The documentary evidence
Jump to
- Introduction
- Events before 1995
- Events during 1995
- Events during 1996
- Events during 1997
- Events during 1998
- Events during 1999
- Events during 2000
- Events during 2001
- Events during 2002
- Events during 2003
- Events during 2004
- Events during 2005 and after
Introduction
4.1 This chapter sets out the evidence that my investigation has uncovered through consideration of departmental files, official publications, and other documentary sources.
Events before 1995
The Maxwell affair
4.2 In December 1991, after the death of Robert Maxwell, a shortfall of £450 million came to light in the Maxwell companies’ pension schemes. It was discovered that, as a result of missing funds - which became the subject of subsequent litigation - the schemes were not able to meet in full their financial commitments. This included being unable to meet their liabilities to pay out employees’ pensions or to enable non-pensioners to transfer their accrued pension rights to another pension scheme or other approved savings facility.
The Pensions Law Review Committee
4.3 In the light of the issues raised by the collapse of the Maxwell business empire and the significant shortfall in its associated pension schemes, the then Secretary of State for Social Security, Peter Lilley, put in place a rescue package for the Maxwell pension funds.
4.4 In June 1992, he also asked Professor Roy Goode to chair a committee of inquiry, whose terms of reference were:
To review the framework of law and regulation within which occupational pension schemes operate, taking into account the rights and interests of scheme members, pensioners and employers; to consider in particular the status and ownership of occupational pension funds and the accountability and roles of trustees, fund managers, auditors, and pension scheme advisers; and to make recommendations.
4.5 The Pension Law Review Committee (PLRC), to give the committee its full title, reported on 30 September 1993.
4.6 The Goode Report – ‘Pension Law Reform’ - provided a critique of then existing pension law. The view of the PLRC was that such law was considerably complex but lacked structure and organisation. The law also allowed such wide powers and discretion to be left in the hands of the sponsoring employer and the scheme trustees that the interests of scheme members were not always sufficiently protected. In the Committee’s view, there was also an undesirable absence of a compensation scheme when things went wrong, in contrast to the position in relation to other investment activity, and there was no regulatory body with the jurisdiction and powers to monitor and enforce proper standards in the administration of occupational pension schemes.
4.7 The Report contained 218 specific recommendations, but, by way of summary, set out six ‘key recommendations’, namely:
(i) that Trust law should continue to provide the foundation for interests, rights and duties arising in connection with occupational pension schemes but should be reinforced by a Pensions Act administered by a pensions regulator;
(ii) that the freedom of action trustees had should be limited so as to ensure the reality of the pensions promise, to protect rights accrued in respect of past service, and to allow members to make appointments to the trustee board;
(iii) that the provision of information to members by their pension scheme should be improved both in content and in clarity and presentation;
(iv) that the security of members’ entitlements should be strengthened by minimum solvency requirements and by monitoring both by a pensions regulator and by scheme auditors and actuaries, coupled with restrictions on withdrawals by employers of surplus funds from schemes where such existed and also, as a last resort, the establishment of a compensation scheme to cover deficits arising from fraud, theft or other misappropriations;
(v) that, on establishing a scheme, the sponsoring employer should be free to reserve the right to close, freeze or wind up their scheme, to approve or to refuse increases in benefit and to reduce or to stop contributions, subject to the minimum solvency requirements; and
(vi) that the administrative burdens on employers and scheme administrators should be reduced wherever possible, and flexibility increased, through simplification of the relevant law and its administration.
The Government’s response
4.8 The Pension Schemes Act 1993 received Royal Assent on 5 November 1993. It consolidated the existing law relating to pensions schemes with the aim of making that law more transparent and better understood.
4.9 The Government also announced that it accepted the main thrust of the Report’s recommendations, which it noted had been widely welcomed, and published a two-volume White Paper, ‘Security, Equality, Choice: The Future for Pensions’, in June 1994.
4.10 The White Paper set out the Government’s proposals, on which views were sought, to implement the key recommendations of the Goode Report that it was inclined to accept.
4.11 In relation to the security of pension scheme members’ accrued rights, the White Paper proposed that a minimum solvency requirement would be introduced for defined benefit schemes. It went on:
The Government agrees with the PLRC proposals that a minimum solvency requirement should be introduced. This is not only to reinforce confidence that accrued rights will be protected but also to provide a basis and yardstick for setting a schedule of contributions to maintain an appropriate funding level – thus providing a key measure for trustees in maintaining and managing the scheme and for giving clear information to members on the health of the scheme…
4.12 The White Paper went on to describe which schemes would be subject to the solvency requirement, how minimum solvency would be calculated, the transitional arrangements for its phasing in, mechanisms for regular ‘health checks’ on each scheme, and the relationship between the solvency requirement and the indexation provisions set out elsewhere in the Government’s proposals.
4.13 Following a consultation process, these proposals formed the basis for a Pensions Bill.
Further discussions on detailed legislative proposals
4.14 On 11 October 1994, while the consultation process and preparations for the introduction of the Bill were undertaken, the chairman of the Pensions Board of the actuarial profession wrote to DSS concerning the basis of calculation for the proposed Minimum Solvency Requirement (MSR).
4.15 The letter specifically discussed proposals to introduce an equity element for pension liabilities in the case of large pension funds. This followed earlier discussions about a letter from DSS on 26 September 1994, which had set out the Government’s thinking in suggesting this.
4.16 After setting out the profession’s views on the impact of these proposals, the letter ended:
I explained that the views we discussed were provisional ones and that I would seek input from other members of the Pensions Board. The ideas have since been discussed in the Current Issues Committee, and generally supported, as long as it is clear that responsibility for the basis is accepted by the Government – i.e. the introduction of an equity element will increase the probability to some extent of schemes being unable to deliver the winding up liabilities and it is for the Government to decide where to strike the balance between security for the members and financial consequences for scheme sponsors.
4.17 The then Secretary of State for Social Security, Peter Lilley, wrote to Sir John Butterfill MP (as he is now) on 8 December 1994. Publication of this letter was the then Government’s chosen mechanism for publicising the changes to the basis for the proposed solvency requirement that had been agreed by it.
4.18 The letter said that ‘on the basis of further detailed analysis, and in response to comments made on the proposals set out in the White Paper, the Government has decided to… authorise a basis for calculating statutory minimum solvency which would allow the larger defined benefit occupational schemes to value a proportion of their pensioner liabilities by reference to equity returns’. It also set out other changes – to the proposed time limits for restoring scheme funding levels to the statutory minimum level and to enable the calculation of the statutory minimum solvency requirement to be based on market values over a period of months.
4.19 Mr Lilley continued (with original emphasis):
The basic rationale for a minimum solvency requirement is clear and is set out forcibly in the report of the Pension Law Review Committee. In the modern world, no employee can make the comfortable assumption that his employer will be around 20, 40, 60 years hence to pay pension benefits as they fall due. If an employer makes a defined benefit pension promise, the pension fund should therefore be adequate to secure that promise, irrespective of what may happen to the employer over the period before the final pension payment is made.
4.20 The letter continued:
The proposed statutory minimum solvency requirement will provide an important, objective measure of the adequacy of a pension fund; something which members and trustees will be able to monitor and against which the performance of the fund and other important matters can be measured.
4.21 After setting out the rationale for the introduction of an equity element, which it was said would have the effect of ‘not weakening the security of members to any significant extent’, the letter then stated that ‘this adjusted package of measures should ensure that the statutory MSR will deliver an appropriate level of security for members, without imposing unnecessary burdens on business’.
4.22 The letter then set out ‘solid gains in security from the introduction of an MSR’ for scheme members. These including the following:
(i) that there would be ‘a consistent basis for measuring the adequacy of a fund in terms of its ability to deliver at least the cash equivalent of its members accrued rights’; and
(ii) that ‘the valuation basis should ensure that schemes have sufficient assets either to buy out their pension liabilities with annuity contracts or to deliver pension benefits as they fall due, and to pay a fair transfer value to non-pensioner members in respect of their accrued rights’. It was said that ‘this represents a fair and practical basis for assessing the adequacy of pension funds to meet their minimum liabilities’.
4.23 The letter, while noting that this would involve additional costs to schemes, stated that such a ‘price is worth paying to produce greater confidence that defined benefit promises will actually be met at the end of the day’.
4.24 On the same day as what became known as ‘the Butterfill letter’ was published, the actuarial profession issued a press statement about its contents. While welcoming the Government’s decisions as to the basis for the proposed minimum solvency requirement, the profession said that it was:
…concerned that the significance of the word “solvency” in describing the proposed test for very large schemes could give a false impression of the winding up position to ordinary members. We therefore see the need for a major effort by Government and those involved in pension provision to educate members of schemes as to the extent of the security for their benefits which the Minimum Solvency Requirement can be expected to provide.
4.25 On 20 January 1995, the actuarial profession wrote to the Secretary of State to express its view that ‘the term solvency was an inappropriate description of the test and was likely to mislead scheme members and others into believing that their benefits would be fully secure if their pension scheme wound up’. The profession suggested that a more appropriate term for the Government’s proposed scheme funding standard was a ‘Minimum Funding Requirement’.
4.26 On 15 February 1995, Mr Lilley replied to the actuarial profession. After setting out the background to the Government’s thinking, he said ‘as to the term “minimum solvency requirement” it could be argued that if minimum solvency is taken to be an absolute guarantee of solvency at all times then it could never be achieved’. He continued by saying that ‘the MSR calculation proposed by the PLRC already accepted the necessity of using the cash equivalent approach in respect of non-pensioner liabilities – which I believe is reasonable and realistic, but which we have to accept is not a guarantee’. He concluded by saying that he believed that ‘it is important how the MSR is explained to members – but whether or not public perceptions might change by using a different name is perhaps debatable’.
