Industry pressure for a review of the Minimum Funding Requirement (MFR) has been growing with genera...
Industry pressure for a review of the Minimum Funding Requirement (MFR) has been growing with general criticism of the requirement to hold assets that will match liabilities over a maximum three-year term.
Paul Myners, who is heading up the Government-backed review of suitable investment vehicles within occupational pension schemes, issued his consultation paper in May. He posed questions about the investment strategies of pension funds relating especially to over-dependence on benchmarking, herding and low levels of investment in small enterprises and companies.
Providers and consultants responded by saying MFR compelled investment in gilts with the only choice beyond that coming in the form of large, liquid UK equities.
Singer & Friedlander said in its response that the present static MFR, where a pension fund needs to be fully funded at all times, did not take into account the long-term nature of pension funds and contributed to a strategy that would produce lower returns than if a longer term strategy was adopted.
Instead Singer & Friedlander advocated the adoption of a Dynamic Minimum Funding Requirement (DMFR), as has been put forward by the European Commission report Rebuilding Pensions.
The DMFR uses an 'ongoing concern' approach by allowing pension funds to gear their strategies individually and invest in asset classes that better reflect their long-term liabilities while accepting there may be short-term shortfalls.
The MFR currently requires trustees to gear their investments towards a three-year review. If a fund falls below 90% funded, employers are required to pump money into the fund to redress the balance.
The normal timescale for restoration to 90% funding is one year, with a five-year timescale for full restoration.
The Association of Consulting Actuaries said it was inevitable that a short-term funding test would not be reliant on risky investments.
Schemes without a significant margin over 100% the MFR would be less willing to adopt an investment policy, which increased the risk of failing it.
The NAPF responded to Myners by pointing out that, as pension funds invest to meet their liabilities, the MFR acts as a disincentive for the funds to invest in asset classes other than UK equities or gilts.
The NAPF also recommended either a significant restructuring of the MFR or its replacement by a more appropriate and effective test.
Respondents to the consultation paper were quick to point out that Myners' assertion that US funds invest 5% in venture capital included investors such as endowments and family trusts, which have different investment horizons and risk profiles to UK pension funds.
The NAPF highlighted pension fund trustees' fiduciary duty to act in the best financial interest of members by maximising returns subject to an appropriate level of risk.
It also argued that the performance of private equity in the UK relative to quoted equity performance has not been generally regarded as a good investment for trustees, especially when coupled with a lack of company transparency.
Consultants Bacon & Woodrow (B&W) responded that it was the purpose of pension funds is to provide for members' benefits in retirement and not to provide capital resources to any particular area of investment.
Michael Robarts, an associate at B&W, said: "To that extent, we would regard regulatory initiatives to promote investment by pension funds in any particular asset class such as venture capital as being inappropriate."
B&W went against the general call for a relaxation of the three year timescale by suggesting its experience had shown longer term investment judgements were hard to achieve. Robarts added: "The changes that occur within fund management organisations and trust bodies renders an extension of the traditional three year monitoring period unlikely."
The Myners report is still in the consultation stage, however, the DSS and Treasury are expected to release soon its recommended changes on MFR. The MFR review was completed earlier this year and is expected to widen the scope for acceptable liability matching assets.
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