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Lord Ezra: As the noble Lord, Lord Eatwell, said before he sat down, this is perhaps one of the most crucial elements in the Bill that we are considering. We are indebted to him for the clarity with which he has set the scene. In my opinion, he has made it much easier for us to debate the underlying issues of this very complex matter.

The noble Lord identified three issues about which many of us were concerned. We expressed that concern at Second Reading. The noble Lord referred in particular

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to the noble Earl, Lord Buckinghamshire. On this side of the Committee we have been most anxious about the way in which the modified MSR, which the Government introduced following the Goode Report, gives and could give a misleading impression to members about solvency which might not exist in the strict meaning of the term. We feel that either the word "funding" or "contribution"—or some other term—should be introduced. That is the first issue to which we should put our minds.

The second issue of concern—my noble friend Lady Seear emphasised this point in her Second Reading speech—was that the way in which this provision is to operate under the Government's proposals could lead to a fundamental shift from equity to gilt investment. The repercussions of that could go way beyond the pension funds themselves. It could have a major economic impact on the country at large. The massive contribution that pension funds make to equity investment is of vital importance. It should not be any part of the Bill to diminish that. On the contrary, it would be better if it could be increased. That is another aspect.

The third aspect mentioned by the noble Lord and which I thought very interesting was the possibility of a discontinuance fund. If we limit the burdens on employers, as we are trying to do by not having them over-fund the schemes in order to meet the minimum solvency requirement, there must be some safeguard. That safeguard, particularly for smaller firms, could well be a discontinuance fund.

The noble Lord set the scene for three vital aspects of this clause which merit very detailed consideration. I am glad he said that his amendment is basically a probing amendment. I believe that the Committee will have many views on it. I am much obliged to him for the way in which he introduced this part of the debate.

5.15 p.m.

The Earl of Buckinghamshire: I almost blush to hear the references to myself. I particularly liked the reference to being the local hero. I wish that I had the same returns on my investments as the film of that name produced. I should also like to thank the noble Lord, Lord Eatwell, for an extremely thorough resumé of the situation facing the Government and everybody in the industry. His was an interesting and extremely innovative approach which has considerable merit. At this point I should say that Hansard will probably come back and bite me at the next meeting of the Committee or at Report stage. Nevertheless, I feel that it was an extremely interesting and innovative approach.

I have a twofold difficulty with this provision. First, I feel that members have a real expectation that promises will be met. That point was very adequately covered by the noble Lord. Members cannot understand why a scheme which is solvent on an ongoing basis should suddenly become insolvent on wind-up. Being very sympathetic to that view, I can quite understand why they think in that way: the situation does not seem very rational. If I understand him correctly, the noble Lord, Lord Eatwell, suggests that a way round that difficulty might be a central discontinuance fund, as in the United States. I thought I had heard a whisper that

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the fund was going bust but that can be verified; my American friends will take me to task if that is not true. However, I should like to have a response from the Minister on that point.

With regard to this being a flawed MSR, my comments at Second Reading did not imply that it was flawed but simply that the wrong word was used. The word should be "funding" instead of "solvency". I did not say that it was flawed. If I did, I should like to take that remark back—at least a little bit.

I feel that perhaps I owe my noble friend the Minister an apology in that I did not bring forward an amendment at this stage to deal with the wording: "solvency" or "funding". I am afraid that the parliamentary draftsman who is helping me on this matter just ran out of steam in view of all the other amendments that we are having to put forward.

There is another issue. We have quoted the professions—the actuaries—and their views. I recall that the noble Baroness, Lady Hollis, spoke at Second Reading about a well known firm of actuaries who said that the Government's new MSR was totally meaningless or ineffectual. I am sure that that can be checked precisely in Hansard. Interestingly enough, I have another quote from the same firm of actuaries, but probably from a different actuary, to say:

    "Little by little the solvency proposal is being turned into something sensible and practical".

That tells me that this is an immensely difficult issue on which there will be possibly no common agreement as we move forward.

In conclusion, I believe that the proposals put forward should be considered by my noble friend the Minister. The question of the MSR, which will be debated with other amendments, particularly in the amendments of the noble Lord, Lord Marsh, may have a greater impact than we anticipate. It may be that we do not welcome the impact because of the implied switch from equities to gilts. But that is something that we still need to see. We do not know what will happen as MSR comes into application.

