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The Deputy Chairman of Committees (Lord Strabolgi): The noble Lord must move the amendment at this stage.

Lord Eatwell: Thank you. That is kind. I beg to move.

Lord Mackay of Ardbrecknish: I must say I am confused. I just about need an actuary to keep me right. We seem to be having a second bite at this particular cherry. I thought I had made my position clear the first time round. This is a matter of balance. Quite clearly the noble Lord, Lord Eatwell, feels that the balance should be a little more in one direction than do I and some of my noble friends who support me. As I said, of course we want to try to ensure that there are safeguards against inflation, as indeed we have done over the past few years. That is in contrast to when the Party opposite was in Government and there were no requirements to index pensions, or as regards the rights of early leavers and other such matters. Pensions continue to improve. I believe we have an improvement in the Bill as regards the minimum requirement being what is called the LPI, which is the RPI or 5 per cent., whichever is the lesser. I believe that is a sensible and balanced requirement to put into the Bill. I am not sure whether the noble Lord, Lord Eatwell, is withdrawing his amendment but if he is not withdrawing it I would certainly invite my noble friends to support me in the Division Lobby.

Lord Eatwell: I am sorry for all the confusion. I was perhaps trying to hurry things along. I ask the noble Lord to examine, at his leisure, the arguments in Hansard when he has the opportunity after the debate and to consider some of the arguments put forward. In the meantime, at this juncture I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 47 agreed to.

Clause 48 [Section 44: end of annual increase in GMP]:

On Question, Whether Clause 48 shall stand part of the Bill?

Baroness Turner of Camden: I rise to oppose the Question that this clause shall stand part of the Bill because I am rather unhappy about it. I hope that in the course of the debate the Government will perhaps explain why it is in the Bill.

As I understand the position from the Notes on Clauses which were kindly supplied, the intention of the clause is to restrict increases in the guaranteed minimum pension as a result of the changes introduced by Clause 44, which we have already discussed. As we know, that clause provides for an annual increase in the rate of a pension under an occupational pension scheme by a prescribed appropriate percentage, which is presumably the RPI.

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At present, guaranteed minimum pensions must be increased in line with a formula in the Pension Schemes Act. What bothers me is that this clause as it stands could worsen the position of people who are among the lower paid. If people belong to a good occupational scheme they will have good protection, and in many instances are likely to have an index-linked pension. If the rate of increase in GMPs is removed in the future the people who are likely to suffer are those for whom the GMP is the major element in their pension.

We shall discuss the whole matter of the GMP, and the Government's desire to do away with it altogether, under another part of the Bill, and no doubt we shall wish to raise a few issues then because we are not happy about that. In the meantime, I am worried about a provision which I believe will impact unfairly on poorly paid pensioners. For them, the certainty of statutory provision which exists at the moment is being removed. They could be significantly disadvantaged as a result.

Furthermore, it appears that not all employers are happy about it. I note from some briefing that I have received about the LPI that some employers fear that the LPI will add to costs for defined benefit schemes, especially when coupled with the removal of the guaranteed minimum pension element for accruals after April 1997. They foresee added costs to them as a result of this proposal.

I hope that the Minister will be able to satisfy this side of the Chamber that the intention is not, as seems to me to be the case, significantly to worsen the position for the poorer paid pensioner.

Lord Mackay of Ardbrecknish: Clause 48 makes consequential amendments to Section 109 of the Pension Schemes Act 1993 as a result of the changes proposed under Clause 44 of the Bill.

Under the existing arrangements contracted out occupational pension schemes must increase that part of the guaranteed minimum pension element of an individual's occupational pension accrued since the beginning of the 1988-89 income tax year. The degree of inflation-proofing is limited to the increase in the RPI for the relevant period or 3 per cent, whichever is less. But from April 1997, Clause 44 requires occupational schemes to increase all of the pension entitlement accrued from that date by the rate of inflation up to 5 per cent. a year.

Under the new contracting out provisions guaranteed minimum pensions will cease to accrue from April 1997, but pre-April 1997 guaranteed minimum pension accruals will continue to be subject to inflation proofing of up to 3 per cent. by pension schemes.

The amendments to Section 109 will therefore restrict increases in an individual's guaranteed minimum pension entitlement to those earned between the tax years 1988-89 and 1996-97, the last tax year before the commencement of Clause 44. Thereafter, increases in respect of occupational pension rights will be made in accordance with the provisions of Clause 44.

