Summary

This briefing looks at the proposals for a new statutory objective for the Pensions Regulator (the Regulator), announced by the Chancellor of the Exchequer in the 2013 Budget. It looks at:

  • what the new objective involves;
  • how it compares with the Regulator’s existing objectives;
  • the impact of the new objective on the Regulator, scheme members and scheme sponsors;
  • when the new objective will be enacted; and
  • background information on the Regulator’s powers.

What is the proposed new statutory objective?

In his Budget statement on 20 March 2013, the Chancellor of the Exchequer, George Osborne, announced that the government will propose legislation to give the Pensions Regulator a new additional statutory objective. The new objective will be:

to support scheme funding arrangements that are ‘compatible with sustainable growth for a sponsoring employer and fully consistent with the 2004 funding legislation’.

The precise wording is not yet finalised – it will be the subject of consultation.

The Chancellor’s statement reads:

‘The Government will provide the Pensions Regulator (TPR) with a new objective to support scheme funding arrangements that are compatible with sustainable growth for the sponsoring employer and fully consistent with the 2004 funding legislation. The precise wording of this new objective will be set out in legislation that the Department for Work and Pensions (DWP) will publish later in spring 2013. Implementation of the new objective will be subject to review after 6 months and TPR will revise its Code of Practice to reflect their forthcoming new objective as soon as possible in 2013’.

This announcement follows the Department of Work and Pensions (DWP) call for evidence on this issue in January 2013.

The Minister for Pensions, Steve Webb said:

‘The best guarantee of a pension scheme keeping its promises is to make sure that the sponsoring employer prospers. This new objective for the Pensions Regulator will help ensure that trustees and employers have the flexibility to come up with plans which deal with pension scheme deficits and benefit both scheme members and firms’.

The Regulator’s existing objectives

The Regulator’s current statutory objectives (in the Pensions Act 2004) focus on the protection of benefits under pension schemes and the protection of the Pension Protection Fund (PPF) against the risk of increased liabilities. This has generated comments that the regime does not allow for other critical economic issues to be balanced against these objectives.

The current objectives (s5, Pensions Act 2004) are:

Five regulator’s objectives

The main objectives of the Regulator in exercising its functions are:

  1. to protect the benefits under occupational pension schemes of, or in respect of, members of such schemes;
  2. to protect the benefits under personal pension schemes of, or in respect of, members of such schemes within subsection (2);
  3. to reduce the risk of situations arising which may lead to compensation being payable from the Pension Protection Fund (see Part 2);
  4. to maximise compliance with the duties under Chapter 1 of Part 1 (and the safeguards in sections 50 and 54) of the Pensions Act 2008 [these are the auto-enrolment duties], and
  5. to promote, and to improve understanding of, the good administration of work-based pension schemes.

The significance of the new objective

The aim of the new objective looks to be to encourage the Regulator to take a more balanced policy view of the costs of funding a pension scheme, weighing the interests of scheme members looking for security against the cost to the employer of achieving security. This may lead to an easing of funding pressure on defined benefit (DB) scheme sponsors, freeing up funds to channel into their businesses rather than into their pension deficits.

On the other hand, this new objective may cause a shift in the balance of power from scheme members to scheme sponsors. Indeed, DB scheme sponsors with large sums of money at stake may be more ready to attack or challenge the Regulator’s decisions.

The Regulator may also need to take a different approach towards proposals towards which it has previously been hostile, such as pre-pack sales out of administrations. Moreover, it may lead to funds increasingly being diverted away from financing pension deficits. Larger deficits would potentially reduce some security for members and potentially increase the likelihood of schemes having to cut benefits and requiring assistance from the PPF.

