Autumn Statement 2012: The Department for Work and Pensions (DWP) will consult on providing The Pensions Regulator (TPR) with a new statutory objective to consider the long-term affordability of final salary pension scheme recovery plans on employers.
The government also said it recognises that volatility in measures of pension scheme deficits can make it hard for employers to manage their investment plans and attract external funding.
The consultation will also look at whether to allow employers undergoing valuation in 2013 or later to smooth asset and liability values.
The Pensions Regulator said, until it is clear whether the regime will be altered in any way, there will be no change in the responsibilities of employers and trustees.
A myth seems to have taken hold that pension schemes must value their liabilities by using an interest rate that starts with current gilt yields and adds a fixed margin. Many schemes instead start with the returns they expect to get on the assets they hold, which will vary with market conditions, and build in a prudence margin. Where the government could help pension funds significantly would be to encourage the regulator to present this as an acceptable approach.
The Chancellor will collect more corporation tax if any change results in companies making smaller payments to their pension schemes. It would be tempting to see this as an easy way to help balance the books, but the government should tread carefully, especially as there is already flexibility over how quickly employers pay off deficits. We hope the government can be persuaded that changing the way the regulator goes about its business would be more sensible than turning the system upside down.
Any adjustments to pension liabilities should be justified by beliefs about the future and not by looking in the rearview mirror to see what gilt yields used to be. Any smoothing approach could result in a less flexible and more rigidly prescribed regime, which could have undesirable consequences when market conditions change.
Employers whose liabilities might initially be reduced by smoothing could find that it makes things look worse if interest rates rise – a case of needing to be careful what you wish for.
Sensibly, the government does not appear to be considering smoothing liability values in isolation. Low interest rates on gilts and high market values for gilts are two sides of the same coin, so it would exaggerate the health of pension scheme funding to smooth liability values without simultaneously marking down the value of gilts held as assets.
The DWP consultation on the long-term affordability of deficit recovery plans and 2013 valuations announced by the Chancellor today will offer a genuine opportunity to debate an area of policy where there are different views. Certainly, it is important that sponsors of defined benefit schemes are not disadvantaged by short-term economic policy decisions designed to boost the economy, but – equally – we do not want to move to a position where either sponsors or trustees lose clarity on the funding needed to meet pension obligations as they fall due.
It is good news that The Pensions Regulator’s statutory objectives may be expanded to include a specific objective to consider the affordability of deficit recovery plans. It is equally good news that the DWP is to consult on the smoothing of asset and liability values. This would recognise that private sector final salary pensions are only affordable if the impact on the sponsoring employer is part of the equation.
Successive governments have turned voluntary pension promises into legal guarantees: responsible governments create a workable framework in which promises can be honoured without endangering investment and jobs. The alternative is the likelihood of more businesses failing as a result of the weight of their pension liabilities and members receiving reduced benefits.
Businesses are struggling with gaping deficits in their final salary pension funds, and quantitative easing (QE) has made things much worse. Firms are being forced to divert cash away from jobs and investment into filling holes in their pension funds. We think QE has distorted the picture and that the deficits can be misleading.
We have been calling on the government to help pension funds deal with the damaging effects of QE for a long time, and we are pleased that it has listened. It is good to see the Chancellor explicitly recognising the problem.
We will work closely with the government and the regulator to help find a solution to the volatility in funding deficits that companies are currently experiencing.
But time is of the essence. It is important that any change is implemented quickly, and helps companies currently going through their funding valuations. These firms are the most affected by the current low gilt yields, and any support should be extended to them too.
What is most important is that this uncertainty about how financing pension schemes should operate in the future is resolved as quickly as possible, because it makes it difficult for trustees and employers to take informed decisions about how they run the scheme and manage risk and could create an uneven playing field between different ‘tranches’ of scheme valuations.
We agree that The Pension Regulator’s objectives need to be reviewed, and that employer affordability could be a key consideration in doing so, since valuations are long-term planning exercises. But just adding a new, employer-related objective might not in itself be a solution. The proposed new objective to consider employer affordability needs to be considered against the regulator’s existing objectives, which already conflict since it has to balance trustee actions, which are driven by trustee objectives and responsibilities, with protecting the PPF. The proposed objective, while sensible in isolation, could send the regulator’s head spinning and result in a very confused set of regulatory actions.
The current valuation regime implicitly permits ‘smoothing’ but via recovery plans rather than smoothed measures of asset and liability values. While market-based measures are not necessarily realistic, the apparent comfort provided by stable measures can be misleading and hide a lot of information. If the regulator’s objectives overall can be amended so that it must take a more balanced view of where risk should sit in the statutory funding system, then we think that the arguments about smoothing could become redundant.
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