By Dan Mikulskis, head of defined benefit, Redington
As we put together the response to the questions the Committee laid out, it became clear there were three themes that we felt were the most important points we wanted to make. They are:
1. The Member Benefit perspective
There are a number of stakeholders within the UK corporate DB scheme system, and regulatory context needs to weigh their objectives against each other to some extent, acknowledging key tensions that may exist. We think it is very important to remember that one of the key roles of pension regulation is to ensure security for pension scheme members, many of whom are relying on their DB pension for financial security in retirement.
There are important cases where further prioritisation of objectives is required: for example, in the case of severely under-funded schemes and weak corporate sponsors, where the objective of protecting accrued member benefits (capital preservation) may conflict with the objective of investing to try and pay the full benefits to members (reaching full funding). It is such cases as these, where regulation can be used effectively to help guide the difficult choices that must be made.
2. Learn from the success stories
There are considerable challenges facing DB pension schemes. However, the picture is more nuanced than the purely negative picture that is commonly presented - some schemes have been able to navigate from positions of poor financial health, to much stronger positions. A thorough analysis of what has created the conditions for this to happen within these schemes is equally as important as the broad picture facing all schemes. (We’d love to offer specific case studies and broader analysis on how some schemes have bucked the trend.)
3. Governance is key
Our experience and research suggest that better governance is a key determinant of better outcomes among pension schemes. The shortcomings of the governance of UK DB schemes has been well analysed and documented. Despite that, decisive change and improvement have been elusive and certainly are not visible across the industry. Best practice is far from universally applied and is conditional on the vision, experience, and enlightenment of certain Trustee Board chairman and/or the corporate sponsor. One of the reasons for the lack of progress in this area are Pensions and Trust Law regulations that are too prescriptive with respect to the make-up and composition of DB pension scheme trustee boards.
On the current regulatory environment and recommendations for how it might evolve we made the following points to the Committee:
• Pension scheme regulation faces the difficult task of balancing security for members against sustainability for employers
• We believe that regulatory flexibility is key to allow fundamentally sound companies who experience temporary periods of difficulty the best chance of honouring their commitments to their pension fund in a sustainable way
• We note that a reasonable degree of flexibility already exists in the current regulatory framework with regard to recovery period length and technical provision assumptions
• The current environment of higher deficits means we are likely to face a period of time where schemes have a higher level of covenant risk
• On balance we believe that a further “strengthening of the hand” of trustees in negotiations with the employer over the recovery period, and additional security that could be offered is warranted in an environment of heightened covenant risk
• However, we note the very careful balance that must be struck in regulation in not damaging the significant goodwill that exists currently between a great many sponsoring employers and the trustees of their schemes.
It makes sense to us that, given the current environment, all options should be considered and researched as potential solutions to the problem of the current under-funded status of the UK DB pension system. However, we would urge against options that simply try and “ignore” current market prices (such as using a fixed, or smoothed discount rate on the liabilities). As this carries a large risk that the problem is simply shifted further down the line, in the case that the current environment persists for many years (or worsens further). In particular allowing significantly off-market liability valuations may create a wealth transfer from stronger to weaker firms, via the PPF. Which should be avoided.
We often find the role investment consultants can play is in supporting the Chair in balancing security for members with sustainability for employers, building on the goodwill that exists and drawing on best practice across schemes that have been able to build much stronger positions.
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