Previous consultation

In the January 2013 call for evidence, the DWP stated:

In considering whether changes to the funding regime are appropriate, the Government needs to weigh up impacts on:

  • members – defined-benefit pension rights are obligations which cannot be altered once rights have accrued. The Government is committed to ensuring that members’ interests are protected;
  • sponsoring employers – the best security for a defined-benefit pension scheme and its members is a properly-funded scheme backed by a solvent, profitable sponsor. The Government recognises that for each scheme a balance needs to be struck between these two elements;
  • the Pension Protection Fund, which provides a safety net for members of pension schemes and is funded by a levy. The Government wants to ensure that it understands the potential impacts on the levy of any smoothing of assets and liabilities; and
  • the wider economy – the Government wants to ensure that the protections in place for members within the defined-benefit pensions regulation system do not act as a brake on investment and growth.

The DWP then referred to the Regulator’s existing objectives, and went on to comment:

‘The argument for a new statutory objective is that the current objectives focus explicitly on protecting members and the Pension Protection Fund but do not explicitly require the Pensions Regulator to consider the long term affordability of deficit repair contributions to sponsoring employers of the pension schemes.

Representations have been made to the Department for Work and Pensions that an explicit statutory objective or duty which focussed on the sponsoring employers would have the effect of redressing the perceived imbalance.

On the other hand, there is an argument that implicitly in the Pensions Regulator’s Funding Defined Benefits Code of Practice16 (which states that trustees should consider the affordability for the employer) and through operational practice, the Pensions Regulator already gives regard to the effect of deficit repair contributions on sponsoring employers. There is recognition that the best way for members’ benefits and the Pension Protection Fund to be protected in the longer term is a properly funded scheme backed by an ongoing sponsoring employer.

When considering whether to exercise its regulatory powers, legislation requires the Pensions Regulator to take into account those parties who are directly affected by the exercise of those powers. Where the regulatory power being considered relates to how a scheme is funded the sponsoring employer would very likely be considered to be a directly affected party.’

The call for evidence focused on a slightly different change to that now being proposed:

‘What would be the advantages of a new statutory objective for the Pensions Regulator to consider the long term affordability of deficit recovery plans to sp

Timing

As included in the Budget statement quoted above, draft legislation to implement the new objective will be published by the DWP for consultation in the spring of 2013 (probably in May). Any changes would be enacted later in the year. Once enacted, the legislation will be reviewed after six months.

The Regulator’s reaction

The Regulator’s chairman, Michael O’Higgins, commented in a press release on budget day:

  • ‘We regulate according to the legislative framework set by Government and Parliament’.
  • ‘In light of the Government's proposal for a new objective to take account of the sustainable growth plans of the sponsoring employer, we will make the changes required, building on the 2004 funding regime, as part of a review of the Code of Practice for defined benefit (DB) funding that we will launch as soon as possible this year’.
  • ‘In addition, we will shortly publish an annual funding statement which will set out our guidance to trustees in the context of current economic circumstances, including the flexibilities available to trustees and company sponsors in the current regime, particularly the freedom to choose the basis on which contribution levels and valuations are calculated’.
  • ‘We will engage fully with stakeholders and the industry on both the revision of the Code of Practice and the next annual funding statement’.

Background

The current economic crisis is providing a crunch test for the new regulatory structure for occupational pensions put in place from April 2005. The key crunch issue for funded occupational pension schemes is how much they are going to cost, and how much advanced funding should be provided.

In the UK, having developed a system with no statutory funding requirements up to 1997, and then tried out a modified system based on a minimum funding requirement (the MFR, fixed at the same prescribed level for every relevant scheme) from 1997 to 2005, the Government (and Parliament) changed direction in the Pensions Act 2004 to set up a new system.

The old MFR basis was criticised as too inflexible (‘one size fits all’). And the Government had not been able to resist, in a previous downturn, reducing the level required. So instead a new regulatory regime was enacted. Ironically this was at the same time that the EU was producing a directive for the funding of occupational pension schemes which pointed more towards a minimum funding requirement basis.

The post 2004 regime has two limbs.

