Consultation Response: The Insolvency Service - Debt Relief Orders and Pensions From the Consumer Financial Education Body (CFEB) June 2010

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1 Consultation Response: The Insolvency Service - Debt Relief Orders and Pensions From the Consumer Financial Education Body (CFEB) June 2010 Introduction The Consumer Financial Education Body (CFEB) welcomes the opportunity to respond to this consultation. CFEB has a statutory responsibility to enhance the public s ability to manage their own financial affairs and to improve the understanding and knowledge of financial matters (including the UK financial system). CFEB is an independent body, established by the Financial Services Authority. We lead the National Strategy for Financial Capability in partnership with government, industry and the third sector. Financial capability means: making ends meet; making informed decisions about financial products; keeping track of finances; planning ahead; and staying up to date about financial matters. Our view is that a financially capable person has the skills, knowledge and confidence to make informed decisions about their finances, and knows when and where to access help. This drives our work. One of CFEB s functions is to enhance the ability of members of the public to manage their own financial affairs. We are concerned that, under the current criteria for Debt Relief Orders, a significant amount of otherwise eligible applicants are being excluded from being able to apply due to future rights to a pension, which is either small or a long time away from being able to draw down. The result of this is that people are left without the ability to select the most appropriate debt resolution tool for their needs, thus reducing the ability of individuals to manage their own financial affairs in the most appropriate way. Background A Debt Relief Order (DRO) is a debt relief solution for individuals who owe relatively small amounts of money, have little or no disposable income and little or no assets to repay what they owe. The scheme was introduced in April 2009 following a consultation by the Insolvency Service which aimed to provide a cheap, easy to administer, non-court based scheme of debt relief that would alleviate debt in certain cases where there was no other alternative solution. In order to qualify for a Debt Relief Order, individuals have to meet certain criteria including having assets of less than 300. Insolvency Rules currently state that any future entitlements to money held within a pension fund should count towards the calculation of assets for the purposes of assessing eligibility for a DRO. This means that many individuals who have small pension pots and/or pension pots that they cannot draw down for a number of years but who would otherwise qualify for a DRO are not eligible. As a result, individuals are becoming trapped in debt because they have nothing to offer to their creditors or only negligible token repayments to offer and cannot afford bankruptcy. Debt Relief Orders were originally introduced to provide a debt relief option to the most vulnerable individuals who were burdened with unmanageable levels of debt. When DROs were introduced, the Insolvency Service estimated that up to 36,000 individuals per year would benefit from the new regime 1. However, less than 12,000 DROs were issued within the first year of the procedure being available. The Insolvency Service have issued this consultation in order to look at the scale of the problem and if and how the DRO regime needs changing by amending the Insolvency Rules. 1 Relief for the indebted An alternative to bankruptcy, The Insolvency Service, March

2 Summary of our response The take up for Debt Relief Orders is significantly lower than was expected by The Insolvency Service when the scheme was originally launched. This leads us to question the appropriateness of the eligibility criteria. Individuals who would have otherwise qualified for a DRO are being excluded due to future rights to a pension which takes them over the asset threshold. As a result, individuals are either being forced into inappropriate debt resolution options such as bankruptcy, or for those who cannot afford bankruptcy, becoming locked into token payment plans which are unsustainable or that have minimal impact on the individual s liabilities. We believe that if the existing structure is maintained, with the introduction of Personal Accounts in 2012, it is likely that the number of people who are eligible for a DRO will fall even further. There is a clear inconsistency within the eligibility rules for Debt Relief Orders compared to the rules for bankruptcy petitions. Given that DROs were introduced as a cheaper, more proportionate alternative to bankruptcy, we believe that there should be a uniform approach to the inclusion of pension assets. Therefore all pensions that are HMRC approved should be excluded from the asset calculation for the purposes of deciding whether an individual is eligible for a DRO. We believe that assets should only be taken into account for the purposes of deciding upon eligibility for a DRO if the property or asset in question is available to make payments to creditors at the time that the DRO is issued. Therefore, we consider that a time cap would not be appropriate for the purposes of deciding whether an applicant s future rights to a pension should be included in the calculation of an individual s assets. As with a time cap, we consider that a financial cap would not be appropriate for the purposes of deciding whether an applicant is eligible for a DRO. We believe that enforcing a financial cap would have a disproportionate effect on those who are over the threshold but only by a small amount, effectively penalising those who have saved more for retirement. We support the proposal for an additional requirement that all pensions that would otherwise qualify for exclusion from the calculation of assets must have HMRC approval in order that they do not count towards the value of assets for the purpose of determining whether an individual is eligible for a DRO. We agree that it is reasonable to suggest that confirmation checks to determine whether the pension is HMRC approved and meets any other new requirements imposed as a result of this consultation should be carried out by the approved intermediary as part of the application process as opposed to the official receiver. However, it is important to note that although the approved intermediary assists the applicant with their application, it is the applicant s ultimate responsibility to ensure that they disclose full information on their assets and liabilities when submitting the application. We recognise that there will be additional costs in order to certify that an applicant s pension meets the set requirements in order to be excluded from the asset calculation. However, in order to ensure that DROs remain cost effective and fit for purpose, it is essential that the application fee remains as low as possible. We therefore believe that any additional costs incurred as a result of the further checks should not be added to the application fee. 2

