Out-Law News 4 min. read
27 Apr 2012, 2:08 pm
The Regulator said employers that are "substantially underfunding" schemes will have to justify using any "available cash" they have for other means.
"Employers that are struggling have greater breathing space to fill deficits over a longer period," Bill Galvin, chief executive of the Pensions Regulator, said in a statement. "However, we will draw a distinction between this group and those cases where schemes are substantially underfunded and employers are able to afford higher contributions. In such cases we will expect pension trustees to be taking steps to put their scheme on a more stable footing."
The Pensions Regulator regulates UK work-based pension schemes. Under the Pensions Act it has the power to apply to the courts to issue an order to recover unpaid contributions.
In guidance (7-page / 85KB PDF) on funding defined benefit (DB) schemes in the current economic climate, the Pensions Regulator said it expects most employers to carry on funding schemes in accordance with plans already in place. Only if there has been a change in an employer's ability to pay should changes be made, it said.
DB pension schemes are schemes that promise a set level of pension once an employee reaches retirement age no matter what happens to the stock market or the value of the pension investment.
Employers that are underfunding schemes will have to justify using any "available cash" they have for other means, the Regulator said.
"Capital expenditure, servicing other debts and making dividend payments have an important role to play in encouraging investment in a healthy, sponsoring employer," it said. "However in some cases dividend payments may need to recognise the shareholders’ subordinate position to the scheme."
"Where available cash is used within a business that might otherwise have been used to increase contributions it should have the demonstrable effect of strengthening the ‘employer covenant’ (the employer’s ability to support the scheme)," the Regulator said.
However, the Confederation of British Industry (CBI) said the Pensions Regulator had failed to account properly for the effect quantitative easing (QE) has had on the way pension scheme funding is calculated.
Pensions law expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said the Regulator had set out clear warnings over underfunding.
"The Regulator considers that most employers with DB schemes will be able to keep to current plans for scheme funding - or at least that any extensions to recovery periods or reductions in employer contributions will be modest," Tyler said. "However, the general tenor of this statement is severe. It is a stark warning that trustees should not go too easy on employers, and that employers should not expect an easy ride from trustees."
"The Regulator advises against the use of rose-tinted spectacles in predicting investment returns. In particular, trustees should not too readily expect a bounce-back in gilt yields. If recovery plans assume economic improvements, trustees need to consider contingency plans. Funding negotiations are likely to be a fair bit tougher in the light of this statement," he said.
QE allows the Bank of England to inject money directly into the economy by buying assets from private sector institutions such as insurance companies, pension firms, banks or other companies and crediting the seller's bank account. This means the seller has more money to spend or invest, while the seller's bank has more money 'on reserve' to lend to other customers.
The majority of the extra money has been used to buy government securities, known as gilts, pushing up their prices – which results in the 'yield', or return, on those gilts falling as a percentage of the price.
QE also drives down annuity rates, which are rates at which a pension fund or part of a pension fund can be converted into a regular income under a special policy which can be purchased from an insurance company.
Final salary and other defined benefit pension schemes, which are schemes that promise a set level of pension once an employee reaches retirement age no matter what happens to the stock market or the value of the pension investment, are particularly affected by QE because they invest heavily in gilts. Lower gilt yields and long-term interest rates affect a formula known as the 'discount rate' which is used by the scheme actuary to calculate the cost of providing all the benefits currently promised during the scheme's regular valuations.
Last month, industry body the National Association of Pension Funds (NAPF) published a report indicating that final salary pension funds had dropped in value by a further £90 billion since the Government's second wave of QE began last October. It explained that change in how scheme values are calculated creates the appearance of a deficit, which a pension fund's sponsoring employer is legally obliged to fill.
“Increases in deficits distorted by QE lead to demands for even more money from hard-pressed employers," Neil Carberry, CBI director of employment & skills policy, said in a statement. "They divert money away from investment in growth and job creation and lock it away unproductively."
"This can have serious implications for firms’ credit ratings, as well as their ability to raise finance and their market outlook. The best form of protection for members’ employment benefits is a healthy, solvent employer and the Regulator and DWP should put this first. To help the private sector provide both the growth we need and the pensions firms have promised to employees, the current method of valuing a pension fund must change."
"It cannot be right that pension schemes with very long-term liabilities, which make them less vulnerable to short-term market fluctuations, have to fund against spot valuations. Greater smoothing is required using data over many months rather on a single day," Carberry said.