  • First, political pressure required that a support fund be set up – this is the Pension Protection Fund (PPF). Ultimately in employer insolvency situations, an underfunded defined benefit pension scheme can enter this fund and a minimum, protected level of benefits should be provided to members. The PPF is funded by the assets received from the schemes entering it and by levies on all other defined benefit pension schemes, which increase the costs to employers of funding those schemes.
  • Second, a new statutory funding regime was put in place. This recognises that individual situations are different. It does not set out a funding test applicable to every scheme (unlike the MFR). Instead the funding obligations are ‘scheme specific’, with the employer and trustee usually needing to agree. This is backed up with a new proactive and dynamic Pensions Regulator set up with new powers.

The aim of the Pensions Regulator is to be ‘risk based’ and generally to monitor pension schemes. Unlike the previous regulator (Opra), the new Regulator was given increased powers and the ‘mission statement’ (see above) of protecting occupational pension benefits and minimising claims on the PPF. Arguably the Regulator was envisaged as being the ‘military wing’ of the PPF.

The existence of the PPF means that, for the first time, it is important for every pension scheme and its sponsoring employer to have some comfort on the funding position of every other pension scheme. Otherwise there could be an increasing number of underfunded schemes entering the PPF and so hitting all other schemes by increases in levies.

Parliament boots this one off to the Regulator

But, in practice, Parliament and the Government realised that setting funding levels for each scheme centrally had its own problems. As a result, in true time honoured political fashion, instead of giving any guidance on this fairly fundamental issue, it booted the ball off to another player. The Pensions Regulator would be the one who would police levels of funding within occupational pensions schemes.

The legislative framework gives fairly wide powers to the Regulator, which in turn back up increased powers given to trustees on funding. The legislation (and TPR guidance), but tends to use words like ‘prudent’ when looking at funding levels.

This vagueness is deliberate, as the framework envisages a ‘scheme specific’ funding basis – in effect agreement must be reached between employers and trustees as to future funding rates, and a recovery plan if there is a deficit. If the trustees have a unilateral right to fix funding under the trust deed, then this seemingly remains unilateral (though there can be difficulties in interpreting precisely how the statutory wording interacts with the wording in the underlying scheme – another problem caused by the legislation).

If agreement cannot be reached between the employer and the trustees, then the Regulator is given power to fix the funding rates itself. The Pensions Act 2008 also gave further powers to the Regulator to intervene even if the funding rates have been agreed between the trustees and the employer. This would apply if the Regulator felt the amounts agreed were not ‘prudent’.

Business needs vs funding – how to resolve?

These points mean that the Regulator, and to a degree trustees, are faced with quandary. Should they seek to protect benefits in occupational pension schemes (which the legislation says is the primary role for the Regulator)? Or do they have to take into account the ability of the employer to pay? Should funding of the pension scheme take priority over (say) business needs? To put it in context, should (for example) an airline be forced to pay money into the pension scheme rather then buy new aircraft?

All of this was readily foreseeable at the time the legislation was put in place, but these questions have now been brought into stark relief by the current economic circumstances. In effect there has been a ‘double whammy’ applied to pension schemes. Employers have become weaker, and often there has been a reduction of funding levels in the pension scheme through a combination of sharp falls in asset values (particularly equities) and a seemingly inexorable rise in liabilities (eg with increased longevity projections).

How should trustees and the Regulator deal with this situation?

Should they ask for more funding, to be paid more quickly, on the basis that the weakening of the employer covenant means that it is more likely that there could be insolvency leaving the scheme underfunded?

Conversely, does the fact that the employer is weaker mean that the trustee should not be pushing for more money, on the grounds that the company cannot reasonably afford to pay?

Trustees in these situations will, of course, look to the views of the Regulator. After all, the Regulator has been given the new powers and may, in effect, be able to override a funding decision in any event. So, the Regulator is faced with a need to give some guidance to trustees and to employers as to how it will assess funding plans in the future. But it is not staffed at a level that would allow it to do this on an individual basis for every scheme. And how will it decide what is appropriate in any specific case, given the Regulator’s current main statutory objectives are to protect pension benefits, rather than (noticeably) to protect jobs, enable businesses to continue, or even to encourage the future provision of pensions by employers?