Lord Mackay of Ardbrecknish: As the noble Lord, Lord Eatwell, acknowledged, this is a very complicated issue and yet a very important one. I apologise in advance to the Committee because I shall speak at some length. The subject is serious enough for me to try to address two matters in the course of my response. First, I want to give my views on the minimum contribution requirement outlined by the noble Lord, Lord Eatwell. At the same time I shall try to explain the reasoning behind the minimum solvency requirement and respond to some of the questions and criticisms which have been raised in that regard. Perhaps the easiest matter to respond to is the point made by my noble friend Lord Buckinghamshire about "funding" or "solvency". That is a well balanced argument and I look forward to whatever amendment that he decides to table.

I shall start by looking at the group of amendments which would introduce the minimum contribution requirement. The noble Baroness, Lady Hollis, said at Second Reading that the Opposition would:

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    "seek to ensure that minimum solvency means ... the ability to secure the pension promise".—[Official Report, 24/1/95; col. 981].

We have here a confusing combination of the proposed minimum contribution requirement and the minimum solvency requirement. But I accept that the noble Lord, Lord Eatwell, indicated that this was by way of probing this specific issue and he was putting forward his suggestion as an alternative to give us, so to speak, something to chew on.

If we look at the minimum contribution requirement, it seems that schemes will be required to pay contributions at a level that would enable them to meet members' benefits. However, given that that is essentially an ongoing funding standard, I was puzzled by the proposal that when producing actuarial valuations and certificates, the actuary will be required to certify that the value of the scheme assets will at least equal the amount of scheme liabilities. While we all agree that we are not exactly up to the high standard of actuaries and actuarial science, it is surely the basic premise on which an ongoing funding standard is founded that the scheme does not need to hold a level of assets that is equal to its accrued liabilities; rather it need only ensure that at some future point in time there will be sufficient assets to meet its future liabilities.

The proposed minimum contribution requirement appears as a curious hybrid of an ongoing funding standard and a minimum solvency test. But I believe also that those proposals would undermine one of the central recommendations of the PLRC report and disregard the fundamentally important point that secure pension scheme funding must provide for rights accrued under the scheme. I am convinced that a measure of solvency that does not address the position of the scheme on discontinuance in some way will not be providing members with adequate security in the event of the scheme being wound up.

The overwhelming argument in favour of a minimum solvency requirement is that if an employer undertakes to provide a pension promise the scheme should be able to secure that promise at all times, especially in the event of the scheme winding up. It is at that time that the members' position is most vulnerable. A minimum solvency requirement should ensure that, irrespective of what happens to the sponsoring employer, the fund will have enough money to meet the value of members' accrued rights which will therefore be protected.

But security has a price and one of the major considerations in deciding the appropriate method of calculating the minimum solvency requirement has always been the need to maintain a balance, to improve security, but avoid creating undue cost for employers. Some commentators on our proposals have taken the view that the minimum solvency requirement should provide an absolute guarantee of security for members at all times. But it is simply not possible, either practically or economically, to require ongoing pension schemes to fund at a level that will enable them to buy out all the liabilities with non-profit annuities. For many schemes the cost would be prohibitive. We must also recognise that, because of the size of some pension

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schemes, there would in any case be insufficient capacity in the insurance market to absorb them, even if that were financially possible.

Nor is it possible to use the cost of annuities as a way of valuing pension scheme liabilities. Larger schemes simply cannot get quotes. Against that background the Pension Law Review Committee realised that the cost of deferred annuities was an unrealistic measure for evaluating non-pensionable liabilities and proposed that actuarial valuations should be used instead. It therefore recommended a cash equivalent approach which produces an amount equivalent to the value of the assets the scheme would need to hold to pay the members' accrued benefit. The cash equivalent is, of course, the basis of the transfer value that a scheme would pay for an early leaver moving to another scheme or indeed to a personal pension.

We listened carefully to the representations about the original PLRC proposals. The White Paper announced modifications developed in consultation with the actuarial profession. This method uses the cash equivalent approach for all members. It is based on rates of return from investment in equities for non-pensioners moving to a gilts base for those approaching retirement and for pensioners. An expense allowance will also be added which will be weighted to reflect either the cost of the scheme running off pensioners' liabilities in a closed fund or of buying out an insurance annuity. We also accept the PLRC proposal that assets should be valued by reference to market values.

