Pensions in the UK: A 10-year scorecard

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The advent of The Pensions Regulator and the Pension Protection Fund in 2005 changed the UK occupational pensions sector for good, writes Taha Lokhandwala. But have they changed it for the better?

The drafting of laws, in modern democracies, involves a compromise between problem solving, politics and vested interests. Ten years ago, the discussions over the reform of the UK’s pension system were no different. In 2005, the then Labour government introduced The Pensions Regulator (TPR) and the Pension Protection Fund (PPF), which changed the way sponsors and trustees looked at defined benefit (DB) schemes. But, a decade later, many still question their effectiveness and the reasons behind their existence.

The Pensions Act 2004, a 325-page document with complex aims, sought to achieve three things. First was to replace the former Occupational Pensions Regulatory Authority (OPRA) with TPR, which was to have greater legal powers of intervention and to protect pension schemes from rogue employers. The second was to increase protection for members against sponsor insolvency by introducing the PPF. The Act created the PPF Board, specified its funding structure, and gave it licence to collect a levy from any DB scheme that might one day require its assistance. 

The third was to transpose the original IORP Directive – the European Commission’s attempt to improve the structure and security of pension systems across the EU – into UK law. This meant introducing scheme-specific funding mechanisms and ensuring liabilities were fully funded, or that each scheme at least had a coherent plan to achieve its goal.

Scheme-specific funding is now a mainstay of UK pensions and was an important element of the Pensions Act 2004. The run-up to the creation of the PPF and TPR also saw political wrangling, tabloid headlines and a even naked beach protest by pensioners affected by scheme sponsor insolvency.

At a glance

• This year marks 10 years of the Pensions Regulator (TPR) and the Pensions Protection Fund.
• The regime introduced in 2005 brought in scheme-specific funding into the UK DB sector and gave TPR power to enforce contributions.
• Criticisms remain over TPR’s statutory objectives and the fairness of the PPF-levy model.

The problem
For about 10 years from the mid 1990s, the UK pensions system worked under the minimum funding requirement (MFR), which had been introduced in the wake of the 1991 Maxwell/Mirror Group Pension Fund fraud case. The MFR used basic assumptions, with a ‘one-size fits all’ approach and triennial valuations. Scheme actuaries certified the MFR funding ratio annually and in cases of underfunding provided a view on whether they thought the scheme could reach 90% – the minimum requirement – through a new employer contribution model, leaving no legal debt on the sponsoring employer.

Tony Hobman, was appointed chief executive of TPR in April 2005, having previously been head of OPRA. Critical of the MFR, he says the old legislation was designed to fix other flaws and never focused on funding. “We had the MFR which was supposed to be a floor but in fact became rather more of a ceiling,” he says.

Transposition of the IORP Directive changed this, effectively creating the concepts of technical provisions and recovery plans, adding more pressure on trustees and corporates to ensure adequate funding.

While a large part of the work of both pension funds and TPR since has been to monitor and assess funding levels, from the outset one of TPR’s major statutory objectives has been to minimise claims on the PPF.

The 2004 Pensions Act also sought to address two flaws. First, DB schemes were forced to cover pensioner benefits in full on failure of the sponsor, with active members second in line. Second, while the MFR was understood to cover liabilities, it actually covered a significantly lower proportion on a bulk annuity valuation basis. This meant schemes would not necessarily have sufficient assets to secure member benefits in cases of insolvency and in some cases sponsors were able to walk away from underfunded schemes on the basis that they were fully funded according to the MFR.

In 2002, the failure of Allied Steel and Wire (ASW) brought this issue to the fore when employees of the firm lost their jobs and their accrued pension rights – including some who had transferred into the fund from the British Steel Pension Scheme. In 2003, the shipping conglomerate Maersk walked away from its DB scheme on the basis of full MFR funding, even though this did not provide the full level of benefits for members.

Both cases led to protests. MPs whose constituents had lost out tabled questions to the House of Commons and ASW scheme members protested outside the Labour Party conference in 2002.

Toby Hobman

The solution
In April 2005, the PPF and TPR came into existence. The PPF is the lifeboat for pension schemes with insolvent sponsors, while the regulator was given new powers to enforce contribution notices (CNs) and financial support directions (FSDs), which would either force companies to fund DB schemes or provide additional funds to cover liquidation.

Mark Dowsey, senior consultant at Towers Watson, emphasises that while TPR has played a role in supporting schemes, its structure has focused on protecting the PPF.

“A lot of the new powers were a direct consequence of the introduction of the PPF. The CNs and FSDs were tied in with the PPF and employer debt provisions – and ensuring member promises were made far more secure than they were at that point,” he says.

But the government was reluctant at the time to set up the PPF, eventually conceding after political and media pressure. Frank Field, a Labour MP, campaigned on the issue with cross-party support, even proposing his own model for a protection fund. 

Robin Ellison

The Department for Work and Pensions studied several models, including the US Pension Benefit Guaranty Corporation, before adopting a scheme-levy funded model. It needed to be fair and reflect the risks of the schemes it covered, and alleviate the government from the need to provide more capital. “It was clear the government had no intention of being the guarantor of last resort,” Dowsey says. “It had to be a levy imposed on the industry.”

The PPF model now caps benefits at 90% of accrued rights. Field’s model, he says, would have spread the cost to the taxpayer, but would have offered a higher level of guarantee.

The scorecard
Behind every debate remains one unanswerable question: what is the counterfactual? TPR and the PPF have had 10 years to embed themselves. An important issue remains with the complexity and bureaucracy of the PPF funding system, under which stronger, larger schemes are seen to support weaker, smaller ones. 