Thrust by the legislation into this position, the Regulator stands to be criticised whatever it does. If it pushes for the increased funding into schemes then it runs the risk of deepening the severity of the recession for employers and increasing insolvencies and unemployment as a result. Conversely if it allows trustees to reduce their demands for contributions, then it runs the risk of increased future levels of claims on the PPF, and hence sharply increased levy payments by other schemes and ultimately by the sponsoring employers, which could find the increased cost burden unsustainable.

What does the Regulator do?

Understandably, faced with this dilemma and its current main objectives, the Regulator has acted cautiously.

On the one hand, it has restated its previous position that trustees should not be aiming to drive employers into insolvency (this is the last resort). The best position for a pension scheme is a strong supporting employer.

So far, so easy.

But short of a potential insolvency, how does the Regulator expect trustees to deal with requests by employers to reschedule contribution plans or deal with increased deficits? Statements from the Regulator point to a need for trustees to consider the position carefully. It would not expect employers to renegotiate extended recovery periods if, at the same time, they were still paying dividends. Otherwise, it has said that it may look favourably on proposals in which recovery plans were extended or back-end loaded in appropriate circumstances.

This demonstrates the difficulty of reconciling the merits of:

  • clear general guidance or prescriptive legislation, which runs the risk of being inappropriate to a particular scheme; and
  • the flexibility of a structure where individual circumstances play a large part, which gives rise to lack of certainty and of which it could be said that policy all depends on how the Regulator feels on the day.

Tabloid newspapers characterise such situations by the headlines ‘Post code lottery’ (where there are regional variations) compared to ‘One size fits all’ (where there are not). Another example of ‘heads you win, tails I lose’.

In practice trustees and employers (and pension lawyers) have been looking to see how well the Regulator copes with dealing with this conundrum. Given the size of pension schemes and their importance to members, it is vital for the Regulator to get the balance right. Too far one way or the other, and it runs the risk of either driving many employers out of business or destroying the pension system through the under provision of benefits and excessive claims on the PPF.

At the end of the day the Regulator needs to keep its main objectives in mind. Currently these direct it to consider benefit security as its main objective. True there is already a duty on the Regulator to consider the impact of its actions on those directly affected (s100, Pensions Act 2004). But to a lawyer, this falls far short of weighing against the main objectives stated earlier in the Act. If more balance is to be required from the Regulator, a new objective is needed.

Parliament has given the Regulator a lot of powers, but precious little guidance on how it thinks they should be used.

The proposal for a new objective based on growth may go some way towards giving that guidance to the Regulator.

The question ultimately remains is whether the Regulator is properly structured and resourced to take account of all these risks. An important social policy issue has been delegated by Parliament (and the Government) to the Regulator.

A new growth duty?

The Government is also consulting on a new growth duty for non-economic regulators, aimed at ensuring that regulators uphold the highest standards of public protection without holding business back. The Treasury ‘is attracted’ to applying this new duty to the Pensions Regulator.

The 2013 Budget report states:

‘Across the entire regulatory system, the Government is taking action to shift the balance of regulation in favour of private sector investment and growth. This is particularly important for the regulation of defined benefit (DB) pensions as recent economic conditions have put companies sponsoring DB schemes under significant financial pressure…

The Government is also consulting on a new growth duty for non-economic regulators and is attracted, subject to the results of that consultation, to applying such a new duty to TPR’.

The Department for Business, Innovation and Skills (BIS) had already started consultation on the potential for a new growth duty for regulators generally. The BIS consultation opened on 8 March and closes on 19 April.

One of the questions in the BIS consultation is: ‘Question 8: Should the Pensions Regulator be included in the scope of the growth duty?’

Smoothing of assets and liabilities in scheme funding valuations

Following consultation, the Government has confirmed that will not be pursuing a change in legislation to permit the ‘smoothing’ of asset values and liabilities in funding valuations. This would have involved the averaging of asset prices and discount rates over a longer period of time, instead of using current market spot rates. The Budget Report states that the DWP consultation ‘did not reveal a strong case’ for amending existing legislation. Industry bodies such as ACA and NAPF have welcomed this decision.