A consultation exercise was held to test the impact of introducing the minimum solvency requirement on the basis set out in the White Paper and we received nearly 500 responses. The results indicated that the vast majority of private sector defined benefit schemes—86 per cent. of those who participated—would meet the minimum solvency requirement; almost all schemes—96 per cent.—were more than 90 per cent. solvent. Most of those schemes would be less than 100 per cent. solvent on the basis of the proposed minimum solvency requirement and in fact regarded as being funded on an ongoing basis. Nevertheless, on the basis of further analysis and in response to detailed comments made, the Government have already announced three important changes to the original proposals. Though they will be set out in regulations, I hope that it will be helpful if I describe them now.

First, we fully accept that a calculation of asset values should be smoothed over a number of months. That position responds to concerns that the original proposal to value assets at market prices on a particular date could have left schemes vulnerable to short-term movements in the market. Secondly, we also accept that the time limits originally proposed for complying with the minimum solvency requirement —three months to attain 90 per cent. and three years to attain 100 per cent.—should be extended. Those time limits are contained in Clause 51 and no doubt we shall come to that later.

Thirdly, we also accepted that the larger defined benefit schemes should be able to value a portion of their pension liabilities by reference to equity returns.

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That would apply to pensioner liabilities due beyond the next 10 or 12 years. That modification in respect of larger schemes recognises that such schemes would be unlikely to wind up if the sponsoring employer went into liquidation. In practice, they would have the necessary economies of scale to allow them to run on most cost-effectively as a closed fund, delivering pension benefits as they fell.

The modification valuation method will apply, as I said, only to larger schemes which would be unlikely to wind up if the employer became insolvent. We were sensitive to the argument that requiring all pensioner liabilities to be valued by reference to gilt returns would have been both impractical and unnecessarily restrictive for the very large schemes. It was also important that we should directly address concerns that the MSR would precipitate a switch of pension fund investments from equities to gilts, which both noble Lords opposite who spoke mentioned. Extending time limits for restoring solvency and smoothing the valuation should reduce volatility in contribution rates and avoid schemes unnecessarily having to inject funds into a scheme due to short-term market fluctuations.

Perhaps I can turn at this point to the estimate which I was asked about directly by the noble Lord, Lord Eatwell, and perhaps in more general terms but certainly expressing his concern, by the noble Lord, Lord Ezra. I refer to any estimates that we have made of any scale in investment shifts. We made a detailed actuarial assessment of the scale of any potential shifts from equities to gilts as a result of the MSR. We published our conclusions in the compliance cost assessment which was published with the Bill and we believe that the overall impact will be modest. Over the next 12 years, which is the period until the MSR is fully in force, we foresee a shift of between £5 billion and £12 billion from equities into gilts. That is contained in the table at paragraph 36 of the compliance cost assessment, which shows, looking forward, how we see the shift. If Members of the Committee were to look at the table they would see that what shift there is, given an optimistic and conservative range, is modest over the long timescale. I hope that drawing attention to the table will help allay Members' understandable fears about an unnecessary shift from equities into gilts.

We recognise that some schemes are underfunded against their own funding targets and may need to increase their contributions; some funds may need to adjust their funding targets to comply with the new minimum solvency test. There will be a transitional period of five years, as recommended in the PLRC report, before the provisions come fully into effect. Taking account of the modifications to the valuation method and time limits, we estimated again in a compliance cost assessment—I believe this answers the point made by the noble Lord, Lord Eatwell—that employers may need to invest an additional £300 million to £400 million per annum in their pension funds over the 12 years until the minimum solvency requirement is in place. We believe that on balance those proposals should ensure that the minimum solvency requirement will deliver an appropriate level of security for members without imposing unnecessary costs on employers.