4.27 On 20 March 1995, the actuarial profession wrote to DSS officials to express its concern about the clarity of the intention behind some of the legislative proposals then being discussed in Parliament. After discussion of other matters, the profession said that it was ‘very concerned at the misleading impression that a signed minimum funding certificate may give to ordinary scheme members’.
Events during 1995
Second Reading of the Pensions Bill in the Lords
4.28 In the meantime, and following its introduction into the Lords, that House gave the resulting Pensions Bill a Second Reading after a debate on 24 January 1995.
4.29 The late Lord Mackay of Ardbrecknish, then the Minister of State at the Department of Social Security, in moving the Second Reading said that:
There are four major principles underlying this legislation. First, confidence in the security of occupational pension schemes was undermined by the Maxwell affair and we intend to restore that confidence by improving security. Secondly, equal pension rights for men and women are required by the European Court of Justice rulings. The Bill will bring domestic legislation into line with European law and will make it easier for contracted-out salary schemes to equalise benefits for men and women in the future. Thirdly, in order to ensure a fair and sustainable basis for state pensions in the next century, we intend to phase in equalisation of state pension age at 65. Finally, we are committed to making personal pensions attractive across a broader age range, introducing age-related rebates for those investing in personal and money purchase pension schemes.
4.30 In setting out the purpose of the provisions of the Bill related to improving the security of occupational pension schemes, the Minister continued:
Pensions are for many people the most significant single investment they will ever make. They must be confident that the pensions promise of today will indeed be matched by the pension of tomorrow.
4.31 After setting out the specific proposals that were contained in the Bill to deliver this objective, the Minister continued:
No system can offer a total guarantee against fraud. However, we will do everything possible to eliminate the likelihood of fraud or other wrongdoing by strengthening the framework of pension provision.
4.32 In addition to proposals to give scheme members rights to clear and relevant information, to nominate trustees, and to have access to a dispute resolution mechanism for any complaints, the Minister then described the Bill’s provisions insofar as they related to the roles of scheme trustees and of their professional advisors – principally actuaries and auditors.
4.33 In relation to proposals for a statutory minimum solvency requirement to ‘underpin the employer’s pension promise’, he said:
This requirement will reinforce trustees’ and employers’ responsibility for ensuring that schemes are properly funded, thus enhancing security for scheme members. This will provide an objective benchmark for assessing the adequacy of the fund, setting contribution levels and monitoring the fund’s performance. It will act as a mechanism for ensuring that schemes have adequate funds to meet contracted-out benefits. Finally, it will provide the measure against which the amount of compensation will be calculated when a successful claim for compensation is made.
We have consulted widely on how such a requirement should be defined in order to balance the concerns of employers… against improving security for scheme members. We believe that we have struck the right balance to give scheme members the security they must have if occupational pensions are to prosper and to encourage employers to run good schemes.
4.34 In the debate, in addition to consideration of the other measures proposed in the Bill, criticism was levelled at the proposed solvency standard as not being consistent with the recommendations of the Goode report and as constituting a ‘watering down’ of the measures on which the Government had consulted through its White Paper. It was also suggested that the name proposed for the requirement was misleading, as the requirement related to scheme funding rather than constituting a solvency test.
4.35 In summing-up and responding to the debate on the proposed measures for increased security, Lord Mackay said:
Our concern has been to devise a consistent basis for valuing scheme liabilities as a measure of the adequacy of pension funds to meet their liabilities, and as a basis for assessing matters such as minimum contributions. In considering what should be the appropriate valuation basis, we have borne in mind the need to define an appropriate level of security for members’ pensions, and for an entitlement, without actually imposing unnecessarily high costs on employers, which might have led to a significant reduction in the level of occupational pension provision.
Consideration of the Bill by the Lords in Committee
4.36 Following approval of the Bill on Second Reading, the House of Lords resolved itself into Committee on 7 February 1995 to consider the Bill in detail.
4.37 In discussion about the proposed minimum solvency requirement and, specifically, in relation to the then Opposition’s attempts to amend the Bill to provide for a minimum contribution requirement instead, Lord Mackay said:
I am convinced that a measure of solvency that does not address the position of the scheme on discontinuance in some way will not be providing members with adequate security in the event of the scheme being wound up.
The overwhelming argument in favour of a minimum solvency requirement is that if an employer undertakes to provide a pension promise the scheme should be able to secure that promise at all times, especially in the event of a scheme winding up. It is at that time that the members’ position is most vulnerable. A minimum solvency requirement should ensure that, irrespective of what happens to the sponsoring employer, the fund will have enough money to meet the value of members’ accrued rights which will therefore be protected.
But security has a price… It is simply not possible, either practically or economically, to require ongoing pension schemes to fund at a level that will enable them to buy out all the liabilities with non-profit annuities. For many schemes the cost would be prohibitive…
We are introducing a new power to enable trustees to secure benefits on wind-up by providing members with a cash value of accrued rights. Where a scheme is only funded at the level of [the] minimum solvency requirement, the calculation for this will be that used for calculating liabilities for the minimum solvency requirement.
4.38 In asking the Committee to reject the Opposition amendments and to support the Government’s proposal, the Minister said:
We believe that our provisions, together with the proper operation of the minimum solvency requirement, will substantially reduce the likelihood of schemes winding-up in deficit.
4.39 A central discontinuance fund, which would provide support to members of schemes which could not meet their liabilities in full, was not in his view necessary and, moreover:
…there would be a real temptation for schemes to sail close to the wire… because they would know that they had a back-up if they wobbled on to the wrong side. I remind the Committee that there is a pension promise to each scheme. There is a promise with regard to the contributors and a promise for when members of the scheme become pensioners.
Consideration of the Bill at Report Stage in the Lords
4.40 Consideration of the relevant provisions of the Bill continued on 13 March 1995, when the House of Lords considered the Report of the Committee. During this debate, Opposition members continued to press for an ongoing funding requirement in contrast to the Government’s proposal.
4.41 Lord Mackay, in countering the Opposition’s arguments, said:
During Committee, I said that the central weakness of an ongoing funding requirement is that it does not aim to provide any level of protection in the event of a scheme winding-up. I know that some noble Lords may want to argue that the bulk of employers do not become insolvent and that it is therefore unreasonable to require schemes, at all times, to have sufficient assets to meet their accrued liabilities. I do not accept that argument. On the contrary, I believe that scheme members have the right to a clearly defined measure of protection…
Members who have had their benefits reduced on a wind-up are unlikely to take much comfort from the fact that they would have been secure had their employer remained in business. To put it another way, it is quite unacceptable that employers should be able to continue trading at the risk of leaving their employees' legitimate pension expectations unfulfilled.
4.42 The Minister went on to ‘repeat the merits of the minimum funding approach and what it is intended to deliver’:
It will require schemes to hold sufficient assets to be able to secure pensions already in payment, either by buying annuities or paying benefits as they fall due, and provide younger members with a sum of money to be invested further. The pensions they eventually draw will obviously depend on how the money is invested and the rates of return on the investment, but there is every chance of it producing a pension at least as good as, and probably better than, that which would be paid from a deferred annuity. The minimum funding proposals offer a far better measure of security for all members of defined benefit schemes than any alternative affordable proposals…
…we need to respond for scheme members who are unfortunate enough to work for employers who go out of business and are thus unable to stand behind their pension fund. These members could well find that, as the law stands at present, they would receive less than they have a right to expect. We live in the real world where employers do go out of business. We believe that schemes must be funded at a proper level to secure benefit rights if that should happen.
4.43 The Minister then explained why it was now proposed to rename the minimum solvency requirement.
4.44 Lord Mackay explained:
… by changing the name to a ‘minimum funding requirement’, there is not the slightest deviation from what the requirement will do. It will mean that members can be confident that the value of their accrued rights is secure, especially in the event of the scheme or the employer company winding up… true solvency could only mean the ability to buy out all benefits with guaranteed insurance annuities. The PLRC recognised that such a measure of solvency would not be practical and would be unduly costly. The Government fully accepted this… It is only right that the members' investment, and their accrued pension rights, should be properly protected. Our proposals are designed to provide that protection. As suggested by the PLRC Report, we had called the vehicle for providing that protection a ‘minimum solvency requirement’. The change of name in no way reduces what the requirement is intended to achieve.
Third Reading debate in the House of Lords
4.45 The House of Lords considered the amended version of the Bill in a debate on 21 March 1995. Disagreement continued on what the most appropriate form of funding test would be to provide the best security for members’ accrued pension rights.
4.46 Lord Mackay reiterated the Government’s view that:
…our proposal for an MFR will not increase costs for most schemes. However, what it will do — by contrast to the [Opposition] amendment — is to provide a greater degree of certainty for the members of schemes that the rights they have accrued at any point in time will be adequately secured.
4.47 In response to a proposed amendment to protect the position of the indexation of existing pensioners’ payments in relation to the proposed new order of priority for the discharging of scheme liabilities on wind-up, the Minister said:
The intention is to ensure that when a scheme winds up, all of the members are treated fairly. If the scheme is fully funded to the level of the minimum funding requirement, all of the members should receive the full actuarial value of their accrued rights, including the right to indexation, should the scheme wind up. But there will be circumstances where schemes wind up less than 100 per cent solvent on the statutory minimum funding basis or are otherwise unable to meet their liabilities in full.
Obviously, we hope that schemes will not wind up in a position where they are unable to secure the benefits promised under the scheme. We believe that the minimum funding requirement and the wide range of other measures for enhancing scheme security incorporated in the Bill will minimise the chances of schemes winding up in this position. But we live in the real world, and we must cater for those cases where things do go wrong despite our best endeavours.
A scheme which does not meet in full the statutory minimum funding requirement will not be able to meet all of its liabilities on wind up. That is when the priority order will come into play and ensure that there is an equitable distribution of assets. It is only right that pensioners should receive some priority over active members. That is why we propose that they should, if possible, suffer no reduction in their income. That is reflected in the priority order we propose.
