Pension benefit protection schemes called for adequate funding in order to reduce the risk they take as underfunding and supervision emerged as the major issues at the OECD (Organisation for Economic Co-operation and Development) seminar on reforming pension benefit protection schemes in Paris in early July.
The chairman of the UK's three-year-old Pension Protection Fund (PPF), Lawrence Churchill, told the seminar that the three key aspects the PPF had learned from the US and Germany were to keep a respectable distance to politicians, to set a levy based on risk and to take steps to avoid moral hazard.
And chair of the OECD working party private pensions, Ambrogio Rinaldi, even reported opposition from pension benefit protection schemes towards the state as a guarantor after the move towards a private pension system.
The PPF's chief executive Partha Dasgupta said the fund needed to be self-financing, as it did not have a guarantee from the UK government. But still, a clear separation of pension benefit protection schemes and the state is not easy.
The UK's HM Treasury sets a levy ceiling of £775m (€1.1bn) and specifies that 80% of the levy has to be risk-based, while the remainder is based on scheme liabilities.
Achieving complete independence from politics is also difficult in the US, according to Vincent Snowbarger, interim director of the US Pension Benefit Guaranty Corporation (PBGC), as the ERISA law (Employee Retirement Income Security Act), was established by Congress.
"Our purpose under ERISA is to assure timely and uninterrupted payment of benefits, maintain insurance premiums at the lowest level necessary to meet obligations and encourage growth of voluntary pension plans," said Snowbarger. "And for that, we need a clearly defined regulatory and operational authority consisting of legislature, administration, a board of corporation and management. But as private plans are voluntary there should not be too much regulation and too strict investment rules. However, I'm not sure we've learned the lesson yet. We still don't know who ultimately pays for the deficit as there is not enough money for insurance claims."
Snowbarger also said that pension benefit protection schemes had to establish whether they were insurance schemes or a social insurance. The US legislator sets the funding rules. But Snowbarger said that investment, regulation of funding and disclosures were fiduciary duties.
Andrew Young, directing actuary at the UK government actuary department, believes it is important to secure adequate funding. He said: "Setting the benefits at an appropriate level - and providing less than a full scheme benefit - is fundamental. If you insured full benefits, it would be too expensive for the pension schemes."
He added that the PPF's moral hazard consisted of three types: manipulation of pension scheme benefits before entry into the PPF to maximise the level of compensation, which in turn increases the cost of claims; the increasing number of claims by employers dumping scheme liabilities on the PPF and the increasing cost of claims by employers organising their affairs so the pension scheme has a reduced claim on the employer in the event of insolvency.
John Ashcroft, head of strategy at the UK's Pensions Regulator (TPR), said to pre-empt moral hazard, TPR has established a clearance process, taken a hard line on abandonment and has been trying to raise the trustees' game. The Pensions Regulator, he continued, was also prepared for infrequent use of expensive normal moral hazard powers such as insurance.
"We rely on trustees and fiduciary duty to make sure schemes are fully funded," he told the seminar. "And there should be enough funding to make sure the liabilities are covered. But by being prudent, we are not expecting the same level of funding as the insurance companies. And prudence also depends in part on the employer covenant."
But although pension benefit protection schemes claim to enable security with affordability, they have introduced novel risks for the regulator such as the rigour of assessing the employer covenant and employer avoidance activity.
Young said addressing the moral hazard as well as creating as much freedom as possible for a pensions insurance fund, a flexible process for setting the levy, strong scheme funding and not guaranteeing the full scheme benefits were important.
He added that pension benefit protection schemes should operate like pension schemes to enable annual claims to be smoothed over time and avoid large changes between years in the levies on employers.
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