This first of two articles on the new Pensions Bill explores the practical implications of the bill for defined contribution schemes for employers, trustees and members
The Pensions Bill was politically inevitable, given the multiple and continuing scandals about defined benefit (DB) schemes where the employer has gone bust.
The bill is largely about improving the likelihood people will receive a high proportion of the pension they have been promised and about giving them confidence to trust pensions. I doubt whether any Government spokesperson will ever say this protection or improvement is at the expense of future DB accrual but that is the reality of the situation.
One extraordinary feature of this bill has been the number of Government-sponsored amendments during its progress through Parliament. It is as if London Transport had mechanics positioned at bus stops along the route of the number 17 and each of the mechanics did a bit of the maintenance while the bus was at their stop. This piecemeal approach would not be conducive to good running of the number 17 bus and neither does it give confidence the Pensions Bill will run smoothly when it comes into force.
A prime example of such amendments is the group of moral hazard clauses. These are causing concern among the suppliers of equity capital in that they could be on the hook indefinitely, both corporately and individually, in an unquantifiable way.
The practical implications of the Bill for DB are extremely significant for employers, trustees and members. For employers, it replaces the minimum funding requirement (MFR) with a scheme-specific funding standard that is intended to be compliant with the European Pensions Directive (IORP).
The core principle is that the scheme must have "sufficient and appropriate assets to cover its technical provisions".
Technical provisions are defined in IORP as "the amount required on an actuarial calculation, to make provision for the scheme's liabilities". If the employer and trustees can not agree on what is, by definition, something to be determined by them in respect of their own scheme, the new Pensions Regulator will have to decide.
The likelihood is the first few cases decided by the regulator will set precedents that will heavily influence employer/ trustee negotiations. The employer may well think, 'if this goes to the Pensions Regulator, based on the XYZ case they will probably say around 18%, so if I can agree anything up to 18% with the trustees I'll do so'.
Conversely, the trustees may conclude that because of the XYZ case, they are unlikely to get more than 18%, so a deal will be done at 18%.
A new funding yardstick will have been born. My guess is that the new funding standard will be much stiffer than MFR, the weakness of which has become obvious from the scandals that led to the Pensions Bill.
Another upward pressure on employer contributions is disclosure to members. Ministers confirmed during the Commons Committee stage of the Pensions Bill that they will change existing regulations so that members are told the solvency cover of their accrued pension if the employer went bust and the scheme had no recourse to additional assets. This cover, in current financial conditions, will be stunningly low for most non-retired people in many schemes. The natural reaction of employees will be to demand that the employer does something about it.
In addition, the actuarial profession is racing to stiffen its longevity assumptions, following the most recent mortality investigations. The fact people are living much longer is great news, but expensive.
Only some combination of substantially higher equity markets and substantially higher long gilt yields can save most DB employers from serious financial pain over the next few years, even if they stop all future accrual.
On top of this, there will be the levies for the Pension Protection Fund (PPF). We do not yet know what the risk-related element will be, but if it does not cause additional pain to weak employers with weak schemes then it is not doing its job.
If any DB employer does not already realise that it has a tiger by the tail, it pretty soon will.
To a large extent, the issues for the trustees are the other side of the coin to those for the employer. When there is a deficiency, they have a fiduciary responsibility to put pressure on the employer to step up the pace of funding, but normally they will be limited by the line which the regulator will take in resolving a dispute.
They also have a hellish judgement to make about investments. Should they bite the bullet and sell equities? A prevailing assumption seems to be that equities will go up, but someone once said that stock markets can behave irrationally for longer than you can stay solvent. What if equities took another nosedive, for whatever reason?
A new concern for trustees of all types of scheme is the requirement in the Pensions Bill that they should have sufficient knowledge and understanding to enable them to exercise properly their function as trustees. The detailed criteria for this will be contained in a Code of Practice from the Pensions Regulator. There is a tightrope to be walked here, maintaining a delicate balance between pushing for high standards and keeping good lay people as trustees.
Next week Stewart Ritchie concludes his look at the practical implications of the Pensions Bill, focusing in particular on the Pension Protection Fund and the role of the intermediary.
Minimum funding requirement to be replaced by scheme-specific funding standard.
Trustees will be required to have sufficient knowledge and understanding to properly exercise their function.