However, to go further and give priority to indexation for all pensions in payment would place at risk the rights of other members. We have to ensure that the assets are shared fairly. We believe that this can best be done by protecting pensions in payment first, then protecting the basic pension entitlement of all other scheme members, then sharing out whatever assets remain for the benefit of all scheme members.
Second Reading debate in the House of Commons
4.48 Following transmission of the Bill from the Lords, the House of Commons gave the Bill a Second Reading on 24 April 1995.
4.49 The then Secretary of State for Social Security, Peter Lilley, reiterated the key principles behind the Bill which, he said, together formed ‘lines of defence against fraud and misuse of pension scheme assets’. The MFR was described as the fourth line of defence.
4.50 The then Minister for Social Security and Disabled People, William Hague, in closing the debate for the Government, said:
Governments have to calculate the costs and benefits of their policies. Governments have to arrive at the right balance, which means that we will have strong, funded occupational pension provision in this country, thoroughly regulated without killing the goose that lays the golden eggs. That is what we are setting about in this major piece of legislation. It is the right legislation. It will bring security, equality and choice to pension provision. It deserves the support of the House.
Consideration of the Bill by Commons Committee
4.51 Following approval in principle of the Bill at Second Reading, Standing Committee D of the House of Commons considered the Bill in late May 1995 and in early June 1995.
4.52 During the afternoon session on 23 May 1995, Mr Hague said:
The key principle underlying the minimum funding requirement and cited by the Pensions Law Review Committee to justify the use of a discontinuance based test was, as the committee put it:
“where there is a risk, however, small, of the employer’s insolvency, funding will meet the requirements of benefit security only if at all times the assets of the scheme are sufficient to cover its liabilities”.
4.53 He went on:
The MFR will enable schemes to provide for pensions and for the accrued rights – nothing to do with the expectation of what might be accrued - of their non-pensioner liabilities.
4.54 In dealing with the then Opposition’s support for an alternative solvency standard based on a minimum contributions requirement, Mr Hague said:
The alternative that I advocate is the Minimum Funding Requirement, under which a scheme would have sufficient money on winding up to cover pensions in payment. If it was one hundred per cent funded according to minimum funding requirements, it would have sufficient funds to cover pensions in payment and to give a transfer value – the value of accrued rights – to non-pensioner members.
4.55 Following discussion about the Swan Hunter case, which had then only recently come to light – and specifically about allegations that, even though the Swan Hunter pension scheme would have been fully funded on an MFR basis had that basis been in place at the relevant time, the scheme was now only able to meet approximately 60% of its pensioner liabilities following wind-up and was not able to cover any of its liabilities towards its non-pensioner members - the Minister said:
Schemes funded to the minimum funding requirement will be able to pay every member the cash equivalent of their accrued pension rights, which they would be able to transfer into another pension scheme or into a personal pension.
4.56 When asked by John Denham MP about the position of people very close to retirement who could not transfer to another scheme, who would need to buy an annuity, and who would thus be ‘significantly worse off’, the Minister replied:
People in that position would have their rights valued on a different basis. If they were near to retirement there would be a much larger element of gilt rather than equity valuation to determine the appropriate value for them. These people would receive a larger value, which would be nearer to what would, in many cases, buy an annuity. That cash equivalent for those who are some distance from retirement would be most unlikely to be sufficient to buy an appropriate annuity, but it would be sufficient to transfer into another fund.
4.57 Mr Hague went on to describe 100% funding on an MFR basis as:
…a target which means that if at any stage that scheme winds up, it will be able to keep its pensions in payment and give the cash equivalent of approved rights to the non-pensioner members.
4.58 During further consideration of the Bill on 6 June 1995, the Minister explained again the rationale for the MFR with specific reference to the need to ensure that employer contributions to bring a scheme’s funding up to MFR levels were made within specified time limits. He said:
After everything that has happened in the past few years… we could not be proud of the Bill or of the Act that it will become if we were not in the end able to say that schemes must have sufficient assets available within a certain time to keep pensions in payment and give non-pensioners the value of their accrued rights.
Parliament would be in an embarrassing position and would not have done its job. That is the least that we should require of schemes. Without that requirement, what on earth would we say to people who may approach us after the Bill has been enacted and ask whether their pension funds will be able to keep their pensions in payment or give them the value of [their] accrued rights if [the scheme] winds up?
Without the MFR, the answer to such a question would be no. What on earth would we have achieved then?
The Minimum Funding Requirement would mean that the answer would be yes. That is all we seek with the MFR.
Royal Assent
4.59 Following consideration of technical amendments suggested by the House of Commons, and approval of the final version by both Houses, the Bill received Royal Assent on 19 July 1995.
Main effects of the Pensions Act 1995
4.60 As a result of the enactment of the Pensions Act 1995, many changes were made to the regime governing pension provision in the UK, including in relation to the basic state pension retirement age, to the rules for contracting out of SERPS, and to sex equality within state and non-state pension provision.
4.61 The principal effects of this new legislation that are relevant to this investigation were:
(i) that OPRA was established, with the remit of ensuring that occupational pension schemes complied with pensions law and the Authority’s other directions;
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(ii) that the MFR was imposed on most defined benefit occupational schemes not in the public sector, to ensure that a scheme was properly funded;
(iii) that a new statutory priority order for the discharge of pension scheme liabilities was introduced which would over-ride an individual scheme’s rules; and
(iv) that pension scheme members would be able to nominate one-third of their scheme’s board of trustees to represent members’ interests.
4.62 The Act provided that the detailed method of calculation to underpin the MFR would be set out in Regulations (and guidance) to be developed with (and by) the actuarial profession and approved by the Secretary of State - and that these and other provisions of the Act would be commenced at a later date.
Further discussion between DSS and actuarial profession
4.63 On 31 October 1995, the actuarial profession wrote to DSS officials to seek a formal statement of the Department’s position on a number of matters, in order to inform the profession’s work on devising the actuarial basis for the MFR.
4.64 DSS replied on 22 November 1995. In relation to the ‘underlying purpose of the MFR’, the DSS official said (with my emphasis):
…that the intention underlying the MFR (which was clearly expressed by Ministers during the passage of the Pensions Bill) is to require schemes to have a level of assets which should as a minimum be sufficient, if the scheme were to wind up, to enable it to pay in respect of each non-pensioner member a sum which if invested in an appropriate alternative pension vehicle could reasonably be expected to generate a pension benefit at least equivalent to that which the scheme would otherwise have paid in respect of rights accrued up to that point in time. By reasonable expectation we mean that there should be at least an even chance.
Events during 1996
Official publicity concerning the Pensions Act 1995
4.65 In January 1996, DSS published a leaflet – ‘The 1995 Pensions Act’ (PEC 3) – which purported in its 21 pages to be a ‘brief summary’ of the ‘changes to state pensions, occupational pensions and personal pensions’ introduced by the 1995 Act. It said that ‘more detailed information will be published later’. This edition was a revision of an earlier leaflet, published in October 1995.
4.66 The introduction to the leaflet, under a heading ‘why was the Pensions Act needed?’ stated that ‘changes were needed’ as ‘the Government wanted to remove any worries people had about the safety of their occupational (company) pension following the Maxwell affair’.
4.67 Section 3 of the leaflet dealt with ‘changes to occupational and personal pensions’. After explaining the roles of OPRA, the Pensions Ombudsman, the compensation scheme, the Occupational Pensions Board, and trustees, the leaflet, under the heading ‘new minimum funding requirement for salary related schemes’, said:
The Pensions Act introduced a new rule aimed at making sure that salary related schemes have enough money in them to meet the pension rights of their members. If the money in the scheme is less than this minimum level, the employer will need to put in more money within time limits. The minimum funding requirement is intended to make sure that pensions are protected whatever happens to the employer. If the pension scheme has to wind up, there should be enough assets for pensions in payment to continue, and to provide all younger members with a cash value of their pension rights which can be transferred to another occupational pension scheme or to a personal pension.
4.68 The leaflet then went on to deal with members’ rights to information from their scheme administrators and trustees, with the Act’s provisions for pensions indexation, with the equalisation of pension rights for men and women, with the position of part-time workers, with new arrangements related to pension transfers and pension sharing on divorce, and with the flexible use of personal pension savings on retirement.
Announcement of the MFR Regulations
4.69 On 10 June 1996, Peter Lilley, the then Secretary of State for Social Security, announced that proposals for Regulations to give force to the MFR had been agreed.
4.70 In the press release – entitled ‘new statutory minimum funding requirement gives pension scheme members greater protection’ - that accompanied this announcement, it was said that:
Schemes funded to this minimum level will be able, in the event of an employer going out of business, to continue paying existing pensions and provide younger members with a fair value of their accrued rights which they can transfer to another scheme or to a personal pension.
4.71 The press release then quoted the Secretary of State’s announcement of two changes to the originally proposed MFR basis following ‘extensive consultation’ – in relation to the valuation basis of pensioner liabilities of larger schemes and to the decision not to require the smoothing of MFR calculations.
4.72 He then said:
These two changes will reduce potential costs overall by some £20 million to £30 million a year over the period until the MFR comes fully into effect. They will make the operation of the MFR more straightforward. And they will maintain the level of security provided to members.
4.73 The ‘package’ of proposals being presented in relation to the MFR basis would in the Minister’s view ‘carefully balance concerns about imposing costs on employers whilst achieving member security’.
Events during 1997
The MFR and Deficiency Regulations
4.74 The Occupational Pension Schemes (Minimum Funding Requirement and Actuarial Valuations) Regulations 1996 were made by the Secretary of State on 12 June 1996 and were laid before Parliament on 18 June 1996. These Regulations, which prescribed the method of calculation for the MFR that had been agreed with the actuarial profession and also other matters, came into force on 6 April 1997.