I hope that with that explanation I can reassure the noble Baroness.

Baroness Turner of Camden: I am very much obliged to the Minister for that explanation. I still feel

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unhappy about the Government's attitude to GMPs. We shall no doubt discuss that matter when the appropriate clauses—Clauses 122 onwards—are before the Committee. In the meantime, I shall look closely in Hansard tomorrow at the assurances given by the Minister. I shall not press my opposition to the clause at this stage.

Clause 48 agreed to.

4.45 p.m.

Clause 49 [Minimum solvency requirement]:

The Deputy Chairman of Committees: I have to inform the Committee that if Amendment No. 145N is agreed to, I cannot call Amendment No. 145NA.

Lord Eatwell moved Amendment No. 145N:

Page 27, line 9, leave out subsection (1) and insert:
("( ) Every occupational pension scheme to which this section applies is subject to a requirement (referred to in this Part as "the minimum contribution requirement ") that the contributions paid to the scheme by the employer, after taking account of any members' contributions required by the rules, shall not be less than those which will be sufficient to meet the cost of providing benefits under the rules of the scheme for its members.").

The noble Lord said: In moving Amendment No. 145N I shall also discuss a series of consequential amendments—Amendments Nos. 145P, 145Q, 145R, 145S, 145T, 145TA, 145U, 145V, 145X, 145Y, 145YA, 145YB, 145YC, 145YE, 145YG, 163BA and 184G. Members of the Committee may have guessed by this time that this will be a rather wide-ranging discussion.

Perhaps I may remove from the grouping with which the Committee has been provided Amendments Nos. 145W and 145YH, which do not belong in the grouping and would be more appropriately considered later. I have given the Minister notice of my intention.

I must also apologise to the Committee for the introduction of a correction to Amendment No. 145N, of which I informed the Minister earlier today. In the final line of the amendment, as it appears on the Marshalled List, the word "active" should be removed so that the amendment applies to all members and not merely to active members of a scheme.

I shall turn to the full significance of Amendment No. 145N and the consequential amendments in a moment. However, I wish first to discuss the position which the Government have taken in this section of the Bill, which seeks to establish a minimum solvency requirement which must be met by appropriate schemes. This is a major innovation in the Bill. I suggest to the Committee that the Government have not got it quite right. I wish therefore to examine the rationale for a minimum solvency requirement (MSR) with some care, as well as the Government's attempt to establish an MSR as set out in Clauses 49 to 54 of the Bill before us.

I shall pose a number of questions to the Government in an attempt to discover the rationale of the approach they have taken in the Bill. I shall suggest that there are serious questions which need to be asked about the formulation of the MSR, questions so serious that they merit the Government taking away this section of the Bill and thinking again. I was intrigued to receive, just

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before I stood up to speak, a briefing from the National Association of Pension Funds which broadly supports the position which I take this afternoon.

The problem that the MSR seeks to solve is clear. It is a problem well worth solving, and the Government are to be commended for their attempt to find a solution, even though I believe that they have failed in the attempt. The problem is how to provide security for the members of an occupational pension scheme—whether pensioners, active members or deferred pensioners—when the employer who is the sponsor of the scheme becomes insolvent.

The answer which the Goode Committee provided to the problem, which the Government have accepted, is that the scheme should meet a minimum solvency requirement. The case put by Goode is as follows:

    "Where there is a risk, however small, of the employer's insolvency, funding will meet the requirements of benefit security only if at all times"—

and I stress "at all times"—

    "the assets of the scheme are sufficient to cover its liabilities ... a minimum solvency standard [is required] in order to ensure that the rights of scheme members are adequately protected against the insolvency of the employer".

It is that point and the series of serious connected problems which arise that the Government appear to have failed to solve. The key to all the Government's difficulties is the fact that the solvency of a scheme on an ongoing basis and the solvency of the scheme on the basis of immediate discontinuance are totally different. The reason why the solvency of a scheme on an ongoing basis is different from a scheme on discontinuance is as follows. On an ongoing basis, the solvency of the scheme is defined by the relationship between the assets of the scheme and the projected benefits for service to date—its liabilities. The task of the actuary is to assess on the basis of reasonable probabilities the best mix of assets; that is, the best investment strategy to meet the liabilities of the fund.

