The DWP has issued a call for evidence in connection with potential legislative changes to allow explicitly for the smoothing of asset and liability values in pension scheme valuations and to introduce a new statutory objective requiring the Pensions Regulator to consider the long-term affordability of deficit recovery plans to sponsoring employers. These changes were first proposed by the Chancellor in his Autumn statement at the end of last year.

Smoothing assets and liabilities

Since the autumn of 2008 deficits in most UK defined benefit (DB) occupational pension schemes have risen because the liabilities of such schemes have grown at a faster rate than the assets. This trend has been particularly marked since the spring of 2011. Rather than declining asset values, a key reason for the increased deficits has been the unprecedented fall in gilt yields, which has resulted in lower discount rates being used to measure the present value of scheme liabilities.

There has been concern that the rising deficits in DB schemes are impacting economic growth by forcing some employers to make substantial additional contributions to their schemes; diverting funds away from business investment. Responding to this concern in his Autumn Statement, the Chancellor said that the Government “recognises that volatility in measures of pension scheme deficits can make it hard for companies to manage their investment plans and attract external funding”. He promised that the DWP would “consult on whether to allow companies undergoing valuations in 2013 or later to smooth asset and liability values”.

Due to the complexity of the issues involved, the DWP has issued an initial call for evidence to seek views on whether the pension scheme funding legislation should be amended to allow explicitly the smoothing of asset values and liabilities in funding valuations. This would enable asset prices and discount rates to be averaged over a period of time, instead of using current market rates, so countering the effects of the current economic situation. The DWP is also seeking views on:

  • whether smoothing should be mandatory or optional for schemes
  • the time period over which asset and liability values should be smoothed
  • whether there should be a requirement to retain a smoothing model for more than one valuation (to aid consistency)
  • whether smoothing should be applied to a scheme's assets as well as its liabilities.

If the call for evidence prompts changes to the legislation, the DWP plans to consult on more detailed proposals and implement any changes as soon as practicable in 2013.

New statutory objective

The DWP is also seeking views on whether the Pensions Regulator should be given a new statutory objective to consider the long-term affordability of deficit recovery plans to sponsoring employers. The argument in favour of a new statutory objective is that this would address the perceived imbalance in the Regulator’s current objectives which focus explicitly on protecting members and the Pension Protection Fund, but make no reference to the interests of sponsoring employers. On the other hand, there is an argument that there is no need for a new objective on the basis that the Regulator has already made clear that it will have regard to affordability when reviewing deficit recovery plans.

Comment

The existing scheme funding regime provides trustees and employers with flexibility to take account of current economic circumstances when agreeing funding valuations and recovery plans. However, to date, the Pensions Regulator has discouraged trustees and employers from smoothing asset and liability values in funding valuations. Therefore, if smoothing were explicitly permitted under the legislation it would provide trustees and employers with greater certainty that such action is allowed.

If smoothing were expressly permitted, it would presumably only be allowed where it is prudent in the context of the scheme in question (bearing in mind the strength of the employer covenant, the funding position of the scheme and the scheme’s investment strategy). In addition, it would be a step backwards if the legislation was amended in a way that reduced the current flexibility for trustees and employers to set methods and assumptions that are appropriate for their scheme (e.g. by making smoothing mandatory), as this flexibility is an important element of the existing funding regime.

As far as the new statutory objective is concerned, it would provide welcome comfort to employers if the Regulator was expressly required to consider the long-term affordability of deficit recovery plans to sponsoring employers. It would also mean that the Regulator’s statutory objectives better reflect the considerations that trustees must take into account when agreeing funding valuations and recovery plans with scheme sponsors. Having said that, given the statements already made by the Regulator, any new statutory objective is unlikely to result in a material change to current practice.

The closing date for submitting views on the new objective is 21 February 2013 and in relation to smoothing it is 7 March 2013.