Memorandum submitted jointly by The Pensions
Regulator and the Pension Protection Fund
1. BACKGROUND
1.1 In 2002 the Pickering report[1]
called for simplification of the overall pensions regulatory regime.
This was followed later in 2002 by the Quinquennial Review of
the Occupational Pensions Regulatory Authority (Opra) and the
pensions Green Paper, "Simplicity, Security and Choice:
Working and saving for retirement". Both these documents
and the National Audit Office report on Opra supported the Pickering
report in stating clearly the need for change in pensions regulation
and for the establishment of a "New Kind of Regulator".
1.2 The reports developed the principle
that regulatory bodies are most effective if they can focus their
resources on the areas of real risk. Opra was seen as having a
"tick-box"' rigid style focusing on non-compliance of
rules. Opra had been created under the Pensions Act 1995, partly
in response to the Maxwell scandal and the theft of scheme funds.
It began work in April 1997. Circumstances have since changed,
and the most serious current problems with pension schemes centre
around funding rather than theft and administration.
1.3 The organisations introduced by the
Pensions Act 2004 address several key concerns related to the
issue of providing extra security and protection for members of
private sector work-based defined benefit pension schemes.[2]
It was recognised that:
— Scheme members needed to be better
protected by a regulator with flexibility and powers to take a
targeted and proportionate approach;
— Those administering, advising or
running pension schemes needed to be provided with better support
and guidance; and where appropriate those who wilfully or recklessly
neglect their statutory duties needed to be punished;
— Burdens on business needed to be
kept to a minimum. By targeting the badly run and highest risk
schemes, well administered and secure schemes could continue without
unnecessary regulatory burden;
— The minimum funding requirement ("MFR"),
where schemes had to hold a minimum level of assets (calculated
on a prescribed basis) to meet their liabilities, had increased
regulation and costs for sponsoring employers without delivering
the expected level of security;
— Under-funding of non money purchase
pension schemes had become so severe that many such pension schemes
faced wind-up. This would impact on a very large number of non-pensioner
members of schemes which were underfunded when their employer
became insolvent, who faced the double blow of losing both their
job and much of the pension they had been expecting.
— The pre-6 April 2005 winding up rules
of such pension schemes meant that although existing pensioners
were often quite well protected, active or deferred members could
lose a large portion of their retirement security;
— Even with regulation in place to
encourage or mandate improvements to scheme funding, some schemes
would face inevitable wind-up.
1.4 In light of these issues, two key functions
were identified:
Firstly, to regulate and protect private
sector pension provision and provide that all employers offering
non money purchase pension schemes should ensure they are well
funded schemes with optimum levels of member security.
Secondly, to compensate scheme members
where the scheme is forced into wind-up.
2. THE NEW
NON-DEPARTMENTAL
PUBLIC BODIES
2.1 Following extensive consultation after
the publication of the Green Paper in December 2002 it was decided
to create two new non-departmental public bodies, the Pensions
Regulator and the Pension Protection Fund.
2.2 Both organisations' functions are based
on the legislative framework laid down in the Pensions Act 2004
(the Act). They carry out the duties given to them by the Act
and as such are publicly accountable to Parliament on their activities.
Both opened for business in April 2005.
3. THE PENSIONS
REGULATOR
The Pensions Regulator replaces the existing
regulator, Opra, building upon its expertise and experience. It
inherits a considerable number of Opra's powers, but with a considerable
difference in the style of regulation. The new body is flexible,
proactive and focuses on protecting the benefits of members of
work-based pension schemes, concentrating its effort on schemes
where it assesses that there is a serious risk to scheme funding,
or a high risk of fraud, bad governance or poor administration.
4. THE PENSION
PROTECTION FUND
The Pension Protection Fund pays compensation
to members of eligible defined benefit pension schemes, when there
is a qualifying insolvency event in relation to the employer and
where there were insufficient assets in the pension scheme to
cover Pension Protection Fund levels of compensation. It holds
and manages a large fund out of which to pay compensation.
5. RELATIONSHIP
OF THE
PENSIONS REGULATOR
AND THE
PENSION PROTECTION
FUND TO
THE DEPARTMENT
FOR WORK
AND PENSIONS
5.1 The Department for Work and Pensions
(DWP) provides the overarching regulatory and legal framework
that governs the operation of both the Pensions Regulator and
the board of the Pension Protection Fund.