3 Consultation Does the present limit exclude persons who would otherwise qualify because of the value being given to a future pension right calculating the application of the DRO limit? Less than 12,000 Debt Relief Orders were issued within the first year of the regime. This is much lower than the 36,000 per year which the Insolvency Service expected would be issued and raises questions around whether the eligibility criteria for the scheme are appropriate and fit for the purpose for which the scheme was intended. Although there is little research available on why the take up of DROs is lower than expected, a study carried out by Advice UK, Citizens Advice, Consumer Credit Counselling Service, the Institute of Money Advisors and National Debtline found that 96.3% of individuals who were unable to access a DRO were excluded only because of their pension rights. Of those, 49.3% were known to have a pension with a current value below 5, Those who would otherwise have qualified for a DRO but are ineligible because of future rights to a pension which could be either insignificant or years away from being able to be drawn are then forced into inappropriate debt resolution options such as bankruptcy. This may not be cost effective. Others, who are unable to afford bankruptcy, remain locked into token payment plans which are either unsustainable or so negligible that they have an insignificant impact on the level of the individual s debt. We are concerned that by forcing people into inappropriate debt resolution options, this reduced the ability of members of the public to manage their own financial affairs in the most appropriate manner. We believe that if the existing structure is maintained, it is also likely that with the introduction of Personal Accounts in 2012, the number of people who are eligible for a DRO will fall even further. How should such a future pension right be valued for this purpose? We recognise that there is a case where an individual has a significant pension right which will lead to a pension in the near future, it would be reasonable that the rights to that pension should be taken into account in determining whether the individual qualifies for a DRO. However, in bankruptcy rules, a trustee cannot claim any pension as an asset, as long as the pension has been approved by HM Revenue and Customs and the bankruptcy petition was presented on or after the 29 May 2000 when the Welfare Reform and Pensions Act 1999 came into force. It is therefore clear that there is a significant inconsistency within the eligibility rules for Debt Relief Orders compared to the rules for bankruptcy petitions. Given that DROs were introduced as a cheaper, more proportionate alternative to bankruptcy, we believe that there should be a change in the rules for the inclusion of pension assets for Debt Relief Orders to bring them in line with those for bankruptcy. This will ensure that individuals are able to opt for the most appropriate debt resolution tool, which is affordable and meets their needs. Specifying a Time Cap Do you think that rights to a pension should not count towards the eligibility criteria relating to assets provided that the pension cannot be brought into payment for at least a specified period of time? We recognise that there is an argument for a time cap so that creditors should not be excluded from receiving benefit if an individual has a pension right that will lead to a pension in the near future. However, we believe that assets should only be taken into account for the purposes of deciding upon 2 Representations from the debt advice sector, Consultation on Debt Relief Orders and Pensions. Study carried out between 1 February 2010 and 14 February