TPR has been criticised over how it implements its statutory objective to protect the PPF, with accusations that its focus is on pension funding regardless of the needs of the sponsor.

Hobman, now chairman of the covenant advisory firm, Lincoln Pensions, led TPR in defining how to execute its new powers and manage its objectives. He wanted to create an approachable regulator, particularly given the unprecedented level of power it was granted.

“The powers have been used sparingly, but have helped the market understand that schemes cannot simply be abandoned and must be treated fairly in the process of negotiating funding outcomes with sponsors,” Hobman says.

“We didn’t want to appear heavy handed. Dialogue [with schemes and sponsors] was helpful. It helped the market understand what our expectations were and TPR to understand the market dynamics.”

Hobman says this did not mean TPR never fully exercised its powers. On the contrary, the regulator enjoyed success in the UK and abroad; after years of protracted legal wrangling it was party to successful claims against both Lehman Brothers and Nortel Networks in 2014 – two of the world’s largest insolvencies that left UK pension schemes underfunded and unsupported. “That was successful, and the market accepted the regime it worked with,” Hobman continues. “Now these powers seem rather unremarkable.”

TPR’s statutory objectives

• To protect the benefits of members of occupational pension schemes and personal pensions schemes (where there is a direct payment arrangement).
• To promote, and to improve understanding of the good administration of work-based pension schemes.
• To reduce the risk of situations that may lead to compensation being payable from the Pension Protection Fund.
• To maximise employer compliance with auto-enrolment (2008).
• To minimise any adverse impact on the sustainable growth of an employer (2014).

Unremarkable they may be, but others are concerned. Robin Ellison, consultant at law firm Pinsent Mason, and former chairman of the UK’s National Association of Pension Funds (NAPF), is not supportive.

The issues that led to the creation of the PPF could have been fixed by repealing ill-thought-out solvency legislation, rather than increasing the burden, he believes.

“Are members better protected?” Ellison asks. “In some ways, yes, because the industry is funding a compensation scheme. But what would have happened without the legislation? I do not think a lot of people would have lost out as other [legal] systems would have helped. You could achieve this with less grief, but it was politically driven.”

TPR, Ellison believes, is structured to protect the PPF which, in turn, is structured to protect its own interests over those of schemes or sponsors. Ellison believes the unintended consequences of the PPF were to scare corporates away from DB provision with a detrimental effect on member rights as a whole. Even with the best of intentions, the framework was not appropriate. “TPR does what it says on the tin. The criticism is over what it says on the tin,” as Ellison puts it. 

Over the past decade, the regulator has prided itself on its risk-proportionate approach. But this means it arguably spends its time on the areas where it perceives the most risk to its own regulatory regime, without spending sufficient time on the risks to members. With around 450 staff to monitor over 40,000 pension funds, this is understandable, particularly in comparison with the Netherlands, where the regulator has greater oversight powers.

Dowsey believes the consequence of TPR’s stretched resources is that it has to be hands-off and rely on whistleblowing. “When it says it is a risk-based regulator it is true? It cannot possibly sign off and approve all recovery plans as it is too big a workload.”

A decade on there are still unanswered questions. Even with stringent control of larger schemes, could TPR prevent a failure? If wilful negligence of its codes leads to the detriment of members in smaller schemes, who is to blame? The PPF currently runs a £3bn surplus so to whom does this belong? 

Both organisations remain key to UK occupational pensions. Despite widespread support for the objectives of pension benefit security and hands-off regulation, many will ask whether the two are reconcilable and whether the UK’s occupational pension regulatory system is really fit for purpose.

TPR chief executive looks ahead to the challenges of defined contribution

As The Pensions Regulator (TPR) began life in 2005 its focus was to improve governance and funding in defined benefit (DB) schemes. Now on its third chief executive, the regulatory body says it has a clear focus. Lesley Titcomb joined in March, moving from the Financial Conduct Authority. While firmly stating that the regulator’s focus will be on auto-enrolment, she points to other areas of concentration.

Continuing as it started, Titcomb says the bulk of TPR’s work will be managing the run-off of DB schemes, many of which will pay out their final liabilities over the next 15 years. However, TPR’s concern is moving to an age where senior management of companies have no experience of DB schemes, either as a member, or of managing them. This means additional work and potential regulation around protecting scheme covenants and ensuring employer engagement. This, and others, are clear risks to the regulator achieving its objectives. Titcomb says she cannot pre-empt the response but deciding what levers to pull and when is all part the regulatory game.

Lesley Titcomb

The regulator’s initial structure has left it with a challenge to implement defined contribution (DC) regulations. TPR accepts it has to develop processes and powers as DC schemes demand a fundamentally different approach. Titcomb says that alleviating the risks to DC members requires proactive regulation. “We’re adapting our regulation, but there are still some missing links,” she says.

TPR was given powers on inception to pursue companies and individuals who violated its rules and ignored its objectives. However, a preventative approach aimed at protecting members is a different style of regulation than punishing wrongdoers.

As is becoming common in other European countries, particularly those with many occupational pension schemes like the UK, consolidation of smaller schemes is an aim. TPR’s ability to regulate the more than 40,000 UK-based Institutions for Occupational Retirement Provision (IOPRs) is limited, as it relies on whistleblowing and the larger schemes. Consolidation is certainly in its interest.

“At the moment we have no power to enforce consolidation,” Titcomb says. “Can we rely on the market or will the government have to think whether it wants this to continue? It is something we keep under review. We have a good relationship with the government and discuss the landscape regularly, so they are aware of the issues.”

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