Pension sharing: The role of the trustees Received: 26th June, 2000

Sue Tye has over 12 years’ experience in the pensions industry advising trustees and employers on all aspects of pensions law and practice. Having worked for five years as a pensions technician and consultant with a leading pensions consultancy she left to pursue her legal career with Biddle, becoming a partner in 1999. Sue has recently joined Baker & McKenzie’s pensions department. She is an APMI, a member of the Association of Pension Lawyers and Secretary of the Business Committee of the PMI London Region Group.

Abstract In December 2000 the first of the new pension-sharing orders may start to land on pension managers’ and trustees’ desks. Hailed as a simpler and cleaner way of dealing with pensions on divorce than earmarking, this paper takes a closer look at what sharing will mean for trustees. The paper focuses on the role of trustees in sharing from first contact with the member’s spouse to implementation of the pension sharing order, looking in detail at: — — — —

the trustees’ powers and duties in relation to both the member and the ex-spouse confidentiality, advice and rule amendments trustee liability, discharge and penalties an action checklist for trustees.

Keywords: divorce; pension sharing; pension credit; pension debit; internal membership/transfer; external transfer

Introduction

Sue Tye (Baker & McKenzie, 100 New Bridge Street, London EC4V 6JA Tel: ⫹44 (0)20 919 1000; Fax: ⫹44 (0)20 919 1999)

Pension sharing is, in the author’s view, broadly to be welcomed, particularly given some of the problems that practitioners have encountered with earmarking. Sharing is simpler in theory and, we hope, in practice, but there are a number of decisions and actions that need to be taken before the Regulations come into force on 1st December, 2000. This paper assumes that readers are broadly familiar with the concept of sharing, in particular the creation of the pension credit and debit, and shall therefore focus on how sharing will impact on trustees and pensions managers in practice by looking at trustees’ powers and duties, issues such as confidentiality, giving

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advice, Rule amendments and how trustees may discharge their liability and what happens if they do not. The paper considers sharing in the context of a funded occupational pension scheme in England; different provisions apply to unfunded arrangements and on divorce in Scotland. The approach taken is to follow the various stages of sharing that trustees and pensions managers will encounter, covering: — first contact with the former spouse or member — notification that a pension-sharing order is looming — what to do when the order arrives

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Table 1 Time limit — runs from date of receipt request/order

Requested by:

Valuation requested

Other

Member Member Member Member Spouse

兹 兹 兹 X X

Section 23(1) request* Court Order

3 months 6 weeks Shorter date ordered 1 month 1 month

*ie, the member notifies trustees that valuation is requested in connection with proceedings under the sharing provisions of s23 of the Welfare Reform and Pensions Act 1999.

— sanctions and penalties — a trustees’ checklist.

First contact The first that trustees or the pension manager are likely to hear of a possible pension-sharing order is the request from the member, his soon-to-be former spouse or Court for information relating to the pension scheme and the member in question. It is also possible that the request may come from the parties’ legal advisers. Various types of information may be requested by the parties and various time limits apply. The request under the Regulations can include: — — — —

a valuation of the member’s rights a summary of how this is calculated benefits included in the valuation whether or not internal membership is to be offered and, if so, the type of benefits available to the former spouse — the alternative method of discharging the liability, ie, the external transfer — a schedule of charges that will apply (if any). Valuation of the member’s rights provides the basis for sharing — a percentage of the member’s cash equivalent will be reallocated to the former spouse as the pensions credit. It is, of course, difficult to predict the incidence of divorces, but schemes

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may benefit from standard documents to deal with information requests to streamline administration. Table 1 summarises the time limits that apply for information provision at this time. It is likely that the trustees will not be providing this information themselves so they need to instruct their administrators accordingly. As with any delegation it is not sufficient simply to give the instruction; trustees should also ensure that they are monitoring the provision of this information and that time limits are being met. Trustees will also need to disclose at this early stage: — whether or not internal membership will be offered to the former spouse or whether a transfer-out of the former spouse’s entitlement will be required; and — whether or not they are going to recover any costs for provision of information, implementation and administration of the pension sharing order. The policy on internal membership is a key topic for trustees and is covered later in this paper. Charging is considered below. Charges