5.2 Subject to legislation, the broad framework
within which the Pensions Regulator and the Pension Protection
Fund operate is set out in a Management Statement and a Financial
Memorandum between DWP and each body. These cover in particular:
— their overall aims, objectives and
targets;
— the rules and guidelines relevant
to the exercise of their functions, duties and powers;
— the conditions under which any public
funds are paid to them; and
— how they are to be held accountable
for their performance.
5.3 The DWP also has a primary role in the
stewardship of the Pensions Regulator and the Pension Protection
Fund, discharging this responsibility through:
— the scrutiny and approval of annual
business plans;
— receiving reports on performance
and outcome measurement;
— receiving financial reports; and
— exchanging information on trends
and risks.
5.4 In addition to this, the chairs of the
Pensions Regulator and the board of the Pension Protection Fund
have regular joint meetings with the Director General for Strategy
and Pensions at DWP.
5.5 The chairs and chief executives of the
Pensions Regulator and the Pension Protection Fund also meet Ministers
at least once a year to discuss priorities, high-level objectives
and certain key operational targets. Apart from these meetings,
concerned with how they are carrying out their statutory duties,
neither the Pensions Regulator nor the Pension Protection Fund
generally have a formal role in helping to formulate government
policy.
6. PENSIONS REGULATOR
AND PENSION
PROTECTION FUND
WORKING TOGETHER
Statutory requirements and mechanisms
6.1 Although independent of one another,
the Pensions Regulator and the board of the Pension Protection
Fund work closely together towards a common objective of pension
security. One of the regulator's statutory objectives (Section
5(3) of the Pensions Act 2004) is to reduce the risk of situations
arising which may lead to the Pension Protection Fund needing
to pay compensation. The Pensions Regulator has specific powers
designed to help fulfil this objective, for example by requiring
the employer, connected or associate persons to guarantee or contribute
to a scheme, and a requirement on trustees and employers to report
certain events (notifiable events) which will provide early warning
of issues that may indicate problems with a scheme. The regulator
is also responsible, under the Act, for collection of the various
levies which fund the activities of the regulator and the Pension
Protection Fund. There is extensive sharing of information between
the two bodies, both under specific requirements in the Act, and
more generally under the specific agreements which exist between
them (see paragraph 6.3 below).
6.2 A tripartite Memorandum of Understanding
(agreed in July 2005) between the department, the regulator and
the Pension Protection Fund establishes a trilateral framework
for co-operation, setting out the role of each public body, and
explains how they will work together towards the common objective
of pension security. The division of responsibilities is based
on four guiding principles:
— regular and appropriate information
exchange.
6.3 The Memorandum of Understanding is supported
by Service Level Agreements (SLAs) between the Pensions Regulator
and the Pension Protection Fund, where one body provides a major
service to the other. SLAs on levy collection services and contact
centre [helpline] services are in place, while an additional SLA
on (non levy related) data exchange requirements is in preparation.
A more general agreement covering early consultation on impending
policy, operational and organisational changes is in the process
of being agreed.
6.4 Other formal, regular links include:
— bi-annual joint board meetings—the
agenda for these meetings specifically concerns joint working
projects of one sort or another;
— periodic attendances by the Pensions
Regulator or Pension Protection Fund chairs at the other's regular
board meetings;
— quarterly meetings between the two
chairs;
— monthly meetings between the two
chief executives; and
— regular meetings between Pension
Protection Fund executive directors and their Pensions Regulator
opposite numbers.
Scheme funding and protection levy—achieving
an affordable balance of interests
6.5 Good working relations between the Pensions
Regulator and the Pension Protection Fund are especially important
in the interaction between the new scheme funding regime for defined
benefit pension schemes (which the Regulator supervises) and the
Pension Protection Fund's risk-based levy. The Regulator must
incentivise schemes to improve their funding (and thus reduce
the potential risk to the Fund) but without imposing a burden
that helps create insolvency among sponsoring employers (which
would increase rather than reduce the risk). For its part, the
Pension Protection Fund needs to take account of the Regulator's
scheme funding proposals in calculating the risk-based levy, and
needs to structure the levy in a way which itself provides an
incentive to schemes to increase their funding in a reasonable
and sustainable way. Close working between the two bodies is clearly
essential to ensure that the necessary balance is maintained between
scheme member protection, manageable risk to the Pension Protection
Fund and affordability for levy payers.