Typically, such a strategy will involve a substantial investment in equities since the return on equities, although subject to fluctuation and therefore subject to some risk, has greatly exceeded the return on other financial assets over the past several decades. In fact, the Goode Report tells us that on average only about 11 per cent. of the assets of UK pension funds are held in gilts, and the remainder are primarily in equities with, of course, some cash. That is the ongoing evaluation. On the basis of immediate discontinuance, the solvency of the scheme is defined as the cost of buying an insured non-profit annuity for pensioners and deferred pensioners. Such annuities will provide an absolutely certain return compared with the probable, but not totally certain, return on equities. There we have a dilemma, with the ongoing scheme evaluated in terms of equity and the discontinuance scheme evaluated in terms of the insured non-profit annuity which gives certainty.

The Goode Report summed up the dilemma as follows:

    "Schemes which are comfortably funded on an ongoing basis may well have insufficient assets to meet their discontinuance liabilities by the purchase of annuities. In an ongoing fund even sharp fluctuations on the price of equities at a particular time are of little

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    significance, since values are based on the anticipated income stream of a notional portfolio over the life of the scheme. But where an ongoing scheme has to be valued for testing its solvency on a discontinuance basis, the relevant figure is the market value of the particular investments at the time of the valuation. If there has been a sharp fall in the market, the solvency of the scheme will be correspondingly reduced. At the same time, the cost of purchasing annuities is not responsive to variations in the market value of the equity-oriented portfolio of a typical ongoing scheme".

Added to the difficulty of the fluctuations of equity is the fact that the market for insured annuities is extremely thin and therefore the purchase is likely to be very expensive indeed.

Let us remember that the whole objective of the MSR is to ensure that schemes are solvent on discontinuance. It is a kind of snapshot test: at every moment those schemes must be solvent on discontinuance. Let us suppose that schemes were indeed required to be truly solvent—sufficient to purchase insured annuities which cover promised benefits (that is, to meet what I call the true MSR)—then, as Goode recognises, serious problems would be created for the pensions industry. The Goode Report states:

    "[The true MSR] could force intrinsically healthy schemes to reduce benefits and increase contributions substantially in order to be able to meet liabilities on a hypothetical discontinuance which in the ordinary way would be very unlikely to occur. A scheme's investment managers might feel constrained to move from an equity-based to a fixed-interest or index-linked portfolio so as to be certain of covering its wind-up liabilities, with the likelihood that over the long term it would lose both income and the prospects of capital growth, and benefits would go down".

So there we have it: a true solvency—a certainty of solvency—will result in higher costs and lower benefits.

Given this major difficulty with the imposition of a true MSR, it might have been expected that the Goode Committee and the Government—they have followed broadly the approach of the Goode Committee in this matter—would have sought new ways to provide the security for pensioners which we all seek. But they did not. Instead of looking for new ways to solve the problem they decided to stick with the idea of the MSR and simply watered down the definition of solvency. Even this afternoon, the noble Lord, Lord Mackay, will move new amendments to the Bill on Clauses 50 and 51 which will yet further water down the strength of the solvency requirement. I believe that the result before us has all the disadvantages of the true MSR—higher costs, lower benefits—and few of its advantages. The MSR, as now defined, does not guarantee the solvency of a pension scheme. Yet it is likely to result in significant distortions of the investment strategy of pension funds to the detriment of employers and members.

How does the Government's minimum solvency requirement—I shall call it the false minimum solvency requirement—differ from the true insured annuity MSR? The Government have decided to define liabilities on the basis of the so-called cash equivalent of benefits of the pension fund, typically determined with respect to the interest on long-term gilts. At a later stage the Government weakened that position still further by permitting "very large schemes", as they called them, to evaluate 25 per cent. of their liabilities to existing pensioners with respect to the rate of return on equities—a rate of return typically higher than on gilts.

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That further lowered the cash equivalence. However, the vital point to make is that that cash equivalence will not typically be enough to purchase an insured annuity. By that definition, the scheme will not be truly solvent. This is the first vital failing of the government scheme. On 8th December last year the noble Lord, Lord Mackay, wrote to my noble friend Lady Hollis in the following terms:

    "Our original proposals envisaged that pensioner liabilities would be valued by reference to the returns on gilt-edged securities. This would provide a reasonable degree of assurance that if their sponsoring employer were to cease trading and the scheme be wound up, benefits could be secured through the purchase of insurance annuities".

