In his Budget Statement last year George Osborne committed to “provide the Pensions Regulator with a new objective to support scheme funding arrangements that are compatible with sustainable growth for the sponsoring employer”. Nearly 12 months on we are little closer to knowing what this means. The 2013 Pensions Bill simply states that the Pensions Regulator is being given an additional objective to “minimise any adverse impact on the sustainable growth of an employer”. Both politicians and regulators seem to be shying away from expanding on the obvious need for greater clarity.
The Pensions Regulator recently issued nearly 200 pages of consultation documents on its new approach to the funding of pension schemes. But nowhere in these documents did it detail what might change as a result of this new objective – especially in the not-for-profit sector where, in many cases and particularly amongst charities, the problems of DB pensions are acutely felt. The Regulator has effectively said it is already being flexible in its approach and little change is needed. The risk therefore is that for all the Chancellor’s talk last year, nothing happens and pension schemes continue to be a major inhibiter to the growth and the recovery of UK plc.
Now it may be the case for employers that playing in equity markets in their pension schemes is a bit of a mug’s game – the aspired benefits of higher investment returns are more than offset by the cost of higher risks and volatility and an inefficient tax position. But, and it’s a big but, the Government – or the Bank of England, depending on your perspective – is currently “rigging” the bond markets with its programme of quantitative easing (QE). This is having the impact of keeping interest rates at unnaturally low levels and hence pension liabilities at unnaturally high values. It also means that with limited investment opportunities available, putting cash into pension schemes, even for a gross investment return, is not attractive for many companies.
QE cannot be sustained indefinitely. At some stage it is going to have to be unwound and bond yields will have to rise and pension liabilities fall. Inevitably, in such an environment employers are wary of switching assets wholesale into bonds and committing too much scarce resource to a pension scheme based on a calculated value of liabilities that is linked to a “rigged” bond market. Companies can also face an added problem in their own accounts, where the interaction of IAS19 and IFRIC14 can mean that signing up to an onerous schedule of contributions in the pension scheme results in a significant balance sheet hit.
Of course, the Pensions Regulator has to be concerned about those pension schemes that may not survive to see the end of QE, where a default event could see thousands more pension scheme members and millions of pounds of liabilities fall into the Pension Protection Fund. Inevitably therefore the Regulator is cautious about calls for a relaxation in funding standards. But in the highly problematic cases the Regulator’s focus on affordability largely ensures that weak employers pay what they can – which is all the Regulator is likely to be able to get out of them in any event. But for those employers who are not about to go bust and are in the DB pensions game for the long term, does it make sense that they are forced to fund their pension schemes to levels based on questionable liability values? For robust employers, why not introduce an explicit temporary funding target – whilst QE is maintained – that is lower than the trustees’ existing target?
For some companies this continued uncertainty and risk is providing a strong incentive to bite the bullet and plan an exit strategy. Indeed, insurance company annuity contracts are currently attractively priced relative to many alternatives – a state of play which may not last once the steady stream of companies planning an exit strategy becomes a torrent. But many companies that are not in any imminent danger of insolvency simply want to retain their DB pension schemes and fund them “sensibly” over the medium to long term. For such companies it should be possible for regulators and politicians to agree a more reasonable and transparent funding objective.