Cicero Policy Briefer

Issue 24, May 2008

The shifting sands in workplace pensions:
Will regulation help employers to keep their promises?

By Mark Twigg

Just how far should public policy go in protecting the rights of those with occupational pension schemes? A minimum level of member protection is a prerequisite for maintaining public confidence in the integrity of workplace pensions. But protection comes at a cost, a cost borne largely by the sponsoring employer. Get the balance wrong and you risk driving employers away from offering good quality pension provision in the first place. Any country with a defined benefit pensions market will have had to grapple with this quandary.

Some do it better than others; note if you will how the US shamefully allows employers to exploit bankruptcy protection in order to dump their long-standing pension obligations onto the Pensions Benefits Guaranty Corporation (PBGC). The UK ’s record has also been coloured by the negative experiences of high-profile company failures in recent years each involving firms with under-funded company pension schemes. The lack of insolvency protection has subsequently resulted in over 125,000 workers losing part or all of their employer’s ‘pension promise’. Of course, when the UK was looking to establish its own equivalent to the PBGC, in the guise of the Pensions Protection Fund (PPF), it was accompanied with a number of anti-avoidance measures to stop sponsoring employers side-stepping their obligations to employees.

Now four years later, policymakers are being forced by the rising tide of the pensions buy-out market to revisit the current protections and whether or not scheme members are offered adequate protection. Of course, there’s nothing wrong with employers offloading their pension liabilities so long as the interests of members are not negatively impacted. The bulk annuity market offers the individual member insurance against their retirement income going up in smoke. The problem is that not all the options currently open to sponsoring employers offer such assurances to the scheme members. The Department for Work and Pensions, in its recently published consultation paper—which proposes amendments to those aspects of the Pensions Act 2004 which aim to stop employers social dumping on the PPF-highlights the growth of business models which sever the link between the employer and pension scheme in order to operate well-funded occupational pension schemes for profit “without adequate account being taken of member interests”.

The concern here, as the DWP highlights, is that occupational pension provision is built on an assumption that the employer is offering the scheme as a deferred employee benefit-and is not seeking to operate the scheme for profit. However, new profit-making parties are developing, and are operating in the pensions regime rather than the FSA regime on the grounds that liabilities may be met more cheaply under the former. Instantly, this raises the important distinction between financial regulation on the one hand and pensions regulation on the other. Charlie McCreevy, the Commissioner for financial services, recently ruled out attempts to align the two when he announced that the CEIOPS review into the Occupational Pensions Directive, or IORPs, will not commit the Commission to undertaking any direct read across from the more stringent funding requirements on insurers, under Solvency II, into the less onerous funding requirements on pension funds under the scheme specific funding requirement of IORPs. Concerns that a heavy-handed regulatory approach may force employers to review (and ultimately close) their final salary schemes seem to have won the day.

Given the unlevel playing field between pension funds and insurers it is perhaps not surprising that certain firms look to exploit what could be considered a loophole. While innovation in risk management is welcomed it should not be at the expense of scheme members. Any changes which involve a disproportionate shift in risk could be deemed unacceptable. The Pensions Regulator will be given new tools to police the marketplace. What is not clear is the scope of the new powers or who exactly will be caught. The DWP claims that the new powers will be ‘appropriately targeted’ and limited to those cases in which it would not have been reasonable to foresee that a particular course of actions would have had a materially detrimental effect on the security of members’ benefits.  For example, large buy-outs involving private equity funds could fall within the scope, especially if it is deemed to be the case that the employer’s obligation to support the scheme has been in any way watered down.  

At this stage the consultation is still very high level. The regulator has yet to offer guidance on the sort of transactions that are likely to have a materially detrimental effect. In the meantime, businesses have been given little clarity on how the powers will work in practice. One of the greatest sources of potential uncertainty will arise in the shift of the burden of proof away from a focus on the motives of a transaction towards the effect. This means that even where the motives were pure, if the effect was otherwise (and the regulator deems with the benefit of hindsight that the effect was foreseeable) then a company could find itself faced with huge liabilities. To some, this could prove to be too much power in the hands of the regulator.  

Mark Twigg can be contacted on +44 (0)20 7665 9537 or click here to email.