I am afraid that that statement is simply false. It is made more false when the calculation of cash equivalence is weakened to include a notional equity return. That is the first major failing of the Government's proposals which must be corrected. The MSR does not guarantee solvency, and it is fundamentally misleading to suggest that it does. That point was made most forcefully at Second Reading by the noble Earl, Lord Buckinghamshire, who suggested, quite rightly, that the Government's requirement is not a minimum solvency requirement but a minimum funding requirement. The noble Earl said:

    "It has never been a minimum solvency requirement".—[Official Report, 24/1/95; col. 1021.]

The noble Earl's position has been supported by the Institute of Actuaries and the Faculty of Actuaries. They have all said that this is not a minimum solvency requirement and it is misleading to call it so.

Have the Government made any estimate of the scale of the shortfall that their weakening of the minimum solvency requirement will produce? Can the Minister tell us what is the typical scale of insolvency which will result from the Government's minimum solvency scheme? At the very least, perhaps I may suggest that the Government must change the name of that requirement. The idea of minimum solvency creates a totally false impression. It will undoubtedly encourage some trustees to fund schemes in a manner which satisfies only the false MSR. That is the first major failing which I believe may well exist within the definition of the minimum solvency requirement.

The second major failing of the Government's false MSR is that it is likely to produce many of the undesirable changes in investment strategy—higher contributions and lower benefits—which the Goode Committee associated with the true MSR. The problem was pinpointed again by our local hero, the noble Earl, Lord Buckinghamshire. At Second Reading he pointed out that even the false MSR (as I have called it) as defined by the Government is likely to result in a major change in the pattern of investments from equities to gilts. That position is also supported by the CBI. That point has been reinforced by my conversations with an actuary responsible for a very large pension fund of one of Britain's biggest companies, who assured me that a significant switch in investment strategy in that fund would be necessary, with higher costs and pressure on benefits.

Have the Government made any estimate whatsoever of the likely change in investment patterns as a result of

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introducing their MSR? The Government have, I know, provided estimates of the cost involved in implementing the MSR. Therefore, because they have estimated the costs, they must have made some assumptions about the change in investment policy. What are those assumptions, and on what research findings are they based?

Moreover, have the Government made any calculations of the likely impact of the proposed contributions schedules on the investment patterns of schemes through time? If, for example, we suppose that the MSR as defined by the Government had been in place for the past 10 years, many of the country's well managed pension funds would have oscillated around the MSR, swinging wildly from 80 per cent. fulfilment in one year to 120 per cent. in the next year, as equity prices fluctuate. It is not at all clear that the Government's proposals for smoothing asset values will entirely take care of that problem. As the noble Earl, Lord Buckinghamshire, said at Second Reading:

    "the requirement to certify a contributions schedule as sufficient to secure solvency over a prescribed period will be totally unworkable".—[Official Report, 24/1/95; col. 1021.]

That leads me on to the third major problem with the Government's proposals. Pension funds account for nearly half the equity investment in the UK stock market. A significant swing out of equity into gilts, even when extended over the transition period which is likely to follow the imposition of the MSR is likely to cause a significant fall in UK equities. It certainly will relative to the levels they would otherwise have obtained. Is that what the Government want?

Of course, the shifts into gilts will make it easier for the Government to fund their deficit, but surely the distortion of the equity and gilts markets is too high a price just to help pay for Mr. Clarke's profligacy. I am sorry, that was a cheap shot.

Let us get back to the serious business. We are distorting the structure of gilts in equity markets. What are the Government's estimates of the likely impact on equity in gilts markets? Surely, they must have made them if they are going to create that kind of distortion. What, for example, is the likely effect on the venture capital market, which is at the margin of more risky investment strategies and therefore likely to be the first to be abandoned? Yet it is the venture capital market that the Chancellor, by other tax concessions, has been trying to encourage, whereas the MSR will destroy it.

To sum up, it seems that the Government's proposed MSR is seriously flawed. It is not a solvency standard at all and it is misleading to label it so. It is likely to increase costs and reduce benefits of pension schemes. It is likely to cause macro-economic disruption. Surely that requires looking at again.

The amendment which I propose is, I confess, a tentative foray into that complex area. Nevertheless, I believe that it provides the skeleton of a truly viable alternative to the flawed minimum solvency requirement approach. I am quite ready to admit that some of the amendments within the group are not technically entirely satisfactory, but they are there to give the Committee and the Government an overall view of an

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alternative approach to this difficult problem. I am interested to see that the National Association of Pension Funds supports it broadly.

