Physics was not my strong point at school and, as for quantum mechanics, well … So imagine my surprise when vague recollections of Schrödinger’s famous thought experiment, about a cat in a box which is both dead and alive at the same time, gave me an excellent (well good enough for me) analogy for one effect of new UK pensions legislation.

Section 29 of the Pensions Act 2011, and the newly laid regulations made under it, will come into force in the next few weeks (the Government has indicated it will be early July). They will go a long way towards resolving some of the uncertainty about what is, or is not, a money purchase benefit, but not without some interesting and sometimes surprising consequences. As flagged in our recent mailing Money Purchase Definition – Do You Know What You Are Dealing With?”, trustees and sponsors of UK occupational pension plans should be considering whether there are any implications for their plan. For a few plans, the classification of the entire plan will change, but for most any changes will be more limited, although many trustees and employers will find there is a greater impact than expected. All will need to ensure that their plans are administered in line with the new legislation. If in doubt, advice should be sought.

But back to Mr Schrödinger’s cat. One of the features of the new legislation is that some plans have benefit promises which will closely resemble that cat. These are the plans which have benefit structures which are money purchase in nature, except there is also a defined benefit underpin or top-up element, the purpose of which is to ensure the provision of a particular level of benefit irrespective of the performance of the allocated assets. So the benefit promise is both money purchase and defined benefit at the same time, but which type of benefit the member will actually receive is not known until the benefits crystallise at the time of retirement, death or transfer out. This is the same way that Schrödinger’s cat is both dead and alive at the same time, until someone lifts the lid on the box to find out which.

The new legislation seeks to deal with the uncertainty which inevitably arises until the benefit crystallises by stating that whenever a benefit’s nature needs to be assessed (e.g. when carrying out an actuarial valuation) the total benefit promise is categorised as money purchase if the money purchase element is, at the relevant time, larger than (or equal to) the defined benefit promise but, if the defined benefit element is the larger, then the entirety of the benefit promise is classified as defined benefit. A consequence of that, of course, is that benefits could flip between money purchase and non-money purchase status from time to time. So it would seem that the same member’s benefit may be included within the defined benefit liabilities for the purposes of a triennial actuarial valuation one time but excluded the next. Theoretically it works, but we are going to need to see how this analysis fits in with the practical application of the legislation. And as to how it will fit into the new pension flexibilities for money purchase benefits promised in both Budget 2014 and the Queen’s Speech 2014, we have yet to find out.

So Schrödinger’s cat is now a pension benefit. And it seems to me that trustees and advisors are going to have to devise their own thought experiments to work out how to manage the risks associated with benefits which are capable of being both money purchase and non-money purchase at the same time, and which for the purposes of the legislation, are capable of flipping between being money purchase in nature and not, depending on when they are looked at.

I never expected my school physics lessons would be so relevant to pensions law.

PS – no cats were harmed in the making of this blog.