There are, broadly speaking, two types of costs that schemes will incur as a

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result of pension sharing: set-up costs and ongoing costs as and when a divorce arises. The set-up costs will arise from the need to revise systems, execute new rules, draft and issue new communications and prepare standard letters. Schemes will have to bear these costs themselves. The Regulations do, however, provide for administration costs (or some of them) for individual divorces to be met by the divorcing couple themselves. The first question is, therefore: should the trustees make provision for recovery of charges? As a trustee, one ought more properly turn the question round and ask: is it proper to use scheme monies to administer provisions on the divorce of an individual member — would this be a legitimate use of Scheme money? It is also an issue that the scheme’s employer may be interested in, given that it is the employer that would normally (either explicitly or implicitly) pay for the expenses of running the scheme. This issue will be all the more transparent for money purchase schemes where expenses are paid directly by the employer. In practice, it is likely that trustees will take advantage of the legislation to recover costs. Indeed, the government has said that it expects divorcing couples to pay for their own costs. It is important that trustees decide this issue at the outset and before 1st December, 2000. This is because the trustees may only recover costs if they send the parties a schedule setting out the costs and how they intend to recover them before the pension-sharing order is made. They must therefore decide: — whether they are going to recover costs — from whom they are going to recover costs; if not specified, then the costs are to be borne by the member

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— how much they are going to charge — how they are going to recover the costs. There are a number of ways in which costs can be recovered — by direct payment from the member or spouse; by deduction from the former spouse’s pension credit, or a charge to the member’s benefits, or by deduction from the transfer value or pension payment. There are also choices about when the costs may be recovered: — before implementation of the order — on payment of the benefits or on transfer — or a combination of these — some before implementation, some later. For example, schemes may seek advance payment for costs of providing information before the order is made, but recoup administration costs at a later stage. As regards the amount that can be recovered, the legislation does not specify an amount nor an upper limit but states that costs to be recovered should be the ‘reasonable administrative expenses . . . incurred or likely to be incurred . . .’ by the scheme. This applies to provision of basic information in the early stages of the pension-sharing process and also when an external transfer is made or benefits put into payment. It would in any event be untrustee-like to charge anything greater than the costs likely to be incurred, given that it is not the trustees’ duty to make a profit out of administering the scheme. Trustees should note that no charge can be made for information that must be provided under the Disclosure Regulations. Both the former spouse and the member will have a right of challenge via the scheme’s Internal Dispute Resolution Procedure,

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OPAS and also the Pensions Ombudsman and may claim that charges are excessive or apparently excessive. It would, therefore, be sensible to: — include, if possible, in the pension-sharing order the charges to be levied; the former spouse and member will have accepted these if contained in an order by which they are bound — follow the guidelines that are apparently being produced by the NAPF — issue a standard letter approved by the trustees setting out the charges to be levied and how they are going to be collected. Confidentiality

Another area where the trustees could become exposed is the type of information that they provide. If the spouse makes the information request then trustees should ensure that they issue only the information that the spouse is allowed to request under the Regulations, otherwise they could be open to criticism for breach of their duty of confidentiality towards the member. By way of example, the valuation of the member’s pension rights is based on the cash equivalent and the spouse cannot ask directly for this, only for a statement from the trustees that they will give this information to him or her if the member requests a cash equivalent. Trustees could therefore be criticised for providing a projected pension statement, or for providing a cash equivalent statement direct to the spouse, particularly if this leads to further wrangling over the financial position on divorce. The trustees should also ensure that the member is copied in on any correspondence with the spouse or their advisers.