The essential idea is that the pensioner is best protected by the enforcement of best practice funding standards on an ongoing basis. If we examine the best practice UK pension funds, we find that they are well funded and are seldom likely to infringe reasonable solvency standards. We propose a minimum contributions requirement, the calculation of which is to be defined in regulations in line with the actuarial analysis of best investment practice in ongoing schemes.

Definition of the minimum contributions requirement in this manner will immediately overcome the problem of schemes being forced to adopt investment strategies which reduce benefits and raise costs. Moreover, it will catch those rogues whose contributions are too low—the main object, after all, of this entire exercise. Finally, it will greatly economise on actuarial effort, though perhaps lower some actuarial incomes. The actuary will be required only to perform the calculations associated with the best practice investment strategy which he or she should be making anyway.

Of course, it may be objected that, even in the case of best practice contributions and investment strategies, there may still be a risk that at any one moment in a fund with a large equity component assets will be insufficient to cover the benefits defined by the rules of the scheme, if that just happens to be the moment that the employer goes broke. That is the problem of the snapshot.

The way to a solution to the problem has been proposed by the noble Lord, Lord Mackay, in his letter of 8th December to my noble friend Lady Hollis. In it he points out that with respect to large schemes,

    "such schemes, if their sponsoring employer went into liquidation, would have to run on as closed funds".

There is no mention any more of insured annuities. They would be run on as closed funds.

    "They would have the administrative infrastructure to do so. They would, realistically, be able to run on ... delivering pension benefits as they fall due—reliably and cost efficiently".

That is what the noble Lord, Lord Mackay, wrote. If that is right, why are we making all this fuss about cash equivalents and wind-up values? If the Government see the schemes of defunct employers as ongoing, why are they then not valued on an ongoing basis?

Actually, I am not as confident as the noble Lord, Lord Mackay, that trustees would always be willing to take up the long-term responsibilities for a closed fund which may extend way beyond the collapse of a firm. Be that as it may, the Minister has opened up an important aspect of a fruitful approach to the problem of pensioner security, for what is true for large funds can be true for small funds too. All that is necessary for the smaller funds is that they be grouped together as closed funds, combined in a central discontinuance fund.

The Goode Committee examined the possibility of establishing a central discontinuance fund and rejected it. I must say that I find its arguments rather unconvincing. Its main objection was that the fund, by adopting an ongoing investment strategy with a significant equity component, would necessarily have

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some risk attached to it. That is true, but if the fund is taking over schemes which have obeyed the best practice minimum contributions requirement and itself obeys the minimum contributions requirement, the risk would seem to be minimised, as Goode admitted; and, as the noble Lord, Lord Mackay, confidently says in his letter, the schemes will be run "reliably and cost efficiently".

Have the Government studied seriously the possibility of establishing a central discontinuance fund? Have they studied the experience of the Pension Benefit Guaranty Corporation in the United States which does that job? If so, what are their conclusions?

I am well aware that even a well-run central discontinuance fund must have an ultimate guarantor if risk is to be entirely eliminated. That could be achieved by a very small levy on existing funds, rather like the bonding scheme for travel agents. Will the Government give serious consideration to the establishment of a central discontinuance fund?

Finally, our proposal for the minimum contributions requirement has another important advantage. At present all money purchase schemes impose all the risk on the employee, since there is no defined benefit and, therefore, there can be no notion of funding or solvency. With best actuarial practice defining minimum contributions requirements for defined benefit schemes in the way that I have described, the regulator could determine a reasonable average of the minimum contributions requirement which would then be applied to money purchase schemes. Those would be the normal best practice contributions made. The employer would be required to make the minimum contributions, but would still, of course, enjoy the advantage of the absence of risk.

I apologise for taking so much of the Committee's time over the issue, but the minimum solvency requirement is a central part of the Bill and distorts and deforms aspects quite far distant from these clauses in the Bill. I believe that we must pursue two separate but equally important tasks in the discussion of the amendments. First, the Committee must subject the Government's proposals to careful scrutiny, which I believe that they desperately need. In that sense, this is a probing amendment. It seems clear that the watered down minimum solvency requirement that we have at the moment is the worst of all worlds. Secondly, I hope that the Committee will be ready to consider the broad brush merits of the alternative approach to pensioner security by means of a minimum contributions requirement, which I have proposed. I beg to move.

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