The Pensions Regulator’s statement – taking things too far

Towards the end of April the Pensions Regulator (tPR) released its first annual statement on the funding of pension schemes. Despite its reporting in the press, I can’t see how this gives any additional slack to employers. However, it does provide perhaps the clearest steer yet on how the Pensions Regulator expects The Occupational Pension Schemes (Scheme Funding) Regulations 2005 to be applied in practice.

It’s fair to say I’m not tPR’s biggest fan. This is largely because I strongly disagree with how they say we should do things (more to come) but also because when I’ve had to deal with them they’ve not been particularly effective (e.g. lack of guidance/help when asked by trustees or making comments that add advisor fees rather than any value). They have of course done some good things. The focus of this blog though is on the difference between the law and how tPR would like us to implement the law. A key quote from tPR’s statement:

“It is a requirement for trustees to calculate technical provisions based on prudent assumptions in relation to their assessment of the employer covenant”

Let’s have a look at what the law says on how schemes should be funded:

“(4) The principles to be followed under paragraph (3) are—

(a)the economic and actuarial assumptions must be chosen prudently, taking account, if applicable, of an appropriate margin for adverse deviation;
(b)the rates of interest used to discount future payments of benefits must be chosen prudently, taking into account either or both-
(i)the yield on assets held by the scheme to fund future benefits and the anticipated future investment returns, and
(ii)the market redemption yields on government or other high-quality bonds;”

No mention of employer covenant there. The whole notion of allowing for employer covenant in calculating the technical provisions has been made up by tPR. It is not law and therefore not necessarily a “requirement”.

Another key statement:

“In the regulator’s view, investment outperformance should be measured relative to the kind of near-risk free return that would be assumed were the scheme to adopt a substantially hedged investment strategy.”

This time they at least preface this with the comment that it is their view. It is quite clear from everything tPR has said over the last couple of years that their view of the future is that all schemes should invest in wholly bonds and be funded on a “self-sufficiency” basis. This is again a significant interpretation of the law and is inefficient, damaging to the long term future of pension funds and unnecessary.

TPR’s continued comments have pushed trustees to use more and more prudent assumptions and focus on short-termism instead of running schemes taking into account their long term nature. This has only accelerated further the trend of the closure and wind-up of both pension schemes AND employers. This goes completely against the tag line on their website:

Committed to increasing confidence and participation in work-based pensions

If this really is what they are committed to do then shouldn’t they be encouraging good pension provision rather than pushing funding so high that it puts employers off (any that aren’t already that is) for good?

A look at tPR’s mandate perhaps gives the biggest clue as to the why they have chosen to regulate pensions like this. From their website:

“The Pensions Acts of 2004 and 2008 give The Pensions Regulator specific objectives:

– To protect the benefits of members of work-based pension schemes
– To promote, and to improve understanding of, the good administration of work-based pension schemes
– To reduce the risk of situations arising which may lead to compensation being payable from the Pension Protection Fund (PPF)
– To maximise employer compliance with employer duties (including the requirement to automatically enrol eligible employees into a qualifying pension provision with a minimum contribution) and with certain employment safeguards”

The third bullet above around protecting the PPF is the only meaningful reason I can think of to allow for employer covenant when calculating technical provisions. It is nothing to do with the first bullet about protecting member’s benefits which would be better served with a significantly lower or significantly higher funding benchmark for all employers no matter what their strength*.

Isn’t this the biggest conflict of interest in pensions?

The difference between tPR’s approach to scheme funding and what the law says is huge. For me this is taking things too far as tPR is there to ensure that the law is abided by, not to write the law. It is after all an unelected quango.

* I will perhaps write a further blog on this but the higher level is obvious in that any funding level less than buy-out is not protecting members adequately and anything less than buy-out of PPF benefits provides no protection whatsoever. The lower level reflects the fact that protection already exists via the PPF and that capital can be better spent by employers than tying it up in the pension fund.

These are my personal thoughts and do not necessarily represent the views of First Actuarial LLP.