Proposals
for Pension Protection Fund and New Pensions Regulator

by Dr. Ros Altmann

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Overview:

The new Regulator and the Pension Protection fund are being
established as part of the current Pensions Bill, in order to try
and restore confidence in occupational pensions in the UK. Until the
last few years, our occupational pensions system was the envy of
other countries and was often held out as a model system, for others
to follow. Unfortunately, due to a combination of circumstances,
occupational pension provision, in particular in the form of final
salary schemes, has started declining and companies are pulling out
of providing defined benefit pensions. Most final salary schemes are
now closed to new members and many have wound up, often in
significant deficit. The existence of enormous pension deficits,
coupled with an ageing population, rising longevity and falling
interest rates, has led to a crisis of confidence in pension
provision. The Government would like to restore some of the lost
confidence and has, therefore, announced measures in the current
Pensions Bill, to establish a new Pensions Regulator and also to
introduce a scheme to offer insurance-style protection to members of
defined benefit pension schemes whose employers fail and whose
schemes do not have sufficient assets to pay the promised pensions.
This will be called the Pension Protection Fund (PPF).

Historical Background:

The last major piece of pensions legislation affecting occupational
pensions in the UK was the 1995 Pensions Act. This was introduced as
a result of the Maxwell pensions scandal of the early 1990’s. Robert
Maxwell plundered the assets of his Mirror Group pension funds. He
and his sons were trustees of the pension schemes and fraudulently
siphoned off money, leaving the pension schemes significantly
underfunded when he died. Therefore, the members were at risk of
losing the pensions they were promised and the Government of the day
decided that legal protections needed to be put in place, to protect
pension scheme assets and restore confidence in occupational
pensions. The Goode Committee was established to investigate the
workings of the UK occupational pension system and make
recommendations as to how to protect members’ pension benefits in
future.

The recommendations of the Goode Committee formed the basis of the
measures of the 1995 Pensions Act, which came fully into force in
April 1997. This Act introduced many measures, including:

• establishing a
  Regulator for occupational pension schemes (known as OPRA –
  Occupational Pensions Regulatory Authority)
• requiring a
  proportion of the trustees to be nominated by members,
• a compensation
  scheme for cases where employers defrauded pension assets
• a Minimum Funding
  Requirement (MFR) for schemes, designed to ensure that they were
  adequately funded to pay the promised pensions.

When the Act was
passed, scheme members were told that pensions would now be
protected by law, accrued rights could not be reduced, a Regulator
would protect members, oversee schemes and would act quickly to
ensure that employers behaved properly and that the new MFR would
ensure schemes were adequately funded.

Why are new measures now needed?

Sadly, the measures of the 1995 Pensions Act, although
well-intentioned, did not, in practice, deliver the promised
protection for defined benefit pension schemes. In the past few
years, tens of thousands of members of UK company schemes have found
that the pensions they thought were safe and protected by law have
disappeared. The Regulator, OPRA, was not effective enough in
policing employers or protecting members. Its powers were not
sufficiently strong to give it enough teeth, it did not act quickly
and it tended to focus on identifying small breaches of the pension
rules, such as penalising employers for late payment of
contributions, but was unable to prevent employers from continuing
to run schemes which had insufficient assets to meet their
liabilities, particularly on wind-up. The Minimum Funding
Requirement (MFR) has proved to be wholly inadequate to ensure that
pension schemes had sufficient assets on discontinuance. Being fully
funded on the MFR gave trustees comfort to believe their schemes
were adequately funded, but, in practice, this was not the case when
the scheme was wound up. The assumptions used for the MFR
calculation were not updated frequently and the test is only applied
every three years, so sharp movements in asset markets in between
MFR valuations can cause significant changes in the adequacy of
scheme funding.

The Government’s proposals:

As a result of the devastating losses suffered by so many members
who saved in their company scheme for decades, the Government has
decided to introduce a protection scheme for members’ pension
benefits, rather than just relying on an official funding standard.
This Pension Protection Fund (PPF) is designed to ensure that
members of final salary schemes, whose employers become insolvent
and whose schemes do not have sufficient assets to meet their
liabilities, will receive a pension from a central insurance fund.
(The payouts will be funded by other employer schemes, not by the
Government). This brings the UK into line with other countries,
which already have an insurance underpin for their defined benefit
pension schemes.

The PPF will be designed to collect levies from all employers who
run defined benefit schemes in the private sector. These levies will
be used to help pay out pensions to members of schemes which fall
into the PPF. The mechanism will be that, when an employer fails,
its scheme assets will be assessed and, if they are not sufficient
to pay out all the future liabilities by buying annuities, these
assets will be put into a central fund. The fund will run the assets
and pay out all the pension commitments of the schemes as they
become due over time. The levies paid in will be designed to ensure
that the PPF has sufficient assets to pay out future liabilities and
the Pensions Bill gives the PPF Board powers to vary the levy.
Initially the levy will be a flat rate charge, per scheme member,
but as soon as possible after the first year of operation, the idea
is that the levies will also reflect the probability of a scheme
ending up in the PPF. Schemes which are thought to be higher risk,
will be required to pay higher levies.

Alongside this PPF, the Government proposes to establish a new
Regulator, to replace OPRA, which is to be given much greater
powers. The new Regulator will be able to investigate the behaviour
of employers and will also be expected to proactively assess the
strength of an employer, whether a pension scheme is likely to be
underfunded and whether there are particular risks that a scheme may
fall into the PPF. The Regulator will have powers to require an
employer to put more money into the scheme and will be expected to
oversee adequate funding and adequate performance of pension fund
trustees in future.

The overall aim of these new measures is to restore confidence in
occupational pensions and encourage more people to contribute. The
should be in place by April 2005. Occupational pension schemes in
the UK are an extremely important part of overall pension provision.
For the past few decades, successive British Governments have tried
to offload the cost of pensions support away from the State pension
system and onto the private sector, with occupational company
schemes being a particularly important part of this provision. If
individuals lose confidence in company schemes, the implications for
pension coverage in the UK are serious. The State pension is
extremely low and, without adequate private provision, people will
end up relying on means tested State benefits, which will add to the
burden of old age support in future. It is, therefore, considered
crucial by the Government to ensure that the new measures for
protecting pensions will be seen to work well.