4.75 On 11 December 1996, the Secretary of State also made the Occupational Pension Schemes (Deficiency on Winding Up etc.) Regulations 1996. These Regulations prescribed the method of the realisation and discharge of the assets and liabilities of pension schemes on wind-up and also provided for the order of priority in which both would be realised and discharged. They came into force on 19 December 1996.
4.76 On the same day, the Occupational Pension Schemes (Winding Up) Regulations 1996 were made, which came into force on 6 April 1997.
OPRA Chairman’s speech on communication
4.77 On 3 June 1997, the then Chairman of OPRA gave a speech on the ‘communications challenge’ for all those involved in the pensions industry at an awards ceremony for pensions and investment journalists at the House of Commons.
4.78 He argued that the 1995 Act had helped focus attention on occupational pensions and that the roles of trustees, pension professionals, employers and scheme members were ‘now clearly defined’. He went on to say that more needed to be done to stimulate awareness about what individuals needed to do to ensure the best long-term provision for themselves and their families.
4.79 He continued:
Communication for OPRA means getting across important messages to all those involved in workplace pension schemes, including scheme members… Communication for OPRA also involves dialogue with the Government where, in the light of operational experience, the law we enforce may need amendment, update or clarification. Whatever the level of input required, OPRA stands ready to play a full part in the widening debate on the future of retirement provision.
Actuarial Guidance Notes
4.80 On 6 April 1997, a new version (4.0) of the actuarial practice standard guidance note, ‘Retirement Benefit Schemes – Winding-up and Scheme Asset Deficiency’, came into force. In addition, a new guidance note (version 1.0) was issued, entitled ‘Retirement Benefit Schemes - Minimum Funding Requirement’. Both guidance notes were issued by the Faculty and Institute of Actuaries.
The Office of Fair Trading report
4.81 In early July 1997, the Director-General of Fair Trading published his report of an inquiry into pensions, which had been launched on 19 September 1996, and which had had as its focus the identification of any practices that might adversely affect the economic interests of consumers.
4.82 In relation to defined benefit schemes, the Director-General noted that such pensions:
…have provided and will continue to provide a comprehensive range of benefits which meet many of the needs of consumers. However… long stayers are rewarded at the expense of early leavers. This is implicit in the design of all DB [defined benefit] final salary pension schemes.
4.83 He went on to observe:
Notwithstanding a dramatic improvement in the position of early leavers over the last two decades, losses for early leavers persist. Furthermore, the transfer values that employees receive on leaving DB schemes are subject to a large degree of actuarial discretion that can dramatically reduce their size. The Pensions Act 1995 has had the perverse effect of reducing transfer values for early leavers though it has reduced the scope for variations.
The 1997 Budget
4.84 On 2 July 1997, the Chancellor of the Exchequer made his Budget Statement. In it, he said:
I can confirm also that this Budget will not proceed with the previous Government's proposal to phase out tax relief on employee pension contributions.
This point in the recovery is, however, the right time to make changes in corporation tax to encourage more long-term investment. My changes in monetary policy were designed to help companies make long-term investment decisions with confidence. The changes in corporation tax are directed to the same long-term objective…
I want the United Kingdom to be the obvious first choice for new investment, so I have decided to cut the main rate of corporation tax by 2 per cent, from 33 per cent to 31 per cent, the lowest ever rate in the United Kingdom.
4.85 He continued:
Too often, British companies have invested too little and too late in the economic cycle… The present system of tax credits encourages companies to pay out dividends rather than reinvest their profits. That cannot be the best way of encouraging investment for the long term, as was acknowledged by the previous Government. Many pension funds are in substantial surplus and at present many companies are enjoying pension holidays, so this is the right time to undertake a long-needed reform. The previous Government cut tax credits paid to funds and companies, so with immediate effect I propose to abolish tax credits paid to pension funds and companies.
Exchanges on the Budget changes in the Lords
4.86 On 10 July 1997, Lord Burnham asked the Government to explain whether they had calculated the consequences of the decisions on advance corporation tax on the MFR and on final salary schemes.
4.87 The then Minister, Baroness Hollis of Heigham, explained the policy rationale for the measure. In response, Lord Burnham asked whether the Government could estimate the number of schemes which would ‘fall into deficit’ as a result of the measure.
4.88 The Minister replied by arguing that ‘about half’ of all schemes were in surplus and were enjoying a partial or full contributions holiday and then defended the reform.
Events during 1998
The Government’s Pensions Review
4.89 On 17 July 1997, the Government announced a review of pensions and initiated a consultation process with a deadline for responses of 31 October 1997. The terms of reference for the review were:
To review the central areas of insecurity for elderly people including all aspects of the basic pension and its value and second pensions including SERPS; to build a sustainable consensus for the long-term future of pensions; and to publish the Government’s proposals, for further consultation, in the first part of 1998.
4.90 In its press release announcing the review, the then Secretary of State was quoted as saying that the review would address ‘nine fundamental challenges’. One of these was ‘to get the regulation of pensions right… people need to have confidence in pensions and be sure their pensions are secure. We need to find a balance which provides an appropriate level of security, minimises the scope for abuse and does not impose an undue burden on providers’.
4.91 Another challenge was said to be ‘to raise awareness of pensions and improve the level of financial education so that people understand the importance of saving for retirement and make the right choice about which pension product is best for them’.
Revised Actuarial Guidance Notes
4.92 On 1 March 1998, the actuarial profession issued a revised version (4.1) of their guidance note, ‘Retirement Benefit Schemes - Winding-up and Scheme Asset Deficiency’ and also a revised version (1.2) of their other guidance note, ‘Retirement Benefit Schemes - Minimum Funding Requirement’. These made minor technical changes to professional guidance which are not of relevance to the heads of complaint.
Parliamentary Questions on the MFR
4.93 On 9 March 1998, John Denham, the Minister of State for Social Security, replied to a question from Quentin Davies MP which asked what plans there were to alter the minimum funding requirement on pension schemes so as to take into account the lower forecast net dividend yield in consequence of the recent Budget changes.
4.94 His reply was:
The detailed requirement for MFR valuations are set out in regulations and in an actuarial guidance note produced by the Faculty and Institute of Actuaries and approved by the Secretary of State. The Faculty and Institute have set up working groups to look at the effects of the July budget changes on a number of issues, including the MFR, and officials are in close contact with the profession.
Although the Faculty and Institute have made recommendations for changes to the valuation method following the Budget changes, they have now indicated that they wish to do further work on the operation of the MFR generally before revising their guidance note. Any changes must await their further recommendations.
4.95 On 13 March 1998, Nick Gibb MP asked the Minister to explain what assessment had been made of the consequences of the abolition of dividend tax credits for the MFR in the light of a recent report on that issue by a firm of consulting actuaries.
4.96 Mr Denham replied:
It is for the Pensions Board of the Faculty and Institute of Actuaries to make recommendations about any changes to the MFR. They will no doubt take account of [the] views in [the actuaries’] paper. We expect to receive a report from the Pensions Board when they have completed their consideration of these issues.
4.97 On 8 June 1998, Julian Lewis MP asked the Minister to set out what factors had underlain the decision not to initiate a full review of the MFR immediately after the July budget.
4.98 He replied:
The methodology and actuarial assumptions in the MFR were devised by the Faculty and Institute of Actuaries. We were informed that they would be carrying out a review following the July budget. We fed into that review a report by the Government Actuary, whose views we had sought on a number of issues.
4.99 On the same day, the Minister informed Howard Flight MP that the actuarial profession’s proposals for a change to the valuation method had been agreed and that their guidance note was being revised. He also said that there was an ‘ongoing review of the minimum funding requirement’.
Green Paper on the Welfare State
4.100 In the meantime, the Government had published on 26 March 1998 a Green Paper on the future of the Welfare State, entitled ‘New Ambitions For Our Country: A New Contract For Welfare’. This set out in outline (among other matters) the Government’s plans for pension reform.
4.101 The then Minister for Welfare Reform, Frank Field, made a statement in the House to announce the publication of the Green Paper. In relation to the Government’s proposals for pension reform, he said that a key principle underpinning those proposals was that:
…[the] public and private sectors should work in partnership to ensure that, wherever possible, people are insured against foreseeable risks and make provision for their retirement… We want everyone to benefit from a second pension, on top of the state pension. It is clear that, unless there is more saving towards retirement, we will continue to see into the next century far too many of our pensioners retiring on incomes that do not properly reflect the rising prosperity of the nation…
Later in the year, we shall publish the Green Paper on pensions. I can say today that the Government [also] plan to bring forward legislation later in this Parliament.
DSS research report
4.102 In April 1998, DSS published its research report number 75, entitled ‘Experiences of Occupational Pension Scheme Wind-up’.
4.103 The research, which had examined the experiences of members whose scheme had been frozen, wound up or was in the process of winding up, had been commissioned by DSS in January 1996. One of the aims of the research was to ‘find out how much members and beneficiaries know and understand about what has happened to their scheme and to their pension rights’. Another aim was to ‘obtain views on the information scheme members and beneficiaries received’.
4.104 Among the report’s conclusions were findings that:
(i) most members had some understanding about what had happened to their scheme and knew that the scheme was no longer operating in the way it had been. The majority knew that contributions had ceased to the scheme and that it had or would in due course cease to exist. Most also knew the reason for the changed status of their scheme, citing as the most common explanations the insolvency of their employer, a company take-over, or the sponsoring employer’s decision that the scheme was too expensive to run;
(ii) members were fairly evenly divided between those who had some understanding of what had happened to their pension rights and those who did not. Those who were not aware were said to be associated mostly with schemes which were frozen or those where the winding up process was not well advanced; and
(iii) members were evenly divided between those who thought that the information they had received about their scheme was good and those who thought it was poor. It was said that the latter group felt that they had not received enough information about the process and that such information as they had received had been difficult to understand, lengthy, and full of jargon and unexplained statistics.
4.105 The report did not deal with the awareness of the risks to their pensions that those members that had been interviewed as part of the research had had prior to the change in status of their scheme.