Scheme funding
6.6 Ensuring that pension schemes take appropriate
action to become adequately funded is consistent with the Pensions
Regulator's statutory objectives to protect members' benefits
and reduce the risks to the Pension Protection Fund. The Pensions
Regulator has an important role in overseeing the implementation
of a new scheme funding framework in the Pensions Act 2004 and
supporting regulations that came into force in December 2005,
replacing the minimum funding requirement ("MFR"). Under
the new requirements scheme trustees must agree with sponsoring
employer a funding strategy to meet the schemes liabilities as
fall due on a prudent basis. Where a valuation shows that a scheme
is under-funded on this basis, the trustees must agree a recovery
plan to reach the level required to meet the schemes liabilities.
The trustees must send a copy of recovery plan to the Pensions
Regulator.
6.7 As required by the Act, the Pensions
Regulator has issued a code of practice on the steps that trustees
should take to implement the new funding framework. It also issued
consultation document, in October 2005, outlining its proposed
approach to regulating the new funding requirements to help give
trustees a clearer idea of what is expected of them. To help identify
those schemes whose funding might need closer investigation, the
regulator has proposed trigger points relating to the funding
target of the scheme and the length of any planned recovery period.
6.8 The Pensions Regulator's proposed trigger
points relate to the relationship between the scheme's funding
level measured using the basis underpinning the Pension Protection
Fund levy and the FRS17 accounting standard, with the relationship
between the funding level and the buy-out measure as a sense-check.
The Pensions Regulator has also proposed to set a trigger level
for the recovery period of 10 years. It acknowledges that the
expectation that trustees should seek to have the deficit paid
off as soon as reasonably practicable for the employer means that
in some cases the trustees will seek recovery plans shorter than
10 years, but that in some others the employer will not be able
to pay off the deficit in 10 years. Where schemes trigger because
of the recovery period, the regulator will be sensitive to the
affordability for the employer, recognising that in most circumstances
the best protection for members' benefits (and the Pension Protection
Fund) will be an ongoing scheme with an ongoing employer.
6.9 The introduction of the new scheme specific
funding requirements should lead to a reduction in pension scheme
deficits over time. In many instances companies are already making
significant efforts to fund legacy deficits through special contributions.
The reduction of deficits will reduce the overall value of risk
to the PPF and should therefore lead to a reduction in the size
of the levy that needs to be collected. The board of the Pension
Protection Fund has implicitly taken these factors into consideration
when setting its levy estimate.
The Pension Protection Levy
6.10 The Pensions Act 2004 imposes on the
Pension Protection Fund board the obligation to balance the interests
of both the levy payers and the scheme members.
6.11 The scheme members' interests are in:
— having confidence in their pensions
promise (through well-funded schemes) and confidence in the safety
net if their scheme fails;
— maintenance of the benefit levels
approved by Parliament. It should be noted that the Pension Protection
Fund board has the discretion to initiate a reduction in benefits
(of revaluation and indexation) if it is so minded. Independent
surveys of stakeholders have confirmed that a majority believe
that the benefits are about right or too low; and
— the solvency of the Pension Protection
Fund. In the short term, solvency in terms of cash flow for compensation
is not an issue, but longer term solvency difficulties might lead
to benefit reductions, and headline deficits would undermine confidence
generally.
6.12 The levy payers' interests are in:
— a levy estimate and distribution
which is fair, simple and proportionate. This means that the amount
of levy charged to each scheme should be proportionate to the
potential risk it poses to the Pension Protection Fund and should
be affordable.
6.13 The Pension Protection Fund's levy
estimate reflects estimates of the level of deficits and insolvency
risk represented by eligible schemes as at the end of October
2005. However, the board will invoice eligible schemes using
a calculation of levy risk factors measured at the close of business
on 31 March 2006. The board anticipates that eligible pension
schemes and their sponsoring employers are likely to respond to
the Pensions Regulator's scheme funding proposals and the board's
levy proposals for 2006-07 by injecting further special deficit-reducing
contributions into their pension scheme and/or using contingent
assets to reduce risk on insolvency to the pension scheme either
through parental guarantees, letters of credit or pledging securities.
The board encourages sponsoring companies to continue to take
action to cut deficits and consequently reduce the aggregate risk
to the board which should result in a lower levy cost and lessen
the likelihood of calls on the Pension Protection Fund.
1 The independent expert, Alan Pickering's report
"A simpler way to better pensions", was published in
June 2002. Back
2
The Pensions Act 2004 refers to schemes that are not money purchase:
this definition includes hybrid-type schemes where there is some
form of employer-guaranteed underpin to the benefits. Back
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