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Advice

Trustees should also consider carefully their role in sharing. There is a general principle that trustees are under no obligation to advise members on the options available to them under the scheme over and above their disclosure duties and basic trust duties. Experience with earmarking has shown that some divorce lawyers have looked towards the trustees to tell them what form the order should take. While trustees would not wish to be unhelpful, they should remember that they have no duty to the former spouse or the member beyond what information they are required to provide and actions they must take to implement the order under the Regulations. It would be a foolhardy trustee or pensions manager who advises the member or the spouse that 50 per cent of a cash equivalent is an appropriate split, or that sharing is appropriate at all. The trustees’ duty is to administer the scheme in accordance with the Rules and Regulations and any sharing order made, not to advise members or their spouses. That is not to say that the trustees have no duty to communicate with the member or the former spouse. The paper has considered some of the disclosure duties on the trustees. There is also a duty to notify the member of the effect of the negative deferred pension on his benefits and on his spouse’s/dependant’s benefit, the latter being particularly important if the member is likely to have a second spouse or family. Benefit statements will need to be revised to cover these points.

Pension-sharing order looming The next that the trustees are likely to hear of pension sharing is notification

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that a pension-sharing order may be made. There are two types of pension-sharing documents: — the pension-sharing order which can be made from 1st December, 2000 — a ‘qualifying agreement’ which can be made between the couple — the date these will be effective is not yet known. Stage-two disclosure

While it is useful to have advance notice of the order, with that comes a second wave of disclosure obligations and time limits for trustees. The information that the trustees have to provide at this time consists of the following: — the scheme name — the address to which any pension-sharing order/agreement should be sent — whether the scheme is in winding up and, if so, the name of the trustees — whether the cash equivalent will be reduced under the Transfer Regulations — if the trustees are aware of any ‘shareable right’ being subject to earmarking, forfeiture, or bankruptcy orders — whether any element of a member’s rights is not shareable — if charges are to be paid before the implementation period and, if so, whether they have to be paid in part or in full — whether any additional charges are to be levied — if the member is a trustee. All of this has to be provided within 21 days after notification that the order may be made (or any later date that the Court may order). Again, it is likely that a standard information sheet may be of use to the trustees and their administrators.

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The trustees may be sent a copy of what the parties intend to agree and have implemented under the scheme. There are two points to consider at this stage: — Are the details correct? Does the order require the trustees to do more than split the cash equivalent, eg, grant internal membership or specific benefits? Much time can be spent at a later date returning the final order to the Court to correct mistakes or clarify the parties’ wishes. — If a sharing order or earmarking order is already in force in relation to this marriage, another one cannot be made. It is essential that the trustees’ records show these orders and that the trustees notify the lawyers or the Court accordingly.

The pension-sharing order arrives Some time may have elapsed between notification that a pension-sharing order is likely to be made and the order actually arriving — this will depend entirely on Court dates and the progress of the divorce. What is there to do at this point? Any policy decisions and preparatory work may have been decided already by 1st December, 2000, but these points will now be considered. There will also be individual case actions. The set-up actions fall under three headings: — the decision on internal membership versus external transfer — systems — scheme documentation. The individual case actions are: — more disclosure of information — implementation and discharge of the order.

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Internal membership versus external transfer

Trustees can only be discharged of liability for the pension credit member by giving the former spouse ‘appropriate rights’ in the scheme or by paying a transfer value equal to the pension credit to a ‘qualifying arrangement’. The Regulations require the former spouse’s consent to either option but, importantly, there is a default provision which allows the trustees to transfer the former spouse’s credit out of the scheme without consent. Trustees will therefore need to decide whether to offer internal membership or to offer only an external transfer and require this where no consent is forthcoming. On the face of the legislation this decision rests with the trustees. Before looking at the decision itself two preliminary points should be considered: — Should it be the trustees’ decision alone? — As trustees, do they have any fiduciary responsibilities here? Should it be the trustees’ decision alone? If internal membership is to be offered there are likely to be implications for the employer, certainly in the form of costs. Set-up and ongoing administration costs have already been considered, but there are other costs associated with internal membership in the form of benefits to be provided. This will be considered later. Scheme rules will also need to be amended and the majority of schemes require involvement of, if not instigation by, the sponsoring employer. So the employer will need to be consulted. A second issue which has been raised in some commentaries is: do trustees have a fiduciary duty towards the former spouse? If so, should this influence their decision on whether to require an external transfer or not?