Actuarial recommendation to amend the MFR
4.106 The actuarial profession wrote to DSS on 1 May 1998. The letter was headed ‘Minimum Funding Requirement: Effect of Budget Changes’. It began by stating that the purpose of the letter was to provide the profession’s ‘conclusions on the changes needed in the short-term, on the assumption that the Government wishes to maintain the strength of the MFR basis’.
4.107 The profession noted that it had, in December 1997, suggested changes to the MFR basis to ‘maintain the strength of the MFR basis at the level previously decided by the Secretary of State in light of the changes to ACT credits introduced in the last year’. These original suggestions were: first, that the assumptions in the MFR basis in relation to equity investments should be reduced from 9% to 8.5% for those below MFR pension age and from 10% to 9.5% for those above MFR pension age; secondly, that the equity market value adjustment should be reduced from 4.25% to 3.5%; and, finally, that net dividend yields on the FTSE Actuaries All-Share Index should be used in place of gross dividend yields.
4.108 The actuarial profession continued:
However, since writing that letter, it has become increasingly clear that the performance of the UK equity market over the last 12 months or so has been inconsistent with the underlying principles on which the equity MVA is calculated. This is due to stagnant dividend growth, which appears to be a result of changes in the way companies are rewarding shareholders (for example, due to the tax changes introduced by the July 1997 Budget). What is impossible to tell is whether these are temporary or permanent features. At the same time, there have been substantial increases in market values, resulting in the dividend yield being at a virtually all time low. The result, however, is that the equity MVA has increased to a much higher figure than expected – 152% as at 30 April 1998.
4.109 The letter went on to explain the principal two effects of this – increased MFR liabilities and increased cash equivalent transfer values for those leaving schemes. It continued by explaining that ‘[i]n the longer term, it will be essential to find a more robust method of dealing with changes in the equity market than the current MVA’ and that consideration of this would be part of the forthcoming review of the MFR that the actuarial profession would undertake on behalf of Government.
4.110 The actuarial profession’s letter concluded by setting out the technical basis of their advice.
Submission to Minister regarding MFR reform
4.111 On 13 May 1998, officials made a submission to Ministers in which they were invited to approve the actuarial profession’s proposal for interim reform of the MFR and also to agree to officials meeting the profession to discuss detailed proposals for their long-term review of the MFR.
4.112 The submission set out the background to the issues in some detail and then provided briefing on ‘presentation’. The latter, in relation to the short-term changes to the MFR basis, said:
The short-term changes, which are fairly minor, should cause no difficulty at all for Treasury Ministers. The MVA adjustment to a net figure has in any case already been agreed by Helen Liddell as it was part of the earlier recommendations which she accepted. The further small change to the MVA could be said to help ensure that the value of liabilities adjusts in line with market conditions (which is what the MVA is intended to do).
4.113 The briefing continued:
A long-term review of the MFR basis is likely to attract Treasury interest particularly in view of speculation in the Press that the changes in market conditions have been as a result of the removal of the ACT tax credit last July. We will need to talk to Treasury officials about the longer term review after we have talked to the F&IoA.
We recommend that these changes are kept fairly low key and that a press release is not appropriate. Because of the need to notify their members of the changes, which will hopefully come into effect very soon, the F&IoA are likely to issue a press release in order to notify their members.
4.114 The submission concluded by noting that the actuarial profession were concerned that the MFR valuation method was not sufficiently robust to be able to deal with changes in market conditions and that this would form part of their review of the MFR. Officials said that they expected the actuarial profession’s suggestions on MFR reform ‘to be fairly wide ranging’.
Report of the Pensions Provision Group
4.115 On 4 June 1998, a group of pension experts known as the Pensions Provision Group, which had been commissioned by the Government to examine the levels of pension provision in the UK and also to analyse possible future trends in that provision, published its report, ‘We All Need Pensions: The Prospects for Pension Provision’.
4.116 They concluded that it was:
…even more important that people have good second tier pensions in order to have adequate incomes in retirement and to avoid the need to depend on means-tested benefits, which themselves can have adverse effects on people’s incentives to save for retirement.
4.117 In a subsequent answer to a parliamentary question, John Denham, the then Pensions Minister, said on 16 June 1998 that:
The Pension Provision Group report… identified that many people will face an avoidable drop in income in retirement because they do not make adequate provision for themselves over and above the basic State pension. One of the key issues underlying this problem is the lack of financial awareness and good information on pensions.
The Pensions Education Working Group
4.118 On 16 June 1998, another group, the Pensions Education Working Group, which had been commissioned by the Government to consider the co-ordination, targeting and efficiency of pensions education and to advise on action needed to improve knowledge of pension issues, published its report, ‘Getting To Know About Pensions’.
4.119 The report made three principal recommendations:
(i) first, that a major pensions education and awareness programme was necessary;
(ii) secondly, that any such programmes should cover a range of initiatives, including personal finance education within the school system and annual and automatic information to be provided by Government and by pensions providers about pension options and entitlements; and
(iii) thirdly, that a programme of pensions simplification was overdue.
4.120 These recommendations were welcomed by the Government, who asked the Group to continue to take forward their work.
4.121 In a press notice published to accompany the report, John Denham, the then Pensions Minister, was quoted as saying ‘people at work and people taking up new jobs need better pensions information’.
4.122 The notice continued:
The Government will examine ways of stressing the benefits of joining employers’ pension schemes and wants to ensure that employees can get good advice about new stakeholder pension schemes at work.
4.123 It then quoted the Minister’s speech that day at the TUC Pensions Conference. He had said:
Today’s report… makes clear that people not only need to understand the importance of saving for retirement, but to have the skills to make the right choice about which pension product is best for them. And today I can announce the first steps in a major campaign to address this.
For the first time, Job Centre staff will stress the importance of pensions to jobseekers moving into work… A new series of user-friendly leaflets will reinforce the message. And improvements will be made to the state pension forecasting system to get the right information to customers.
Revised Actuarial Guidance Note
4.124 In the meantime, on 15 June 1998, the actuarial profession had issued a revised version (1.3) of their guidance note, ‘Retirement Benefit Schemes - Minimum Funding Requirement’. This incorporated guidance to reflect the change to the MFR basis.
DSS research report
4.125 On 8 October 1998, DSS published research it had commissioned on public attitudes to pension provision.
4.126 The press notice announcing publication of the report stated, under a heading ‘report highlights lack of public awareness on pensions’, that the research had shown that ‘…people find the whole area of pensions very confusing and many feel uncertain about their future’.
4.127 The press notice went on to describe the ‘main findings’ of the research, which included:
(i) that ‘the complex and changing pension system is often poorly understood by the public’;
(ii) that ‘pension planning is often limited and belated’;
(iii) that ‘people need more, better and accessible information on pensions, and want the Government to make sure the public is properly informed and advised’; and
(iv) that ‘personal pensions are seen as risky, and confusing’ and that ‘occupational pensions are seen as providing a good return’.
Briefing for Ministers on MFR
4.128 In a briefing note by DSS officials for a Ministerial meeting in October 1998, in relation to the purpose of the MFR it was stated that:
The MFR is intended to provide a reasonable level of security for members in the event of the sponsoring employer becoming insolvent and no further funds being available to pay into the scheme…
The underlying assumptions were shaken by the decision in the July 1997 Budget to abolish the 20% tax credit on UK equity dividends formerly available to occupational pension schemes, which invest on average about half their assets in UK equities. Adjustments had to be made to the assumptions in the MFR valuation method in June this year to avoid the risk of employers having to put extra funds into their schemes unnecessarily.
4.129 The above formulation was also used in later briefing for Ministers and officials in both DSS and the Treasury.
The Pensions Green Paper
4.130 The Government published its Green Paper on pensions on 15 December 1998. Entitled ‘A New Contract For Welfare:
Partnership in Pensions’, the document set out the Government’s ‘plans for radical reform of the whole pension system, to rebuild trust and ensure that everyone can look forward to a secure retirement’.
4.131 The Paper summarised the Government’s proposals for non-state pension reform as being:
(i) ‘better regulation’ to restore confidence in the system;
(ii) ‘better information on schemes’;
(iii) ‘better information on people’s own need to save’, including the development of annual joint statements of a person’s state and non-state pension provision, ‘so that they can see for themselves if they should save more for retirement’; and
(iv) ‘wider recognition of the benefits of occupational pension schemes and measures to encourage more people to join them’.
4.132 The Paper argued that the Government’s proposals were fair, affordable, provided security and would build ‘a new partnership in pensions’.
4.133 After dealing with the position of people who could not afford to save, and under a heading ‘those able to save – a public-private partnership’, the introduction to the Paper said:
Those who are able to save for their own retirement should do so. For this, they need to have trust in the system; for the right schemes to be available and affordable; to be able to cope with flexible working and variations in earnings…; and to know how much they should save to deliver the income they want in retirement.
4.134 The introduction went on to say that the Government believed that ‘the current system does not meet these needs’. It then described occupational pensions as ‘usually good value and secure and… generally the best choice’. It continued:
Occupational pension schemes are one of the great welfare success stories of this century. They are run voluntarily by employers, or groups of employers for their staff, and provide a pension on retirement and often other benefits.
4.135 It also noted that ‘some confidence in occupational schemes has been lost since the Maxwell scandal’. Furthermore, the Paper noted that while being ‘an excellent means of providing for retirement… the growth of occupational pension scheme coverage may have peaked’ - due to a decline in the number of people employed in large companies and the public sector, changes in the regulation of occupational schemes, and the move away from final salary to money purchase schemes.
