At the end of last week the Treasury released its consultation paper on the minimum funding requirem...
At the end of last week the Treasury released its consultation paper on the minimum funding requirement (MFR) that applies to most private sector defined benefit (DB) occupational pension schemes.
It was issued in parallel with a report on the MFR from the Pensions Board of the Faculty and Institute of Actuaries (comments from this report can also be viewed in this issue on IW page 67.)
It also seeks views on alternatives to the MFR in the light of both the Actuaries' report and in the context of Paul Myners' review of institutional investment commissioned by the Chancellor of the Exchequer earlier this year. Following are excerpts from the report, which can be viewed in full at www.hm-treasury.gov.uk.
Occupational pensions are important. About 4.5m people already get pensions from private sector DB occupational pension schemes and about another 8.5m people of working age have pension rights through such occupational schemes which will become payable in future.
To provide for their liabilities, defined benefit occupational pension schemes build up funds. These are subject to the minimum funding requirement introduced under the Pensions Act 1995. Schemes whose assets fall below the minimum set by the MFR test have to make up the shortfall within prescribed time periods.
However, the MFR does not provide a guarantee that, in the event of an employer becoming insolvent, its pension scheme members' rights will be honoured in full. And there have been indications that the MFR also adversely influences the investment decisions of scheme managers. This could damage the longer-term prospects for such schemes, which remain an important way of providing for retirement
The Government wishes to explore a range of approaches to protecting pensioners' interests and securing other scheme members' pension rights.
There are a number of ways in which these objectives could be addressed, ranging from amending the current MFR formula to abolishing it entirely and finding another structure.
In considering amending the MFR itself, the weaknesses in the current calculation needs to be recognised. As the Actuaries' report identifies, the current test fails to reflect equity price movements accurately, the benchmark by which it is intended that future liabilities for non-pensioners should be calculated. The Actuaries' proposed that a 1% premium above the composite index yield represents an approximation to long-term equity yields (less 1% for expenses), but using this as the discount rate might simply exacerbate the current supply-demand mismatch for gilts and bonds, increasing funding costs in the process. It might also create a greater divergence between a scheme's actual portfolio and one that would match the discounting applied to its liabilities, imposing greater volatility on a fund and also increasing the cost of providing a defined benefit pension scheme in order to provide a buffer against the volatility.
The Government therefore wants to investigate other objective ways to incorporate a measure of equity returns in discounting certain liabilities to avoid these potential problems. Possibilities include using returns measured over a period leading up to the relevant date, but other ideas are invited along with views on their likely consequences for investment behaviour, funding levels and costs to schemes.
The current MFR test seeks to provide security for pensions in the event of the discontinuance of the scheme but it might be in the longer-term interests of present and future scheme members to view the funding of a scheme on an ongoing basis for all scheme members.
The Government recognises this would imply a change in the underlying rationale for the funding test, particularly in respect of pensioner liabilities. It welcomes views on which measures would be suitable for a minimum funding requirement framed in this way, whether they should be combined with some other form of protection and the extent to which they would encourage a long term view to be taken in investment decisions.
Proposed revisions to the MFR need to be assessed not just in isolation but also in conjunction with other ways of protecting pensions. A revised funding requirement might require the support of supervision or insurance in order to meet the Government's objectives of security and affordability for defined benefit pensions. Equally, approaches such as insurance or a central discontinuance fund might necessitate the continued existence of a funding requirement in order to meet the objectives.
Among the possible alternatives to a funding requirement on its own is prudential supervision by a regulator. This would constitute a more proactive form of regulation than currently exists, but would enable funding to be monitored more regularly, perhaps reducing the impact of volatility in the adequacy of funding levels generated by short term market fluctuations.
It would also allow the qualities of a scheme beyond simply its funding, for example its management, to be regulated and for the financial strength of the employer to be taken into account in the supervision process. But the additional administrative burden that supervision would bring cannot be ignored. The benefits of prudential supervision would have to be weighed against the difficulties and costs that this would bring. While the required funding level of a scheme could be more sensitive to schemes' circumstances under this approach, prudential supervision is unlikely to eliminate the need for a funding requirement altogether.
A further option is compulsory insurance, either mutual or commercial terms. Such insurance would allow risks to be pooled across the sector, offering greater pr
What made financial headlines over the weekend?
Compared to 6% of 55-64 years olds
Sam Gold and Doug Abbott to take reins
Bionic advice for private clients