Technical Bulletins - Issue 8 November 2005
The Pensions Regulator Consults on Funding Defined Benefit Schemes

The goalposts on scheme funding have been shifted again by the Department for Work and Pensions (DWP) which indicated that the regulations and Code of Practice on scheme specific funding will now come into force on 30 December 2005. However, the legislation will still apply to any valuations carried out with an effective date of 22 September or later so long as the valuation is not signed off until after 30 December 2005.

While we are waiting for the details of the new regime to be finalised, the Pensions Regulator (the Regulator) has issued a consultation paper on how it plans to regulate the funding of defined benefit schemes. There are two key purposes to this paper. The first is to use scheme funding as one of the tools by which the Regulator will assess which schemes are most at risk (along with other tools like whistleblowing, notifiable events and clearance). The second is to give an indication of how the Regulator will intervene in the event that trustees and the employer are unable to agree on the funding of a scheme.

The Regulator sets out trigger points relating to the scheme’s funding target and the period over which it plans to recover the shortfall. When a trigger point is reached, the Regulator may carry out further investigations to determine whether intervention is appropriate. The Regulator will look for funding targets that fall below 70-80%of the full buy-out measure (which values the cost of securing members’ benefits with an insurance company). This range has been chosen, because, for ‘typical’ schemes, full funding on the FRS17 basis (used for company accounts) or on the Pension Protection Fund (PPF) basis (the basis on which benefits will be assessed for the purpose of the PPF levy) falls in this range. Where the scheme’s funding target is below this range, there is a trigger for further involvement by the Regulator. The trigger point for the period for recovering a shortfall is ten years; where the recovery period is longer than ten years, then the Regulator is likely to become involved, although he may decide not to intervene after taking all the circumstances (including the age profile of the membership and the strength of the employer) into account. The Regulator will be particularly interested where both triggers occur, i.e. the funding target is lower than the specified range and the recovery period is longer than ten years.

The consultation paper also indicates that, where trustees and the employer cannot agree on scheme funding, the Regulator will initially seek to bring about a resolution by informal means, such as encouraging the trustees to consider mediation or reducing future accrual if they have not already done so. It may grant an extra period of time for trustees to seek agreement with the employer. Only when it is clear that a resolution is not possible will the Regulator use its powers under the legislation, including the power to impose a contribution rate on the employer.

Whilst the Regulator says that it is not its intention to impose a funding standard to replace the Minimum Funding Requirement, it recognises that, by publishing this consultation paper, it has set out its expectations on scheme funding and is likely to influence trustee and employer behaviour. It is now likely that those employers that can afford to target full funding on a PPF or FRS17 basis within ten years will seek to do so to minimise the risk of regulatory intervention.

New Rules on Disclosure to Scheme Members

The DWP is currently consulting on changes to the regulations under which schemes must provide information to their members. The main change is that defined benefit schemes will be required to provide annual benefit statements to their members. At present, this is only a requirement for defined contribution schemes (although many defined benefit schemes do choose to provide annual statements, especially to active members). The proposal is that benefit statements must be provided automatically to all active members and to any member who becomes deferred after 6 April 2007. In addition, if a member who became deferred before that date requests an annual benefit statement, then annual benefit statements must be provided to that member automatically in future.

The Pension Protection Fund Updates its Plans for the Pension Protection Levy

Following the end of the consultation period on its original paper, the PPF has published an update making a number of additions to its proposals. The basic principle remains the same that the risk-based levy will be calculated by multiplying a measure of scheme underfunding by the probability of employer insolvency.

One of the most important updates relates to schemes with more than one participating employer. More details have been provided about how the insolvency risk for the scheme as a whole is to be calculated. An average of the risks of individual employers will be taken, weighted by reference to the number of employees for each employer. This will then be multiplied by a factor that takes account of the extent to which the risks for individual employers are correlated. For the first year of operation of the risk-based levy, schemes will have the option of providing the detailed breakdown of information on employers to enable this calculation to be made. If they do not provide this information or if they do but the detailed calculation ends up giving a higher value, then the insolvency risk of the employer with most members in the scheme will be used instead.

A number of welcome changes are made to the calculation of underfunding. Previously, any contributions made after the valuation date would simply have been ignored in calculating the level of underfunding. However, now any contributions which are made to remedy a deficit will be included and so will reduce the level of underfunding taken into account in the levy calculation. In order to encourage schemes to submit a PPF valuation to be taken into account for the 2006/7 levy year, the deadline for submitting the valuation has been moved from 31 December 2005 to 31 March 2006 and it will also be possible for actuaries to use prudent approximations. However, if schemes do not provide a PPF valuation for the 2006/7 year, the calculation will be based on the scheme’s latest MFR valuation, adjusted according to detailed formulae set out in the update.

The PPF has also indicated that it is likely to allow contingent assets to be taken into account when calculating the level of underfunding, although the details of this are not yet available.

It is heartening to see the PPF responding to concerns expressed by the pensions industry by publishing this update document; however, serious concerns remain about the affordability of the levy for many small employers and the practicality for many schemes of carrying out PPF valuations by March in order for their 2006/7 levy to be based on the result.

Other Recent Developments

Cross-Border Schemes: Draft regulations from the DWP had previously suggested that any scheme with members on secondment abroad for more than 12 months would be classed as ‘cross-border’ and so would have to be fully funded at all times. The DWP has now indicated that they intend to relax these requirements to exempt any existing secondments as well as new secondments lasting less than five years.

Internal Controls: The Pensions Regulator has now published a draft code of practice covering the systems of internal controls that trustees should have in place in order to monitor the various sources of risk to their pension scheme.

Mortality: The Continuous Mortality Investigation (CMI) has recently published new estimates of the mortality experienced by pensioners. When these tables were last published (in 1994), a 65 year old man could expect to live until just over age 83, but now he may expect to live on average until he is 86 years and seven months.

British Business and the Pensions Crisis: David Willetts MP, Senior Advisor to Punter Southall, made a speech recently on some of the options for dealing with the UK pensions crisis, in particular examining the possibility of the state taking back the contracted-out part of members’ benefits. Please contact hati.oliver@puntersouthall.com if you would like a copy of the speech.