4.136 Under a heading, ‘poor information and lack of trust in the pension system’, chapter 3 of the Green Paper, which set out ‘the need for change’, concluded by saying:
Few people really understand pensions. Few know about their own pension position and the action they need to take to improve it. Added to this lack of understanding, the Maxwell affair and the mis-selling of personal pensions has left many people lacking confidence and trust in any type of pension arrangement. People are not sure where to get advice and who they can trust. Much of the information that is available is of poor quality. Because of this, many people run the risk of making the wrong pension choices, their confidence and trust in pensions may be undermined and they may be put off saving altogether.
If people do not trust any type of pension scheme it can become a reason to do nothing, even though pension savings made early are worth far more than those made late in a working life. If people do not know their own position they cannot judge whether and how to make better provision, or be confident of finding the best way to improve their position.
To overcome these problems action needs to be taken to educate people about pensions and provide better, more secure pension schemes which give them confidence and restore trust.
4.137 Chapter 8 of the Paper was entitled ‘strengthening the framework for occupational pension schemes’ and was introduced by the statement that ‘occupational pension schemes provide a secure pension for millions. We want to build on this success by strengthening the framework for occupational pension schemes and encouraging those who can to join them’.
4.138 Notice was given that the Government was issuing a separate consultation on a package of technical measures it proposed would simplify the contracting-out of schemes and the procedure for the nomination of member trustees (see below).
4.139 The Government also said that it wished ‘to do more to encourage people to join occupational schemes’. In noting the decline in membership of such schemes, the Government said that ‘a continuation of this trend would be counter to our objective of increasing occupational pension coverage in the future’ and also that the Government wanted ‘to reverse this and achieve a significant reduction in the numbers of non-joiners’.
4.140 The Paper continued:
We expect some increase in the take-up of occupational pensions to result from improvements to pensions education. We have already taken steps to ensure that people are better informed about pension issues generally, and about the options available to them as individuals in particular. It is highly desirable that individuals are given the clearest possible statement of the value to them of joining their employer’s occupational pension scheme.
4.141 The Paper, in paragraphs 22 and 23 of Chapter 8, went on to consider the MFR:
We know that one of the areas of concern to employers is the MFR. The concept behind the MFR is a straightforward one – that is, people who have built up pension rights should be able to draw their pensions in full, even if the employer is no longer there to pay extra contributions. But devising a method of securing pension rights without imposing too much of a burden on employers is not so straightforward. We are asking the actuarial profession to look again at the present valuation method, and consider whether there are different ways of delivering the level of security we feel is right. There will need to be full discussions about any proposals.
We are also considering the viability of a Central Discontinuance Fund to which pension rights might be transferred when a scheme has to wind up because the employer is insolvent. We will be looking at this as part of our review of the MFR.
4.142 Chapter 8 continued with a discussion of possible reform to the provisions related to guaranteed minimum pensions and contracting out and the removal of regulatory burdens from certain schemes. It ended with a summary of the Government’s proposals for strengthening the framework for occupational pensions, two of which were proposals to make ‘improvements to the compensation scheme’ and to ‘encourage improvements in transparency and accountability’.
4.143 In proposing improvements to the arrangements for the protection of members of occupational pension schemes where the employer was insolvent and where the assets of the scheme had been lost because of theft or fraud, the Government said:
The present compensation rules could produce potentially very unfair results for members of salary-related pension schemes. When such a scheme winds up, pensioners generally have priority over other members. Therefore in a mature scheme, where many of the members are pensioners, active members could receive very little of their expected benefits.
It is an important principle that consumers should exercise care in the choices they make. This principle applies to pension scheme members who have access to information about how the scheme is run, the ability to nominate trustees and to complain if they think things are going wrong so that investigations can be carried out. It would not, therefore, be appropriate to provide 100 per cent compensation. But we believe it is possible to introduce a more equitable scheme consistent with this principle, which would be of particular benefit to members of mature schemes.
4.144 The Paper continued:
For salary-related schemes, we propose that the calculation of the amount of compensation payable should be based more closely on the age profile of the members. So instead of limiting the funding to 90 per cent of all the scheme’s liabilities, we will increase it to 100 per cent in respect of pensioner members and those who are within 10 years of the scheme’s pension age (who have to be identified already for the MFR valuation). That means that, when the scheme’s assets are allocated to meet individual pension rights, there would be a greater chance of providing younger members with a fair value of their basic pension rights, whilst preserving in full the level of pensions that are already in payment.
4.145 Chapter 10 of the Paper was entitled ‘education and trust’. It began with the statement that:
…people are confused by the many pensions options and have lost faith in the system. We need to help people to understand how they can ensure they have the level of income in retirement that they want and which type of pension is best for them. We need to rebuild trust so that people will save with confidence.
4.146 It continued:
People need better and more accessible information about state and non-state pensions. They need to know where to get information and advice from sources they can trust. At the moment much of the general and personal advice given is of variable quality. People rightly want trustworthy, clear and impartial information and want the Government to facilitate access to simpler products and better and more meaningful advice. That is our challenge.
4.147 The Paper said that one of the ‘clear’ and ‘key’ principles that underpinned a pension education and awareness programme was that ‘individuals need clear information and advice on alternative forms of pension provision to make the right pension choices’. It continued:
We believe it is necessary to bring about a radical improvement in the quality and accessibility of information on pensions, both in general and in the information people are given about their own pension position. We will work closely with the Financial Services Authority to improve the general quality and comparability of pensions information…
The Government and the financial regulators have the central role to play in developing the long-term framework and for driving forward the specific initiatives needed to improve pensions information. In turn, we believe that the private sector can provide expertise, ideas and enthusiasm to make a significant contribution in many areas. In partnership, we can press ahead with a dynamic and effective programme of action to counter lack of awareness, interest and understanding of pensions.
4.148 In describing the work that the Government and the FSA would be doing in the wider financial context, the Paper said:
Any improvement in pensions information and public awareness will only have maximum effect if individuals have the basic skills to interpret information and understand the overall financial context in which decisions are made. This will include promoting awareness of the benefits and risks associated with different kinds of investment and providing appropriate information and advice.
4.149 In setting out the detailed work programme to take forward the Government’s agenda, the Paper categorised this as involving personalised pensions information, work-related advice (including the need to emphasise ‘the importance of occupational schemes’), and general pensions information. In relation to the latter, the Government proposed to issue new DSS pensions leaflets, complemented by a marketing campaign, to support the promotion of financial education in schools, the piloting of pension information helplines and also the development of a Plain English guide to pension terms.
4.150 It then dealt with some new DSS leaflets, which had recently been issued (see above), and said:
We published a new series of DSS pension leaflets in June 1998 which help to meet the need [for standardised and simplified pensions information and a general introductory document issued by the Government]. The leaflets are concise, accessible and relate information directly to decisions individuals need to take at various life stages. The leaflets met the Plain English Crystal Mark standard and have been awarded the Money Management Council Quality Mark for providing clear and unbiased information on money matters. We are running a nationwide marketing campaign to promote the leaflets.
4.151 The Government sought responses to the proposals set out in the Paper by 31 March 1999.
The ‘technical’ consultation document
4.152 At the same time, the Government issued a consultation document, entitled ‘strengthening the pensions framework’, which set out the more detailed or technical proposals that were referred to in the Green Paper.
4.153 In the introduction, the then Minister, John Denham, said that the focus of the consultation was on measures related to contracting-out procedures and also on some amendments to the provisions of the Pensions Act 1995. He continued:
People should be encouraged to join their employer's occupational pension scheme where, as it usually is, it is in their best interests to do so. But they will only do so if they believe their pension rights are properly protected. Security is of paramount importance. But we must also avoid actions which will deter employers from continuing to run occupational pension schemes. So it has been important to allow most of the major changes introduced by the Pensions Act to settle in before deciding what further action is necessary. It is costing schemes and employers some effort and money to meet the requirements of the Pensions Act, and we do not want to increase their costs unnecessarily, or to discourage employers from sponsoring and supporting occupational pension schemes.
We already know from those who run and advise pension schemes, that there are some simplifications which should be made now. We want to achieve simplifications where we can reduce the burden on schemes without adversely affecting the security of members' rights.
4.154 The document, in part 4, set out suggested improvements to the framework provided by the Pensions Act 1995. It explained:
Pension funds can work effectively only if their members can have confidence that the benefits promised to them when they are working will actually be delivered when they retire. The Pensions Act 1995 and the regulations made under it have provided increased security for members. There remain, however, restrictions and inconsistencies which we believe create or perpetuate unfair treatment.
4.155 The paper then went on to suggest ways to remove these restrictions and inconsistencies and it sought responses to the proposals by 12 February 1999.
Events during 1999
Compensation for NIRS2 delays
4.156 Alistair Darling, the then Secretary of State for Social Security, announced on 1 February 1999 that he would be bringing forward measures to compensate those who had suffered financial loss due to delays in the receipt of social security benefits that had been caused by problems with the Government’s NIRS2 computer system.
4.157 In the official press release, he was quoted as saying that he had been ‘concerned for some time about these delays and [was] determined that any inconvenience suffered by those who would otherwise not get anything should be properly recognised’.
Commons debate on Government pensions policy
4.158 On 3 February 1999, the Opposition launched a debate on the pensions policy of the Government through a motion which argued that:
…the Government has failed pensioners and thrown away a unique opportunity for reform… [we deplore] their attack on pensioners through the abolition of the [advance corporation tax] dividend tax credit, which will cost pensioners and all future pensioners £5 billion per year; [we believe that] the Government has further hurt occupational schemes by increasing the regulatory and cost burden in the pensions Green Paper; [we reject] the Government’s proposals, which will make pension provision more complex and offer no real security for pensioners in the future; and [we condemn] the Government for their extensions of means-testing in the welfare and pensions system, which will undermine the incentive to save.
4.159 Answering the debate, Mr Darling said:
We firmly believe that everyone who can save ought to save. We want to give people the flexibility, the choice and the incentives to do so. A one-size-fits-all approach to pensions will not do; everyone has different requirements.