4 eligibility for a DRO if the property or asset in question is available to the client to enable them to make payments to their creditors at the time that the DRO is issued. Additionally, given that such a cap does not currently exist under the rules for bankruptcy, we do not support the argument for a time cap when assessing eligibility for a DRO. This will ensure that individuals are able to opt for the most appropriate debt resolution tool, which is affordable and meets their needs. Should a time cap be specified for the purposes of assessing an individual s eligibility for a DRO, careful consideration needs to be given to the specific time cap. There is a risk that by setting a specific cut-off point for deciding whether future rights to a pension should be included in an individual s asset calculations, this may lead to some vulnerable individuals being unduly penalised by being ineligible for the scheme. For example, if a limit of 5 years is set, those who are close to the limit but who have just more than 5 years until they can draw their pension would be eligible and would have their debts discharged after one year should the order be given. However, those who have just less than 5 years until they can draw their pension will be ineligible and will be forced into either making token payments indefinitely or opting for another debt resolution option which may not be appropriate for them, even though their financial circumstances may only be trivially better. Specifying a Financial Cap Do you think that having an entitlement to a pension should not count towards the eligibility criteria relating to assets provided that the current value of the pension is no more than a specified amount? Although we recognise there is an argument for a financial cap so that creditors should not be excluded from receiving benefit if an individual has future entitlement to a large pension fund; given that such a cap does not exist under the rules for bankruptcy, we do not support the case for a financial cap when assessing eligibility for a DRO. Consideration should be given to whether a fixed financial cap is appropriate. We believe that by enforcing a fixed financial cap, it would have a disproportionate effect on those who are over the limit but only by a small amount, effectively penalising those who have saved more for retirement. For example, if the limit was set at 5,000 then those who had only 5,001 or more in their pension pot would not be eligible for the scheme despite the fact that their future entitlements are only trivially higher. Should a financial cap be specified for the purposes of assessing an individual s eligibility for a DRO, there needs to be careful consideration to the value of this cap. Any financial cap should take into account the average present value of the pension pots of those who the scheme is aimed at. For example, the Wealth and Assets survey found that in 2006/08, 9% of individuals had wealth held in pensions to which they no longer contributed to but they were not yet drawing an income. This was highest amongst those aged 45-54, where 16% surveyed had future pension rights to a pension that they were no longer contributing to. Given that the mean average of the present value of future entitlements for this age group is 99,500 3, it would be therefore reasonable to construe from this that the value of the average pension pot of those who have contributed to a pension scheme but are no longer doing so is higher than the 300 asset threshold. For those with future pension rights that are only trivially higher than the current 300 asset threshold, they would be unable to apply for a debt relief order, despite the fact that they are a number of years away from drawing an income which may have only a minimal impact on their financial circumstances when they do. Any financial cap which may be set as a result of this consultation should be sufficiently high enough that those individuals who are most vulnerable today are not excluded from being able to apply for a 3 Wealth in Great Britain, Main results from the Wealth and Assets Survey 2006/08, Office for National Statistics. 4

5 DRO due to future entitlements to a small pension pot which is not realisable for a number of years. If a cap is introduced, we would suggest that it be set at no less than the mean value of pension pots held by successful petitioners for their own bankruptcy. Requirement that the pension scheme has to be HMRC approved Should there be additional requirement that pensions must have HMRC approval in order that the pension rights do not count towards the value of assets for the purpose of determining whether an individual is eligible for a DRO? We support the proposal for an additional requirement that all pensions that would otherwise qualify for exclusion from the calculation of assets must have HMRC approval in order that they do not count towards the value of assets for the purpose of determining whether an individual is eligible for a DRO. In bankruptcy, a pension that has been approved by HMRC cannot generally be claimed by a trustee for the benefit of creditors. Having an additional requirement that pensions must have HMRC approval in order that the present value of the future pension rights are not counted within the calculation of assets would align DROs with bankruptcy in this respect. It would also provide reassurance to creditors that the funds held in the scheme would not be money that they could be likely to be able to claim today or in the future. Checking the pension details Is it practical to suggest that the approved intermediary needs to be in possession of details about a debtor s pension(s) before making the application for a DRO? It is important to note that, whilst the approved intermediary will assist the applicant through the Debt Relief Order application process, it is the ultimate responsibility of the applicant to disclose complete information to the intermediary regarding their asset and liability position. However, we agree that it is reasonable to suggest that confirmation checks to determine whether the pension is HMRC approved and meets any other new requirements imposed as a result of this consultation should be carried out by the approved intermediary as part of the application process as opposed to the official receiver. Given that individuals have to pay the non-refundable application fee in order that the application is considered by the official receiver, it would be unreasonable that the application could then be rejected on the grounds that the excluded pension is not HMRC approved or meets other specified criteria. We recognise that there will be additional costs in order to ensure that an applicant s pension meets the set requirements in order to be excluded from the asset calculation. However, in order to ensure that DRO s remain cost effective and fit for purpose, it is essential that the application fee remains as low as possible. We therefore believe it is reasonable that any increased costs incurred as a result of the further checks should not be added to the application fee. As approved intermediaries should already carry out checks to establish whether the present value of an applicant s future pension rights are over 300, it is likely that there will be only a minimal increase in costs and administrative burden to the approved intermediary. If would like to discuss any aspects of this response further please contact Laura Tidbury on or laura.tidbury@moneymadeclear.org.uk. 5