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I have argued in favour of the minimum solvency requirement as laid down in the Bill. Perhaps I may go a step further and argue that I believe it is important that any basis for assessing scheme solvency should be consistent. Returning, if I may, to the minimum contribution requirement, which the noble Lord, Lord Eatwell, proposes as an alternative to the minimum solvency requirement, I do not believe that it appears to meet the objective of being able to be applied in assessing scheme solvency in a consistent way. The wording of the proposed test that the actuary would apply when certifying the schedule of contributions as adequate to meet the minimum contribution requirement would be that contributions were "fair and reasonable in all the circumstances". I imagine that the noble Lord, Lord Eatwell, might say that that wording might be improved on or worked on. But "fair and reasonable in all the circumstances" does not suggest to me an objective and consistent evaluation basis. It is by no means clear—it would have to be clear—what measure of security such a requirement would afford scheme members.

I was further puzzled by Amendment No. 163BA which would seek to apply the concept of the minimum contribution requirement to money purchase schemes. That would have the effect of requiring employers who run money purchase schemes to pay a minimum amount into the scheme based on targeting a particular level of benefit. If anything, that appears even more inappropriate for money purchase schemes. Indeed, it is hard to see how such schemes could continue to be called money purchase if such a requirement were to be imposed. The liability of an employer who runs a money purchase scheme is to make a defined level of contributions to the scheme. Those contributions, along with any made by the employee and the investment return on the contributions, determine the benefits provided by the scheme. It is an important part of our proposals for the minimum solvency requirement that schemes should be required to disclose full information to their members about their funding adequacy by reference to the MSR. We shall be returning to that issue later.

With regard to Amendment No. 145YE, I should point out that the schedule of contributions will be a working document which may contain very detailed information. When I asked about that I was threatened with complicated computer print-outs. Some of that could be of a sensitive nature relating to both the financial position of the scheme and of the employer. It would not be appropriate to make that generally available, nor would it convey the kind of information concerning scheme solvency that members require. The key point is that trustees will be required to inform members if the contributions are not paid in accordance with the schedule and to disclose the regular solvency certificates.

It appears to me that the minimum solvency requirement which we propose will afford scheme members a much greater level of protection than would be provided by the minimum contribution requirement proposed in these amendments. In Amendment No. 145TA, the noble Lord, Lord Eatwell, proposed, as an

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alternative method of providing security for accrued rights in the event of a scheme wind-up, a central discontinuance fund. He prayed in aid American experience. My noble friend Lord Buckinghamshire promptly suggested that there may be some doubts about that. That will be something interesting for us all to try to find out tomorrow. The PLRC concluded, in looking at a central discontinuance fund, that it would not be a viable solution to the problem of discontinuance. The Government have accepted that view and continue to believe that such a fund will not be needed under our proposed minimum solvency requirement. Such a fund would be complicated to operate. Almost all variations of the proposals would require the fund to be underpinned by a guarantee from either the Government—other taxpayers—or from other pension funds. I do not believe it would be appropriate to ask either of them to take on an open-ended commitment of that nature.

We are introducing a new power to enable trustees to secure benefits on wind-up by providing members with a cash value of accrued rights. Where a scheme is funded only at the level of minimum solvency requirement, the calculation for this will be that used for calculating liabilities for the minimum solvency requirement. Other schemes that would not wind-up in the event of employer insolvency will run off as closed funds.

We believe that our provisions, together with the proper operation of the minimum solvency requirement, will substantially reduce the likelihood of schemes winding up in deficit. The central discontinuance fund is therefore neither necessary nor appropriate.

I think I have covered all the main points. Perhaps I may be allowed to try to sum up what we believe the package of measures in the Bill will do and against which the alternative proposal of the noble Lord, Lord Eatwell, has to be judged. First, it will give a new measure of security to scheme members by ensuring that schemes are adequately funded to provide at the least the cash value of members' accrued rights in the event of the scheme winding up. Secondly, and no less importantly, it will provide an objective benchmark for setting contribution levels. Thirdly, coupled with the requirement to maintain a schedule of contributions, it will provide a focus for trustees in monitoring that contributions have been paid at an appropriate rate and by the due date. Finally, it will provide a benchmark for calculating compensation.

I have little doubt that all our words of wisdom will be pored over in Hansard tomorrow by the people who understand all these matters. Our debate about the minimum solvency requirement, the minimum contribution requirement and the central discontinuance fund has been useful. I believe that what we propose is still the better of the two options—one from myself and one from the noble Lord, Lord Eatwell—before us.

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