There have been huge labour market changes. In the past, many people had access to occupational pension funds, which are extremely good options for those who are lucky enough to be able to take advantage of them. As the House well knows, however, many people do not have that option. Although personal pensions are certainly a good option for some, they are not so, as we know only too well, for low-paid people or even for some moderate earners.
4.160 He continued:
Above all, the Government must ensure that people have a range of options. We must increase flexibility to ensure that as many people as possible save. That is our objective: we want people to save more, invest more and to ensure that they can provide for themselves adequately in their retirement… It is very clear: we are telling people to do the best that they can for their retirement.
Welfare Reform and Pensions Act 1999
4.161 Following both the consultation exercises referred to above, the Government implemented some of its proposals through secondary legislation, such as the introduction of a new requirement that scheme trustees should provide information to members about their policy on ethical investment.
4.162 Other proposals, which required primary legislation, were set out in a Welfare Reform and Pensions Bill, which received its Second Reading in the House of Commons on 23 February 1999.
4.163 The Bill:
(i) established the framework for the introduction, sale and regulation of stakeholder pensions;
(ii) made amendments to the regulatory framework for other pensions;
(iii) enabled the courts to order that pensions could be shared on divorce like other assets;
(iv) made changes to the provision of bereavement benefits;
(v) reformed incapacity benefit and some of the provisions of disability living allowance; and
(vi) introduced a new ‘single work-focused gateway’ to handle claims for unemployment benefits.
4.164 The changes to the regulatory framework for pensions included provisions related to the monitoring of employers’ payments to personal pension schemes; dealing with late payments by employers to occupational pension schemes; the effect of insolvency on unapproved pension rights; the forfeiture of rights under pension arrangements; and the compensation arrangements for members of occupational pension schemes which had lost assets due to fraud or other dishonesty.
4.165 The then Secretary of State for Social Security, Alistair Darling, in moving the Second Reading of the Bill, informed the House that the aim of the pension reform aspects of the Bill was ‘to ensure that the system provides security in retirement for future pensioners and allows pension sharing on divorce’.
4.166 Following parliamentary approval of the Bill, the Welfare Reform and Pensions Act 1999 received Royal Assent on 11 November 1999.
Announcement of MFR review
4.167 On 3 March 1999, DSS issued a press notice announcing the review of the MFR. The notice explained:
The review’s aim is to find the best way to safeguard the pension rights of those in occupational pension schemes. The review will focus on the valuation method, and consider fundamental changes in approach to the existing system.
Mr Timms [the Pensions Minister] said:
“The terms of reference of the review are thorough and wide-ranging. The aim is to find ways to protect people’s pension rights that are reasonable and affordable. The work will not be straightforward. The issues that need to be addressed are complex and will require careful consideration. We shall be taking this forward in partnership and are grateful for the help provided by the profession. The review of the Minimum Funding Requirement is part of the process to strengthen the framework for occupational pension schemes.”
The review of the MFR will be carried out by the Faculty and Institute of Actuaries Pensions Board in conjunction with the Department of Social Security. There will be full discussion of any proposals.
DSS consultation on a quality accreditation scheme
4.168 On 11 March 1999, DSS issued a consultation document entitled ‘Strengthening the Pensions Framework: the Quality in Pensions Accreditation Scheme’.
4.169 The central aim of this initiative, according to the Foreword by the Pensions Minister, was to raise standards and to encourage the spread of best practice in all occupational pension schemes, with a view to reinforcing the role of employers in pension provision and of providing employees with confidence in the quality of that provision.
4.170 One of the proposed criteria on which applicants for accreditation would be judged was ‘scheme communication’. Each applicant scheme would be assessed as to whether it provided ‘clear information about the structure of the scheme and the benefits available to all members and prospective members’.
4.171 The accreditation scheme was later dropped.
Parliamentary questions on reform of the MFR
4.172 On 19 March 1999, Stephen Timms, the Pensions Minister, replied to a question from Nick Gibb MP who had asked for details of who would be undertaking the review of the MFR.
4.173 The Minister replied:
The Pensions Board of the Faculty and Institute of Actuaries have been asked to carry out the review in partnership with this Department. The Department is also advised by the Government Actuary. The Pensions Board may decide to set up technical working groups to research particular aspects. The Confederation of British Industry, Trade Union Congress, National Association of Pension Funds and the Association of British Insurers have been invited to comment on the scope of the review.
4.174 On 29 March 1999, the Minister also replied to a question from David Heathcoat-Amory MP, who had asked when the review had been announced. The Minister replied that the terms of reference for the review had been announced by means of the press notice issued on 3 March 1999 (see above).
OPRA support for plain English and clear communication
4.175 On 27 April 1999, OPRA issued a press notice, to coincide with the launch of the Plain English Campaign’s guide to pension terms, in which OPRA recorded its support for the proposition that schemes should ‘treat communication as an opportunity, not a chore’.
4.176 It began:
A good company pension scheme is often the best perk of the job – and sometimes the best kept secret as well.
4.177 The then Chief Executive of OPRA was then said to have ‘urged everyone involved in running pension schemes to cut through the jargon and to get people as wised up about their pension benefits as about their other job perks’, and was quoted as saying:
The law which OPRA enforces sets out what company pension schemes have to tell their members, but it doesn’t set out the words they should use to do this. This means that some pension schemes comply with the law – aimed at involving and empowering the members – yet still produce information that baffles and excludes people.
OPRA ‘guide to the MFR’
4.178 On 1 May 1999, OPRA published a ‘guide to the MFR: a summary for pension scheme members’. The Foreword by the then Chairman of OPRA stated that:
…this is only a guide and is not a definitive statement of the law. You should always get appropriate legal advice about how the Pensions Act will affect your scheme. You will also need the advice of the scheme actuary.
4.179 In a section entitled ‘what is the MFR?’, the guide said:
A scheme that complies with the MFR will either already be funded to at least the minimum level required by the law or will be aiming to have that level of funding within certain time limits. This will not necessarily ensure that all of a scheme’s liabilities can be met fully if the scheme were to be wound up. However, the MFR sets a benchmark against which the trustees must measure the funding level of a scheme. The MFR means that any shortfall below that benchmark must be corrected.
4.180 After dealing with the types of scheme covered by the MFR, the funding timescales and other corrective action required of schemes that were not fully funded, the position of multi-employer schemes, penalties which trustees would be liable to incur should they not discharge their responsibilities appropriately, and the actuarial methods employed, the guide then set out the detailed provisions related to - and the timetable for undertaking - MFR valuations and other related matters.
4.181 This edition of the Guide did not repeat the statement in an earlier, 1997, edition of the Guide that ‘the MFR refers to the minimum amount of funds that should be in the scheme at any one time in order to meet the schemes liabilities if it were to be discontinued’.
The winding-up consultation
4.182 On 28 May 1999, the DSS launched a consultation called ‘Winding Up Occupational Pension Schemes: Speeding Up The Process’.
4.183 Stephen Timms, then as now the Pensions Minister, in the Foreword to the document, said:
The process of winding-up occupational pension schemes has always been problematic… Many members of schemes that are being wound-up cannot see why it is taking so many years for them to get their pensions sorted out – and often show a deep frustration when there appears to be nobody to turn to who can make things happen.
We want to do something about that. We realise schemes which have been contracted-out are facing added difficulties and delays because the new NIRS2 computer system is not producing membership lists and schedules of Guaranteed Minimum Pension liabilities. But that problem will be tackled later this year. In the meantime, we need to make headway in addressing other causes of delay.
4.184 He continued:
The winding-up of an occupational pension scheme can be a very complicated and traumatic process, particularly where winding up has been triggered by the insolvency of the sponsoring employer. The long time often taken for the process to be completed, and the uncertainty for members during this time, can make members feel particularly vulnerable.
It is a process which we all would like carried out properly and as quickly as possible. We want to make sure that action is taken promptly but also allow the trustees enough time to be able to carry out all that is required of them under trust law, scheme rules and legislation, and in the best interests of members.
4.185 The focus of the proposals, he said, was to be the provision of additional powers to OPRA to oversee the winding-up process and to allow it to intervene where it considered that the process was being unreasonably delayed.
4.186 After describing the background to the consultation and the process of winding-up, including the responsibilities of scheme trustees, the document set out the Government’s understanding of the ‘causes of delay’ in a process where it recognised that six or more years to wind up a scheme was not unusual.
4.187 The factors listed by the document included:
(i) poor scheme records which led to delays in determining who scheme members were and to what they were entitled;
(ii) the time taken to appoint an independent trustee;
(iii) difficulties in getting access to documentation from an insolvent sponsoring employer’s files or in retrieving such from the relevant insolvency practitioner;
(iv) discrepancies and other difficulties in reconciling contracted-out liabilities;
(v) ambiguities in scheme rules which required subsequent interpretation in the Courts to resolve disputes;
(vi) delays caused by the need for scheme trustees to seek legal advice on how legislative change over time had affected the calculation of members’ benefits; and
(vii) difficulties in tracing scheme members, especially those deferred members who had not provided up-to-date contact information since leaving the employment of the sponsoring company.
4.188 The document noted that, with respect to the problems in the reconciliation of contracted-out liabilities between scheme records and those held in national insurance records, there was no provision in the relevant legislation for flexibility in the process, for example on a de minimis basis. It also noted that ‘there is evidence that scheme administrators contribute to the delay by taking a long time to respond or query details’ with the Contracted-Out Employment Group of the then Contributions Agency of DSS, which it was subsequently announced – at the time of the March 1998 Budget – would become part of NICO from April 1999.
4.189 The document explained, however, that:
There have always been concerns about the length of time taken to agree contracted-out liabilities… However, the difficulties are exacerbated by the current NIRS2 computer problems.