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This may be quite a difficult point and one on which trustees may wish to seek advice. Arguably, the former spouse becomes a member of the scheme as soon as the Court order creates a pension credit under the scheme. The trustees at that point have a duty towards the former spouse in respect of that entitlement, although it has not been undertaken voluntarily and has been imposed by the Court. Can trustees compel an external transfer, or should they allow the former spouse to stay in the scheme? The legislation permits a transfer out without consent, but should the trustees exercise this power? Can they make a policy decision before 1st December, 2000, before creation of the first transfer credit? In making any decision under the scheme, trustees need to take into account the interests of the beneficiaries, so if the costs of sharing on divorce are unlikely to be met fully by the couple but in part from scheme assets, could it be argued that this is detrimental to the existing members and therefore not a trustee-like decision? In practice, it would seem sensible for trustees to set a policy on offering internal membership before 1st December, 2000, but be prepared to review this as cases arise; this, for reasons relating to external transfers which the author will return to below, may in any event be the most prudent course of action. Before looking at what factors trustees should take into account in their decision-making, the paper now looks in more detail at internal membership and external transfers. Internal membership

Under the Regulations the trustees can treat the pension credit member in a similar way to a standard deferred

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pensioner, but they do not have to. The trustees can choose the form of benefit and the date it may be drawn, provided Revenue limits and requirements are not breached and the benefits are equal in value to the pension credit. For example, it would be possible to grant pension benefit only and no cash option or dependant benefits, although in practice this may be somewhat harsh and difficult to justify. Money purchase benefits could be offered as an alternative to final salary. In practice, it may be likely that a final salary benefit mirroring existing deferred pensions will be the more popular option, although the money purchase option may be attractive where there already exists a money purchase section in the scheme, or where the employer is reluctant to take the balance of cost risk for the former spouse whom it has never employed. Mirroring deferred pension benefits will in itself require some thought. A ‘normal benefit age’ will need to be set and consideration given to, for example, early-retirement and late-retirement options and the basis on which they are offered. In some schemes deferred members are given enhanced early-retirement or late-retirement factors — will these apply to the former spouses, or is it possible to differentiate? It is likely that the employer will not be prepared to pay for enhanced treatment and that the only options the employer will agree to are cost-neutral. External transfers

Trustees must offer the former spouse an external transfer of the pensions credit. The transfer must be made to a ‘qualifying arrangement’ in accordance with the Regulations. Qualifying arrangements include another occupational pension scheme, a personal pension plan, an insurance contract, and stakeholders when available.

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The key issue for trustees considering transfers without consent as the default option must be where to transfer the credit. The analogy that it would seem sensible to draw is securing benefits on wind-up using deferred or current annuities. Trustees will need to ensure that the vehicle they transfer the credit to is an appropriate vehicle and that they do not breach the Financial Services Act by giving unauthorised investment advice to the former spouse. There is a further complexity when considering a compulsory external transfer which arises in relation to schemes that are contracted out of SERPS. The effect of a sharing order is to split the member’s benefits vertically, including therefore any contracted out rights. Once split, these become known as ‘safeguarded rights’. Safeguarded rights may only be transferred out of the scheme with the consent of the former spouse or if the trustees deem it reasonable to do so in the circumstances. This test is not prescribed for rights in excess of the contracted out rights and seems at first glance to add another procedural layer for trustees of a contracted out scheme. If, however, it is accepted that the former spouse becomes a beneficiary of a sort on being awarded a pension credit, the trustees will arguably owe him or her a duty of care in making the external transfer which would require them to apply the reasonableness test to the transfer as a whole. For example, in circumstances where the pension credit is small and annuity rates poor, would trustees need to consider whether purchasing an annuity in the market would be poor value for money compared with some form of internal membership? If so, should this prevent them making a compulsory external transfer? In order to protect themselves and the former spouse trustees will need to

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consider the compulsory external transfer route very carefully; if they choose to go ahead, investment advice will be crucial. So which way will schemes turn? Interestingly, at the NAPF Conference in May 2000 a straw poll was taken among the audience the majority of whom: — had not yet taken any action in relation to pension sharing, which is not surprising as not all the Regulations were available then; and — were in favour of requiring compulsory external transfers. The main reasons would seem to be that: — it appears easier administratively to require an external transfer — if the former spouse is allowed membership then systems must be implemented to deal with the new pension credit member — an actuary will also need to be involved to calculate ‘appropriate rights’ to be awarded to the former spouse — scheme rules will be simpler to amend without compulsory external transfers. All this means extra cost both now and when individual cases arise. While these factors point towards a policy of external transfers, other factors will need to be considered and may complicate matters. For example: — a certain amount of administration/system review will be needed in any event to record the member’s negative deferred pension — will a compulsory external transfer be appropriate for all former spouses? What about those who are already members of the scheme? — how will transfers-in with a pension

