Do new regulations signal the end of Section 32 buy outs?
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In 1981 IBM launched a new product. They called it the Personal Computer or PC for short. In the same year, the pension industry also launched a new product - the Section 32 Buy Out Plan (aka a deferred annuity plan). It’s fair to say that the Section 32 wasn’t bought in the same numbers as the PC, but a lot were bought by trustees looking to transfer DC and sometimes Guaranteed Minimum Pension (GMP) liabilities ahead of scheme wind ups.
Section 32s continue to be used by trustees today, although few insurers offer to cover GMPs, having suffered the consequences of over optimistic assumptions made by 1980s actuaries. They’re mainly used by trustees and employers of DC schemes who want to effect a wind up, and up until now there hasn’t been a simple alternative. If an employer wanted to transfer to another scheme they had to follow a process largely designed with defined benefit schemes in mind. The process involved obtaining an actuarial certificate, and ensuring that the transfer satisfied the requirements to be a scheme reorganisation. Essentially the transferring and receiving schemes needed to be run by the same employer.
It was a more complicated transfer process than the application form demanded by a Section 32 but one that was used by a number of employers and trustees. They saw the value of transferring to schemes that offer members a bit more than is on offer from some Section 32 plans. A bit like the early adopters of laptops and tablets, they were willing to put up with some short-term pain and perhaps higher costs to deliver a longer term gain, in this case for their scheme members.
Times are changing
Things will change from 6 April, with further simplification set to follow as master trusts become authorised under the Pensions Act 2017. The requirement for the employer to participate in the receiving scheme will fall away, as will the need for actuarial sign off. Trustees will need to take appropriate advice unless they are transferring to an authorised master trust. All in all the process starts to look a lot like the Section 32 Buy Out process.
Just as PCs sales have fallen and been replaced by better performing laptops and tablets, the same could start to happen with Section 32s. Some trustees might be tempted by a Section 32 at a lower price but after a couple of years of doing their value for money assessment they, more than any other stakeholder, may find price and value are not always the same thing. They should also be the first individuals to recognise the long-term value to their members of independent governance, from professional trustees.
The importance of governance
Ongoing governance could drive the demise of the old Section 32. While independent governance should ensure that master trusts keep up with, or lead the way, with new developments the Section 32 inhabits a netherworld, neither subject to the governance of Trustees nor provider Independent Governance Committees.
It is not a product that can be easily transferred, without the risk of an HMRC penalty, in the form of a loss of protected tax-free cash sum rights. In some cases providers have struggled to offer the full range of pension freedoms, and the digital engagement that is now expected by consumers.
The Department for Work and Pensions (DWP) have also issued some guidance1:
"We would encourage trustees who are continuing to use deferred annuity contracts….. to consider whether this remains in members’ best interests, or whether their fiduciary duty is better met through a newly simplified bulk transfer approach, which confers additional flexibility on how the member exercises their pension rights in future".
When George Osborne decided to relax the rules on drawdown he announced that people would no longer need to buy an annuity. The DWP’s announcement of a simplified bulk transfer process could be couched in similar terms - from April 2018 trustees of defined contribution pension schemes no longer need to buy a Section 32 plan.
If you’d like to discuss this further, please get in touch with your Aviva contact.
1Department of Work and Pensions. Simplifying the process for defined contribution pension scheme consolidation while maintaining member protection, February 2018