LONDON - New rules designed to protect U.K. pension benefits may undercut that promise if they prompt adoption of defined contribution plans in place of traditional, final-pay defined benefit plans, pension experts warn.
As the British government is drafting its general approach to regulating the U.K. pension markets, pension experts fear overly burdensome rules will drive employers away from defined benefit plans and/or to lower benefit levels.
"Nothing is free in this vale of tears, and the cost of best practice will shift the balance just a little further against anyone voluntarily undertaking a final salary pension promise," Stephen G.M. Hodge, group treasurer of the Royal Dutch/Shell Group of Companies, London, said at a recent conference sponsored by The Economist.
The U.K. government is expected to issue its general policy conclusions in mid-March. Those conclusions are based on a wide-ranging report issued last fall by the Pension Law Review Committee, which called for creation of a pensions regulator, imposition of minimum funding standards, mandatory participant representation on boards of trustees and establishment of a compensation scheme to cover loss of pension assets due to fraud, theft or misappropriation (Pensions & Investments, Oct. 4).
The creation of the committee, chaired by Oxford University professor Roy Goode, was prompted by the plundering of pension funds under the control of the late media tycoon Robert Maxwell.
Based on the Goode Committee's 218 recommendations, the U.K.'s Department of Social Security in December issued a set of seven papers asking for public comment.
In response, pension experts warned overregulation of pension funds could lead to a shift to defined contribution plans.
In particular, stringent new minimum funding rules could drive employers to adopt defined contribution plans or reduce guaranteed benefits, said Ron Amy, chairman of The National Association of Pension Funds, London.
"In a prolonged bear market, a sound but less than fully funded defined benefit scheme will be a better method of pension provision for its members than a defined contribution scheme, and it would be a dreadful irony if the (committee's) recommendation left everyone much worse off in an attempt to protect a tiny minority," the NAPF wrote the Department of Social Security.
While supportive of the overall framework the Goode Committee proposed, the NAPF said the proposed minimum solvency, or funding, standard is too harsh. Requiring employers to inject cash immediately into a pension plan that becomes less than 90% funded could cause severe cash drains.
One NAPF member estimated it would have to make a cash infusion equal to 100% of current payroll if the proposal were enacted.
The risk of becoming underfunded could drive pension funds away from equities, the organization said. That could weaken British industry by causing greater reliance on debt financing and raising the cost of equity capital, it explained.
Rather, the committee's proposal to require plans that slip to between 90% and 100% of minimum funding to submit a business plan to the pensions regulator to restore full funding within three years should be extended to all underfunded situations, the NAPF wrote.
How to calculate a pension fund's liabilities on a termination basis and obtaining a realistic cost of buying immediate annuities also is troublesome. In particular, actuaries are debating how to treat equities when valuing liabilities, and to what extent they can be considered within mature plans and those with retirees only.
Paul Trickett, head of pensions at British Coal's Pensions and Insurance Centre, Sheffield, England, which administers the Mineworkers' Pension Scheme, said the insolvency rules should be scrapped altogether.
As proposed, the rules will mean perfectly well-funded plans will not meet the standard, he said. If the rules are relaxed, they will provide little reassurance that benefits will be protected, he added.
"The proposals as they now stand are likely to lead to a substantial reduction in benefit levels relative to contributions," Mr. Trickett told the conference.
Shell's Mr. Hodge said in a time when the Western world is moving into a low-growth phase, radical cost reduction by corporations is essential and "there can be no sacred cows."
Pension plans are costly, he said. "The final-salary pension promise is one of the least controllable of all corporate liabilities - and it is becoming less controllable - and this at a time when liability control has never been more important."
To the extent the funding standards shift investment practices toward security and solvency and away from asset/liability matching, they 'could be another nail in the coffin of the funded final-salary pension fund," he said.
In addition, requiring well-run pension funds to pay to compensate participants whose plans have been looted is unfair, Mr. Hodge said.
Rather, the government should pay for any losses, Mr. Hodge said, finding himself in a rare agreement with the Trades Union Congress.
Stuart James, pensions partner with the law firm of Rowe & Maw, London, who was a member of the Goode Committee, said a shift to defined contribution plans "is not necessarily the logical effect" of the committee's report.
"People will move to money purchase schemes anyway," as a means to control costs, now that their contribution holidays are at an end, Mr. James told the conference.
People "may use the report as an excuse for it, but it is not the reason for it," Mr. James said.
While legislation is being debated, some trade associations, including the NAPF, are developing codes of best guidance to assist the industry in the interim. Those codes can form the basis for future regulations, Mr. Amy said.
But other groups are opposed to the codes.
"We think it is a very dangerous move. It gives the government the opportunity to get off the hook and not introduce legislation," said Joanne Segars, pensions officer for the Trades Union Congress, London, the U.K. equivalent of the AFL-CIO.
Mr. Trickett said: "I agree wholeheartedly that we need a statutory scheme and not one based on codes of best practice because self-regulation has failed."