By David Brooks, Technical Director, Broadstone
This month I’d like to focus on DB funding. Next month a summary of the actions of a busy Frank Field and the work and Pensions Selection Committee (including their CDC call for evidence).
DB Funding and regulation
The system we have now broadly follows the below pattern.
1. Employer has DB scheme and funds the deficit following negotiation/discussion with Trustees.
2. Most schemes will be in deficit due, largely, to the way liabilities are measured, the performance of investments and some improvements to mortality.
3. The situation persists for as long as the employer is able to (or willing to) fund the scheme. It could buy-out the scheme on the open market should it both be able to afford to and wish to.
4. The Regulator steps in where it deems necessary to query the methods and decisions of the Trustees and the actions of the employer.
5. The Regulator has a range of “moral hazard” powers which can be brought to bear should it believe that the actions of the trustees or employer are detriment to the best interests of other interested parties (members, employer, trustees or Pension Protection Fund).
6. Should the employer go bust the pension scheme will either use the assets (if sufficient) to purchase benefits in the private sector or (and currently the most common outcome) the scheme will fall to the PPF and members receive a benefit as prescribed in regulation.
On the way down the employer, if it has time, may be able to convince the Regulator that all interested parties would be better served by negotiating an alternate deal. For instance, a Regulated Apportionment Arrangement - potentially reducing the hit on the PPF, saving the employer from going bust and providing greater benefits for the members (with no loss in protection).
For 13 years or so this has been the way things have worked around dealing with employer failure in pension funding.
However, questions are being asked as to whether this is the right system. The Conservative Government have re-emphasised their manifesto pledge to protect employees’ pensions by punishing company directors. Frank Field, even mooted the idea of “nuclear deterrent” punitive fines should it be discovered that employer actions robbed the pension scheme of funds. The Work and Pensions Select Committee went further in their 2016 report on BHS, to ask for greater powers for the Regulator including mandatory clearance from the Regulator for corporate actions that may be detrimental to supported pension schemes.
The bogey man at the moment is dividends. Their size, in relation to employer contributions to schemes, had been held up by Government as proof that the system is working and DB pensions are affordable. However, it may yet be the same ratio by which employers may now be judged and how important they appear to be taking their pension promises and prioritising shareholders over pension obligations.
The Government’s White Paper, now delayed until the Spring, will be the place to address this area if the Government is minded to do something about the issues it sees - although the comments from Government to date don’t convince me that they are too convinced of the need for change.
What will the Government do? Well I think they will quickly realise that creating a system of fines for the actions of directors will be almost impossible to draft and enforce in a way that doesn’t either restrict legitimate business or be so unenforceable as to be pointless. What the Government should do is sit down with the Regulator and PPF and understand what they’d like to see happen.
The Regulator has not asked for swingeing powers; it wants more resource and more power to gather information. I believe the White Paper, when It comes, will have a review, repackage and re-launch of the Regulator’s powers. In a similar way when the Regulator was (unhelpfully) given the further statutory power of looking after the sustainable growth of scheme sponsors. However, this time with the pendulum swung back towards the Trustees with the regulator in their corner able to question employer action.
In a complex system involving 5,800 DB pension schemes and countless employers, most of which operate their business and schemes appropriately, introducing headline grabbing powers that are nothing more than a paper tiger will achieve little.
The Government may also wish to highlight the success of the PPF. Introduced via EU regulation it looks stronger than ever and able to provide protection for members at a decent level.
Through 2017 and into 2018 we are seeing a more active regulator; perhaps stung by criticism around BHS. We now have a zero-tolerance policy across many areas, from the less glamorous scheme returns through to a more hands on approach to valuation discussions from an early stage.
This increase in regulatory action will be the legacy of this latest corporate failure and political rhetoric. We will have a regulator willing, and increasingly able, to be involved in setting the standard across the DB funding area. Yet I will be surprised (close to hat eatingly surprised) if we see major changes to the way companies work and directors penalised for poor decision making.
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