers?

Question 3

Is there anything sponsoring employers or pension schemes want to bring to DWP’s attention about the operation of the alternative quality requirements, in particular regarding previously unforeseen issues when compared to the TSS?

6. Glossary

6.1 Hybrid schemes

Hybrid schemes are defined, for the purposes of automatic enrolment only, as schemes that are neither money purchase nor defined benefits. They generally have elements of both types of benefits, and depending on the type of scheme involved, they may need to satisfy a combination of the defined benefits quality requirement (including the alternative quality requirements prescribed under Pensions Act 2008 section 23A) and the money purchase quality requirement, or they may only need to satisfy either of the requirements ^{[footnote 13]}.

6.2 Contracting out

Under the old State Pension legislation, up to 5 April 2016, individuals were able to ‘contract out’ of the Additional State Pension. This meant that workers and employer could pay less National Insurance contributions into the state system. It was not possible to contract out of the basic State Pension. Individuals could only opt out (‘contract out’) of the Additional State Pension if they were part of a private pension – such as a workplace or personal pension scheme – that could build up to replace the State Pension.

The new State Pension has replaced the existing basic and Additional State Pension, ending contracting out from 6 April 2016.

6.3 Defined benefit contracting out

Many workplace pension schemes where the pension is linked to the individual’s earnings contracted out all of their scheme members as part of their scheme rules. The new State Pension has replaced the existing basic and Additional State Pension and ended contracting out for defined benefit pension schemes.

6.4 Terms in the ‘cost of accruals’ test ^{[footnote 14]}

Under the test, a defined benefits scheme (or defined benefits element of a hybrid scheme) is a qualifying scheme, if the cost of providing benefits accruing for or in respect of the relevant members over a relevant period would require contributions to be made of a total amount equal to at least a prescribed percentage of the member’s total relevant earnings.

6.5 Relevant members

Relevant members for the purposes of the cost of accrual test are the active members of the scheme of which the jobholder is a member. However, where there is or was a material difference in the cost of providing the benefits accruing for different groups of relevant members over the relevant period, then (subject to the transitional arrangement) the testing is carried out separately for each sub-group (for example, benefit scale). The actuary, having considered a range of factors, will determine whether there is a material difference in cost ^{[footnote 15]}.

6.6 Relevant period

The relevant period is the period over which the cost of providing the accruing benefits is estimated. The period is normally to be taken from the most recent written report signed by the actuary, containing information about the cost of future benefit accrual by reference to a period which begins later than the date report takes effect ^{[footnote 16]}.

6.7 Relevant earnings

The relevant earnings are the earnings which the scheme uses to determine pensionable earnings, provided that they are at least equal to or more than the earnings calculated using one or more of the definitions set out in the table below, for all of the relevant members. To ensure that the cost of providing benefits, under the alternative quality requirements, is broadly equivalent to the cost of similar benefits, under the test scheme standard, the earnings definitions have a corresponding prescribed percentage contribution rate ^{[footnote 17]} set out in the table below.

Earnings definition and corresponding minimum contribution rate ^{[footnote 18]}

Legislative definitions	Prescribed percentage of relevant earnings
Relevant earnings must be at least equal to or more than	Survivors' pension benefits provided by scheme	Survivors' pension benefits not provided by scheme
Qualifying earnings	10%	9%
Basic pay	11%	10%
Basic pay and, taking all of the relevant members together, the pensionable earnings of those members constitute at least 85 per cent of the earnings of those members in the relevant period	10%	9%
Earnings	9%	8%
Basic pay above the single person's basic State Pension or the Lower Earnings Limit	13%	12%

1. Section 23A(7) Pensions Act 2008. ↩

2. Aged between 22 and State Pension age, earning over £10,000 Section 3(1) 2008 Act. ↩

3. In Sections 21 to 23 of the Pensions Act 2008. ↩

4. The Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010. ↩

5. Automatic enrolment: Guidance for employers on certifying defined benefit and hybrid pension schemes. ↩

6. Jobholder is defined as is a worker: (a) who is working or ordinarily works in Great Britain under the worker’s contract; (b) who is aged at least 16 and under 75; and (c) to whom qualifying earnings are payable by the employer Section 1 of Pensions Act 2008. ↩

7. Workplace pensions: proposed technical changes to auto enrolment. ↩

8. Workplace pensions automatic enrolment: simplifying the process and reducing burdens on employers. ↩

9. The Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010. ↩

10. The Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010. ↩

11. Used for the ‘cost of accruals’ test (regulation 32M). ↩

12. The Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010 (regulations 5A, 5B, 5C and 32M). ↩

13. Section 99, Pensions Act 2008. ↩

14. The Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010 (regulation 32M). ↩

15. The Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010 (regulation 32M). ↩

16. Section 23A(2) Pensions Act 2008. ↩

17. Section 23A(2) Pensions Act 2008. ↩

18. Section 23A Pensions Act 2008 (regulation 32M). ↩