In its response to the Department of Work and Pensions’ (DWP) call for evidence: ‘Pensions and Growth’ Mercer has said it considers that the existing regulatory regime for funding defined benefit (DB) pension schemes remains fit for purpose, provided the Pensions Regulator (tPR) reviews its regulatory stance along the following lines:
• It affirms that its statutory objectives require it to take a sponsor’s financial position and ongoing solvency into account when setting its regulatory policy;
• It rebalances its treatment of the interests of sponsoring employers and trustees so that trustees have the necessary flexibility to adapt to the challenges faced by the employer as well as those faced by the pension scheme; and
• It reconsiders its statements on the level of risk it believes the system can maintain, so that it is clear that trustees can agree with employers to fund schemes without targeting winding up (or an equivalent measure).
The DWP’s call for evidence considers whether tPR should have a new objective “to consider the long-term affordability of deficit reduction contributions”. It also considers whether the scheme funding regime should be amended to permit trustees to calculate liability and/or asset values using a ‘smoothed’, rather than ‘market consistent’, approach.
According to Mercer, smoothing is likely to impose a narrower rules-based approach on trustees. Instead, the Government and tPR should take a wider view about how the statutory funding regime should be regulated in a way that encourages companies to continue to support DB schemes over the long-term.
According to Deborah Cooper, a partner at Mercer, “tPR’s encouragement of trustees to engage in risk reduction solely by means of increasing funding levels increases the cost to employers of providing DB schemes. This is why some organisations which had continued to provide at least some DB accrual for their employees are now closing schemes completely.
“Since its inception, tPR has set a very strong agenda. This has included strengthening trustees’ standards of governance, particularly to ensure that the risk environment in which pension schemes operate is better understood. These were very legitimate goals and tPR deserves praise for raising both standards of governance and risk awareness. However, the regulatory regime does not require trustees to remove risk entirely.”
Mercer is concerned that some trustees might find it difficult to strike the right balance between strengthening funding and reliance on employer covenant as a consequence of the Regulator’s messaging on risk. Mercer’s view is that a trustee focus on increased contributions to pension schemes and de-risked investment strategies is not necessarily the appropriate response to tPR’s statutory objectives.
“Now that tPR has had time to raise both behavioural and financial standards, the way it implements its ‘corporate objectives’ should be reviewed,” says Ms Cooper. “Rather than introduce a new objective, it would be more productive to provide clarity around how the Regulator’s existing objectives should be interpreted and to be clear about the success measures.
“Following a strategy that supports continued employer solvency, including measuring the affordability of contributions in the context of other demands on the employer’s discretionary spend, is already implicit in the Regulator’s statutory objectives,” she continued. “As the call for evidence notes, solvent employers are key to member security, so it would seem impossible for the Regulator to ignore this.”
The consultancy also considers that changing the statutory funding regime to introduce ‘smoothed’ measures of liabilities and assets is unlikely to materially reduce the pressure on employers sponsoring DB schemes.
“Ultimately, any system that is applied too rigidly will from time to time result in outcomes that are unsatisfactory," said Ms Cooper. "The current regime is perceived as unsatisfactory because tPR is adhering to its strategy of reducing risk as the over-arching aim for all trustees. This is even though, ultimately, its approach could result in more risk to scheme members and perhaps also the Pension Protection Fund by adversely affecting company performance.”
Mercer applauds the UK Government for initiating a re-evaluation of the dynamic between increasing DB funding levels and promoting growth. The consultancy believes that neither smoothing, nor a new statutory objective for tPR is necessary. Instead, it considers that the current regime is sufficiently flexible, provided tPR rebalances how it takes the interests of employers and trustees into account when setting its strategy for meeting its statutory objectives.
“Taking this approach would give the Government, employers, trustees and scheme members the greatest chance of achieving the twin goals of meeting pension obligations and stimulating growth,” Ms Cooper said.
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