The Social Welfare and Pensions Bill, published on 5 April, finally sheds light on the long-delayed revision to the funding standard for defined benefit schemes which was announced by the Minister for Social Protection, Joan Burton, late last year.
- The Bill requires defined benefit schemes to hold additional assets in excess of those required by the current funding standard as a risk reserve to provide an additional level of protection against future volatility in financial markets
- The requirement to provide for a risk reserve will take effect from 1 January 2016 and pension schemes will have approximately 11 years from the reintroduction of the funding standard (until 2022) to satisfy the risk reserve requirements
- The Bill provides that the risk reserve will be the aggregate of:
- (i) 15% of the amount of the funding standard liabilities, less the value of EU bonds and cash held; and
- (ii) the amount by which the funding standard liabilities would increase on the effective date of an actuarial funding certificate if there was a 0.5% fall in interest rates
- Trustees will be required to submit an actuarial funding reserve certificate to the Pensions Board in addition to an actuarial funding certificate
- Subject to certain exceptions, a funding proposal would have to be submitted to the Pensions Board to restore funding by the next funding certificate date if either the actuarial funding certificate or the actuarial funding reserve certificate indicate that the scheme has failed to meet the funding requirements
- Trustees will also have to include a statement in their annual report specifying whether or not the scheme satisfies the funding standard reserve requirements
- The Bill also provides that the Minister would have the power to revise the percentage that pension schemes would be required to hold in reserve to as much as 50% of that scheme’s liabilities.
The Bill is expected to pass into law by the end of April 2012 and the Pensions Board is currently preparing revised guidelines to take account of the changes to the funding standard. It is expected that the Board’s guidelines will also provide all the technical information needed by trustees and their advisers to calculate the necessary risk reserve.
While the introduction of a risk reserve is intended to bring increased stability to defined benefit pension provision and to lessen their exposure to risks, the requirement to maintain such a risk reserve, if it is passed into law, will have significant consequences for both sponsoring employers and trustees of defined benefit schemes.
- It appears that the introduction of the risk reserve will increase the cost of providing pension schemes (and it is estimated that the provision of risk reserves may add a further 10% to scheme funding requirements). In addition to increasing scheme funding requirements, trustees may also have increased costs due to additional administration requirements e.g. in relation to the preparation of actuarial funding reserve certificates and their annual reports
- As the Bill allows for pension schemes to offset the increased funding reserve of 15% of scheme liabilities by holding both cash and EU-issued bonds, it may lead to pension schemes attempting to de-risk their asset allocation by redirecting investment towards the more expensive and lower return EU bonds. The introduction of a risk reserve could therefore undermine investment in equities
- The controversial provision of the Bill which gives the Minister power to revise the risk reserve percentage up to as much as 50% of a scheme’s liabilities effectively means that the Minister could unilaterally increase the minimum funding standard for defined benefit schemes. This provision gives rise to a concern that the measure could be used whenever the Exchequer needs additional financing
Until much of the finer detail is available, it will be difficult for sponsoring employers and trustees to fully assess the impact of the new risk reserve.