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credit be accommodated? — if the divorcing member is receiving his or her pension would it be easier to pay a pension to the former spouse rather than arrange a transfer? — what happens if an external transfer is not possible, for example, where the former spouse dies before implementation, or where the scheme is underfunded on an MFR basis? All of these need some thought but are resolvable: — existing scheme members can have their credits applied as added years, as can transfers-in — internal membership may be a sensible policy for pensioners who divorce — rules will need to cater for distribution of the credit on death before implementation as a lump sum and/or spouse’s/dependant’s pension (within Revenue limits) and for internal membership on underfunding. The result may therefore be a hybrid of internal membership and external transfer. So perhaps sharing is not as simple in practice as in theory. Systems

It will be the trustees’ responsibility to ensure that their administration systems are adapted to cater for pension sharing. Trustees should therefore consider conducting an administration audit now to identify what changes are needed. Systems will need to provide for: — creation of the pension credit and a new category of pension credit members — normal pension age and benefit calculations for the new pension credit member

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— — — — —

pension debits new Inland Revenue limit calculations recovery of costs new benefit statements payment of tax on the former spouse’s benefit.

Trustees and administrators alike will need to review their administration agreements to determine whether this additional work is part of the service specification or whether it will need to be undertaken at additional cost. Rules

The trustees will need to ensure that sharing is adequately reflected in the scheme’s rules. The Revenue has provided a set of standard rules which will need to be expanded on for individual schemes. If a new scheme is seeking approval after 10th May, 2000, the Revenue will not approve that scheme unless sharing provisions have been incorporated; schemes that are already approved at that date will be deemed to have the relevant provisions by statutory override from 1st December, 2000 to enable trustees to act on a sharing order; but trustees will still need to have considered their stance on sharing and will need to incorporate provisions properly as soon as practicable after 1st December, 2000. The first time a deed of amendment is submitted after 1st December, 2000 the Revenue is likely to return the deed unless it has incorporated sharing provisions. The extent of amendment will, of course, depend on the decision made by the trustees and how complex the rules are already. Where the provisions mirror standard deferred pensioners’ provisions this is likely to be a simpler job and a less costly exercise than creating an entirely separate category of internal membership with different benefits.

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Other issues

No doubt more issues will arise as people become more familiar with pension sharing. Here are two more: — Will it be necessary for trustees to set up a sub-committee to deal with individual divorce cases like many did for earmarking? It may be necessary to set up a sub-committee to consider sharing and report back to the trustee board prior to 1st December, 2000 since many schemes may have only one trustee meeting between now and then. It is also likely to be necessary to set up a standing committee to review individual cases and obtain advice on external transfer where appropriate. — Will it be sensible to review AVC options? Sharing may encourage members to try to make up the pension lost in creating the pension credit (within the Inland Revenue restrictions imposed), so a review may be timely. It may also be advisable for trustees to remind members of the AVC facility when notifying them of their negative deferred pensions. Individual cases

Trustees’ obligations when the order arrives fall under two headings: — disclosure of information (again) — implementation and discharge. More information

The obligation on trustees to disclose information does not stop at the early stages. Once the necessary order is received, trustees need to obtain information from the divorcing couple before they implement the order. This is primarily to protect the trustees and to ensure that they implement the order against the correct member and the correct spouse. The pension-sharing

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order implementation period cannot be triggered until the trustees have all the following information: — all the names the member/spouse has been known by — their dates of birth — their addresses — their National Insurance numbers — the scheme name — the member’s membership number, if applicable — details of the receiving arrangements if a transfer-out — the address of the receiving arrangement — the former spouse’s membership number/policy number — details of person dealing with the arrangement. Trustees must also say at this point what charges are due to be paid before implementation of the order. This must all be done within 21 days after receipt of the order. Implementation and discharge

