15 November 2004
The recent Turner Report emphasised the scale of the pensions crisis in the UK. The report was just an interim one but it contained a clear pointer on the way to overcome the crisis. It indicates the need for a combination of remedies – there is no single catch-all remedy – and of that combination, revitalising the voluntary pension system is an important part. In effect, that means encouraging employers to set up or to continue defined benefit (DB) pension schemes rather than less generous defined contribution arrangements.
The sentiment is fine, but DB schemes have been struggling. Due to government tax on dividends, increased life expectancy and the stock market downturn, they now risk being dragged down by over-regulation. If companies have set up DB schemes voluntarily, they now have to wake up to the fact that, on the one hand, they are losing control of the schemes and will have limited ability to adapt them to changing employment market trends or to help reduce the financial burden, while on the other hand they have retained the funding responsibility. If they have not set one up, the legislative burden is likely to discourage them from doing so.
Traditionally, schemes have been funded over the working lives of the members – an ‘ongoing’ basis that helped minimise the cost. Scheme rules would allow the company to cease contributing and wind up the scheme with no further liability for any deficit. But following amendments to regulations with effect from June 2003, if a company is solvent when the scheme is wound up, the company will have to pay a debt to the trustees based on the full cost of buying out benefits. This could result in a very large debt indeed. So, the option of winding up the scheme is no longer realistically available.
To compound concerns about companies losing control over their pension schemes, the Pensions Bill currently going through Parliament gives the scheme trustees the power, whatever the scheme rules say, to lay down the basis on which the scheme will be funded. The employing company’s consent is needed, but if there is a failure to agree, the new Pensions Regulator can make the ultimate decision. The regulator’s statutory objectives include protecting benefits and reducing the risk of claims on the Pension Protection Fund (PPF), which will be set up by the Pensions Bill – but the interests of the employer are not mentioned. The fear from this is that the regulator may require contributions at a level that the employer regards as unreasonable.
The PPF raises other concerns. It is intended to compensate members if their company becomes insolvent when their DB scheme is in deficit, but there will be no government funding or guarantee of the PPF – the cost rests with employers. To force companies to keep their schemes fully funded (and so avoid claims on the PPF) the bill contains ‘moral hazard’ clauses which will give the Pensions Regulator the power to require a person, who may be a director or majority shareholder, to make good a deficit in the scheme if the regulator thinks that they are a party to an act that prevented the recovery of the statutory wind-up debt. The problem is that those acts may include activities that may be perfectly normal corporate activities – the payment of a dividend, for example, or the sale of a business or a parent company ceasing to fund a subsidiary.
So back to the pensions crisis. If Adair Turner seriously thinks that encouraging DB provision is an important part of the solution, in his second report he may like to suggest giving back to companies a degree of control over their schemes – at least allowing them to restructure for the future so as to cap their liabilities. It may sound counter-intuitive in a climate where good pension provision is to be encouraged, but in real life, giving companies an escape route may paradoxically ensure that they stay on the DB highway.