U.K. pensions bill won’t solve country’s problems

By Catherine Lafferty

LONDON — The British government's long-awaited pensions bill gets high marks for effort from observers, but many think it is far from solving the U.K. pensions crisis — which it was intended to do.

The bill is an attempt to grapple with the United Kingdom's pension crisis, which has seen a number of high-profile pension schemes terminated or frozen. But many in the pensions industry aren't sure the bill will do the trick.

Key features of the bill, which was announced earlier this month, include:

-- creating a Pension Protection Fund, which would be modeled on the U.S. Pension Benefit Guaranty Corp.;

-- creating a new pensions regulator, which would replace and have more extensive powers than the current Occupational Pensions Regulatory Authority;

-- replacing the minimum funding requirement with scheme-specific funding; and

-- requiring trustee education on investments.

One of the most debated parts of the bill is the Pension Protection Fund, which would act as a safety net when employers become insolvent and are unable to meet their pension promises. Funding will come from the assets of terminated plans and through levies paid by final-salary and hybrid occupational pension schemes of solvent employers.

The PPF would provide compensation covering 100% of the original pension promise for people who have reached the scheme's mandated pension age, and 90% for people below that age (subject to an overall benefit cap). It is estimated the levies could top £300 million ($571 million) a year industrywide. The total charge will have three parts: the pension protection premium, an administration premium and a fraud compensation premium.

The pension protection premium, in turn, also has two parts. One payment will be based on scheme factors, such as number of members. The second will be risk-based, linked to the level of the each fund's underfunding and other factors.

The risk-based levy will be at least 50% of the total charge. However, the risk-based premium won't be introduced immediately; it will start in the second year of the program.

In the event of any large claims being made against the PPF, its board will have the power to change the rate of indexation and revaluation. In extreme circumstances, the secretary of state may reduce the level of compensation.

According to Rachel Vahey, manager, pensions development, at Scottish Equitable PLC, Edinburgh, the PPF will start from a weak funding position, with only 50% of the potential levy raised in the first year. The phased introduction of the risk-based element could work against the PPF, she said.

Wendy Beaver, European partner at Mercer Human Resource Consulting, London, applauded establishing the PPF, calling it "a bold move by government, aimed at restoring member confidence in final salary pension schemes."

But she warned it would not be effective unless it is affordable.

"A flat rate charge will apply only for the first year. After that, the intention is to make the levy vary according to the funding level of the scheme. A move to a risk-related levy is essential if the PPF is to succeed. Well-funded schemes are less likely to claim on the fund, so it is right that their sponsoring employer should pay a lower levy. A risk-related levy will help encourage the right funding behaviors by sponsoring employers of poorly funded schemes who should gain through lower levies in future if their scheme's funding level improves."

There are criticisms that the PPF will add another layer of cost to pension funds. Chris Mullen, head of pensions at specialist lawyers Pinsent Curtis Biddle in London, said: "The drive to pensions simplification, which was sensible, seems to be over. Now pension schemes are being strangled by too many regulations. And those companies that do provide pension schemes will pay for the cost of insolvency."

"Much of the work we have done has been related to employers shutting down schemes or closing them to new members. This bill will only accelerate that trend," he added.

Ms. Vahey agreed the PPF could drive more employers away from final salary schemes: "Certainly the introduction of the PPF will lead employers to seriously consider whether to keep the final salary scheme open."

She cited the National Association of Pension Funds' annual survey for 2003, which showed that half of respondents believed that a protection fund would make it less attractive to employers to provide defined benefit schemes. Also, 46% of respondents believed that the government should have most responsibility for funding such a protection fund.

Indeed, the survey by the London-based NAPF found that 107 out of 464 schemes had closed a final salary scheme to new members in the last 12 months. A further 11 had closed the scheme to existing members. Recent research by the Chartered Institute of Personnel and Development at the University of Huddersfield found that 94% of 572 employers are still contributing to staff arrangements, but only 50% have an open final salary scheme. The majority of new employees are offered money purchase schemes. In addition, 15% of employers had already increased the retirement age within their organization, and nearly 20% planned to follow suit over the next two years.

Unions have welcomed the proposals for the PPF, but have called for it to work retroactively. As it stands now, if the bill is enacted, the PPF is not likely to start before 2005 or 2006.

Another key section of the bill involves replacing the Occupational Pensions Regulatory Authority with a new, more powerful pensions regulator. The new agency would have a more investigative role than the OPRA with the goal of taking a more proactive role in pension fund regulation. It will be able to look into potential problems at individual pension funds earlier than OPRA and will have the power to remove trustees and appoint new ones.

The new powers include issuing improvement notices or third-party notices to remedy breaches; the ability to freeze a scheme to protect member benefits or assets while investigations take place; and greater whistle-blowing responsibilities to report certain events.

In addition, the regulator will be able to issue codes of practice, which will give those in the industry practical guidance about their duties and responsibilities under the legislation, assisting schemes in improving compliance and encouraging best practice. In some areas — for example, disclosure of information to scheme members — it will be legally obliged to provide these codes of practice.

The bill has also said the minimum funding requirement will be replaced by a scheme-specific funding standard. However an EU pensions directive which is due to come into force in the United Kingdom in September 2005, requires that all defined benefit plans must be "fully funded at all times."

According to Robin Ellison, head of strategic development, pensions, at Pinsent Curtis Biddle, EU officials take the directive to mean that in the event of a pension scheme closing, all benefits must be paid immediately. Yet the U.K.'s Department for Work and Pensions takes a more liberal approach to the directive, interpreting it to mean employers could pay the benefits over a period of time. Mr. Ellison said there is a potential for conflict between the scheme-specific funding standard and the EU directive.

"The question is what is meant by ‘fully funded,'" Mr. Ellison said. "Does it include future contributions from employers and employees? Does it take into account the future of the stock market and possible pension fund growth or depletion?"

But Jonathan Lawlor, actuarial consultant at Mercer, noted the bill's powers and clauses are in a form that when implemented, the scheme-specific funding standard could meet the requirements of the directive.

"Presently, our understanding is that ‘scheme funding' is a misnomer in that there will still be a minimum standard to meet. This minimum standard should mean that U.K. legislation complies with the EU pensions directive," he said.

The pensions bill also places a heavy educational requirement on pension trustees. According to the bill, trustees are under a statutory duty to be knowledgeable of their trust deed and rules, statements of investment and funding principles and any other document relating to the scheme's administration policy. They must also have adequate knowledge and comprehension of pensions and trust law, and particular issues, such as those relating to funding and investment, to enable them to carry out their duties.

In a statement, consulting firm Watson Wyatt Worldwide, Reigate, expressed concerns that "the bill sets an unrealistically high standard and could discourage members from assuming the responsibility of trusteeship."

Scottish Equitable's Ms. Vahey said even if trustees receive education, the degree to which they will be able to effect policy — such as increasing use of alternative investments — would be dictated to a significant extent by the circumstances and security of each plan.

"If it is well funded and/or there is a strong employer covenant, then the trustees can afford to deviate from a matching investment strategy in the hope of greater return," she said. "And one of the advantages of alternative investments is the possibility that it will smooth out the overall investment performance."

But some question the usefulness of trustee education in the case of smaller funds. Mr. Mullen, of Pinsent Curtis Biddle, said: "Smaller funds don't have money for independent advice. The question is whether some education will equip the trustees to make investment decisions as well as the experts. I think it is na%EF;ve to think that they will."