Once the trustees have received all of that information, they have four months to implement the order either by a transfer-out or creation of the pension credit member within the scheme. The clock starts running from the date of the order or, if later, when the trustees have received all of the specified information. An extension may be sought from Opra in certain circumstances. By the four-month deadline, the trustees must either send a notice of implementation or a statement saying that they have been unable to implement the order with, it is suggested, appropriate reasons. A further note is then required 21 days after the implementation period has ended; this is probably the key document for the trustees, being the discharge-of-liability

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notice. This must be sent to the former spouse and member setting out: — — — —

the member’s cash equivalent the value of the credit the charges to be deducted the date of transfer, either internally or externally — how charges are to be recovered — if appropriate, details of the transfer and the receiving vehicle.

Failure to provide this information on time may result in a fine which leads to the next section on penalties.

Penalties and sanctions Pension sharing brings with it a new layer of penalties that may be imposed by Opra and scope for additional maladministration claims. Each of these will be considered in turn. Penalties

Failure to meet some of the disclosure regulations without good cause may incur a fine of £200 for individual trustees or £1,000 for corporate trustees. Failure to implement the pension-sharing order may give rise to a fine of £1,000 for individual trustees or £10,000 for corporate trustees. The total penalty possible appears to be £1,600 for individual trustees or £13,000 for corporate trustees per divorce. Trustees will note that these fines cannot be paid from scheme assets, although it may be possible to look to a third party such as the administrator to see if the fault lies with them. Trustees should also be aware that they cannot ignore any implementation breaches — there is a duty to report to Opra. If, however, they have taken reasonable steps to comply and still cannot meet the deadline it is suggested that they report to Opra before the deadline, request an

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extension, explain the action taken and specify the date by which they think they will be able to meet the deadline. Given the short run-in period for pension sharing it is hoped that Opra will be sympathetic towards first offenders.

to ensure that their schemes are ready for 1st December, 2000. The following is a list of ‘dos’ and ‘don’ts’ that schemes can build on to ensure they are ready. Do:

The Ombudsman

Pension sharing will undoubtedly widen the scope for maladministration claims before the Ombudsman. The former spouse will be, if only for a short time, a member and entitled to use the scheme’s internal dispute-resolution procedure, OPAS and the Ombudsman procedures. Likely areas for a claim would seem to be excessive charges and failure by the trustees to implement the pension-sharing order within the necessary time limit or accurately. As with many complaints, lack of understanding by the relevant party is often the cause and so communications are clearly going to be crucial. A further area which could give rise to a claim relates to the member. The member could go to the Ombudsman if the order is not valid for whatever reason (for example, the wrong scheme name is quoted) but implemented anyway and/or the trustees make a payment to the spouse incorrectly. The trustees could be found to be guilty of maladministration or even in breach of trust if a member’s entitlement is re-allocated wrongly. If a claim is to succeed there must of course be some form of loss, but it is possible to envisage situations where a pension is paid wrongly to the former spouse and is not recoverable. In those circumstances, the member will have suffered a loss and would be looking to the trustees of the scheme to make up the difference.

— decide on whether to offer internal membership — if internal membership is allowed, decide what benefits will apply — if external transfers only are allowed, take advice on how and to where transfers will be made — conduct an administration audit: What needs to be done by when, by whom, how, who pays? — decide on charges — whether to recover, the amount and recovery method — prepare standard letters and charging schedules for disclosure of information on: • first contact • notification that an order may be made • the start of implementation period • discharge of the order — set up a diary system to ensure that time limits are met, and early-warning systems to notify the trustees when they are not likely to be met — ensure members are copied in on all correspondence with the former spouse and advisers — check what rule amendments are required and how much this will cost — review information provision: booklets, benefit statements — review AVC arrangements — set up a sub-committee if appropriate and formalise delegation of divorce matters to pension managers/administrators.

Trustees’ checklist

Don’t:

Trustees, pension managers and their advisers will no doubt be working hard

— give advice to divorcing couples!

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