4.190 Part II of the document set out the Government’s proposals for legislation and asked five questions:
(i) in relation to a proposal to require scheme administrators to notify OPRA where no independent trustee had been appointed within three months of the sponsoring employer’s insolvency, the Government asked whether this requirement should be extended to scheme professionals such as actuaries and auditors and also whether the three month period was reasonable;
(ii) in relation to a proposal to enable OPRA to amend scheme rules to enable the speedy completion of the winding-up process, the Government asked whether trustees should be required to seek the consent of their members before asking OPRA to do this;
(iii) in relation to a proposal to require trustees to report to OPRA where a scheme was still being wound up three years after the commencement of that process, the Government asked whether the three year period was appropriate and also whether such reports should be provided thereafter on an annual or other basis;
(iv) in relation to a proposal to give OPRA the power to direct specified action on the part of someone involved in the winding-up process, the Government asked whether the proposed powers were directed towards all of the appropriate people; and
(v) in relation to a proposal to extend the existing provisions for the disclosure of information to scheme members and, in particular, to require trustees to provide members with an indication of the benefits that they might in due course expect once three years from the commencement of wind-up had elapsed, the Government asked whether there was other information that members should be given at this time.
4.191 The issues were summarised on pages 14 and 15 of the document. It stated there that ‘poor records is a fact of life – but should improve over time’ and that ‘reconciling contracted-out liabilities should be quicker once NIRS2 is fully operational’.
4.192 Responses to the consultation were sought by 2 July 1999. In the press notice which accompanied publication of the document, the Minister was quoted as saying that ‘these proposals are the first step in speeding up the process by introducing some accountability and enabling action to be directed where needed’.
Revised Actuarial Guidance Note
4.193 On 1 June 1999, the actuarial profession issued a revised version (1.4) of their guidance note, ‘Retirement Benefit Schemes - Minimum Funding Requirement’. These made minor technical changes to professional guidance which are not of relevance to the heads of complaint.
FSA guides
4.194 In June 1999, the FSA issued a ‘guide to the risks of pension transfers’. It stated, in relation to final salary schemes, that ‘you are guaranteed a certain level of pension when you retire, as well as other benefits’. It also referred, when an individual received a cash transfer value to transfer from a final salary scheme to another pension vehicle, to such a value as being a sum that ‘reflects the benefits that were guaranteed’.
4.195 It continued:
If you transfer from a final salary scheme to a money purchase scheme run by a new employer or to a personal pension, you give up the promise of a guaranteed pension. What you get instead is a pension whose value depends on how well the invested money grows. You, rather than the employer, carry the risk if the investments perform badly.
4.196 The guide went on to explain the need to seek proper advice but cautioned, in a position where a financial adviser suggested that the reader transfer out of a final salary scheme, ‘that, with a personal pension, you will give up any guarantees you had in the former employer’s scheme’.
4.197 In another guide published at the same time, entitled ‘guide to the risks of opting out of your employer’s pension scheme’, the FSA said that final salary schemes ‘offer guaranteed benefits’ and explained that ‘you should not be advised to opt out of your employer’s pension scheme unless there is a very good reason to do so… think very carefully before you opt out of your employer’s scheme’. It also stated that final salary schemes ‘give you a guaranteed pension. The amount of pension you get from a personal pension is unpredictable’.
4.198 Later editions of these guides were amended to remove the above references.
GAD letter to DSS on MFR
4.199 In a letter dated 9 June 1999 from a GAD directing actuary to a DSS official, which discussed the strength of the MFR in the context of the ongoing review of it by the actuarial profession, the directing actuary wrote:
The whole issue of the conflict between the MFR and the benefits which individuals are likely to get from a scheme if it winds up and buys out some or all of the liabilities is a fundamental problem. I am still waiting for the whole edifice to collapse once the first big scheme goes through that process and members complain that they did not get their fully accrued benefits in spite of this scheme having assets equal to 100% of its MFR liabilities. I think it is likely that this aspect will be given prominence by many members of the profession and the particular focus of it in relation to pensioners will be highlighted, so this particular issue is likely to feature highly in the radical options.
OPRA press notice about its guide to the MFR
4.200 On 19 July 1999, OPRA issued a press notice to advertise the fact that it had published a guide to the MFR for pension scheme trustees.
4.201 It said:
…the aim of the booklet is to help give trustees a better understanding of the issues involved in complying with the MFR. Much of the technical work in this area will be carried out for trustees by experts such as actuaries. But trustees still need a grasp of the subject to be able to ask the right questions and understand fully the advice they are given.
The Best Practice Guidelines Working Group
4.202 On 22 July 1999, DSS announced that it had established a new working group, with members drawn from the pensions industry, industry leaders, and the trade union movement and chaired by the Department.
4.203 Its role would be to advise on the development and promotion of best practice guidelines for occupational pension schemes.
FSA factsheet
4.204 In July 1999, the FSA published a factsheet entitled ‘joining or rejoining your employer’s pension scheme’.
4.205 The factsheet explained that it aimed to provide general information about why the reader might have been ‘better off in your employer’s pension scheme’ and to set out the main points that needed to be thought about when deciding whether to join or rejoin such a scheme. It also indicated other sources of information. The factsheet then defined the types of scheme to which it referred and explained the rationale for taking prompt action in the context of the personal pensions mis-selling review.
4.206 Under a heading ‘will I be better off if I join or rejoin my employer’s pension scheme?’, it suggested that ‘you will nearly always be better off in your employer’s pension scheme rather than in a personal pension scheme’.
4.207 After setting out the key characteristics of the benefits provided by occupational pension schemes, the factsheet contained a section called ‘is my employer’s pension scheme in financial difficulties or being “wound up”?’
4.208 This section said:
Occasionally, an employer’s pension scheme may run into financial difficulties. This means there is a chance it may not be able to pay benefits in the future. And sometimes, even if there are no financial difficulties, some employers just decide to close down their pension scheme. The scheme may then be ‘wound up’.
These situations don’t happen very often but it is worth checking they don’t apply to your employer’s pension scheme. You can check this by writing to your employer (or to the scheme trustees). Ask them to confirm in writing that there are no plans to ‘stop benefit accrual in the pension scheme’. If they cannot confirm this, then you are almost certainly better off not joining or rejoining now.
If your employer’s pension scheme is a ‘final salary scheme’, you should also ask if ‘the latest actuarial statement (made under the Disclosure Regulations) confirmed that the assets of the scheme fully covered its liabilities as at the valuation date’. If they cannot confirm this, then again you are almost certainly better off not joining or rejoining now.
If you are in any doubt about your position, you should contact an authorised financial adviser.
4.209 The factsheet then signposted readers who wished further information to other FSA publications, including those referred to above. A revised edition, which reproduced this section, was produced in September 2001.
Consultation on stakeholder pensions
4.210 On 2 August 1999, DSS issued a consultation document as part of its series of consultations on the new stakeholder pensions. This document was called ‘regulation, advice and information: the Government’s proposals’.
4.211 Paragraph 26 of the document dealt with information provided by Government or regulators:
The Government already produces a number of basic information leaflets on pensions. The aim of these is to provide straightforward explanations to enable people to understand the main pensions options and the differences between them. The FSA also produces a number of consumer guides to pensions… Such information is not, however, intended to be sufficient in itself to enable someone to decide about their pension needs, nor to choose between different schemes.
Further Ministerial briefing and meeting with actuaries
4.212 On 16 November 1999, Jeff Rooker, the then Minister for Pensions, met representatives of the actuarial profession following submission to DSS of the preliminary findings of their review of the MFR in a draft progress update on that review.
4.213 In the briefing for that meeting, DSS officials suggested that, in the meeting, the Minister should, in relation to the draft finding related to what members knew about the real purpose and strength of the MFR, ask the actuaries to:
…expand on the premise that members believe that the MFR is a solvency guarantee. Is it not up to trustees to ensure that the position is communicated to members?
4.214 Additional briefing, which described the background to the MFR, was annexed to the note, and stated that:
The MFR valuation is a discontinuance test… but it is not a guarantee of solvency. Although the valuation of pensioner liabilities should reflect the cost of securing those liabilities by annuities, the calculation of non-pensioner liabilities does not. Ministers at the time felt that it would impose an unreasonable burden on employers of ongoing schemes to require them to fund on the basis of being able to fully secure all liabilities with guaranteed annuities should the scheme wind up.
The objective of the MFR is that a scheme fully funded according to the MFR would, if the employer became insolvent, protect fully the pensions already in payment, and provide members with a transfer value that would give them an even chance of replicating scheme benefits if they transferred to an occupational or a personal pension scheme. It should not impose unreasonable costs on employers…
4.215 It continued:
The removal of tax credits on UK equity dividends in the July 1997 Budget reduced the rate of return on UK equities and had the effect of weakening the MFR test as prescribed at that time. In June 1998, following recommendations from the [actuarial profession] a short-term change was made to the MFR valuation method concerning the rates of return on investment from equities in order to try to maintain the intended strength of the MFR.
4.216 At the meeting, the actuarial profession also tabled a ‘briefing note’ for the Minister, which set out some proposals for ‘short-term changes’ to the MFR.
4.217 After noting that there had been two ‘significant changes’ since the establishment of the MFR basis – the sharp decline in inflation and in interest rates and improved pensioner mortality – the actuaries then set out two proposals ‘to maintain the basis at the level of strength which it had when it was originally established’, namely:
- Making allowance in the valuation of pension increases for the possibility that price levels may at times fall. In this case, pensions would not actually be reduced. In current circumstances this would increase the accruing (future service) MFR liabilities of most schemes by about 3.5%. The increase in the accrued (past service) MFR liabilities depends on the type of pension increase awarded in payment on pre-97 accrued pensions. There will be no effect on this significant part of the accrued (past service) liabilities for schemes which gave a fixed guaranteed increase or no increase at all; and
- Reducing the mortality rates in the MFR basis by two years, producing an increase in the accrued (past service) and future liabilities of about 6.5%.
4.218 The briefing then went on to note that:
…the effect of individual schemes would depend on the mix between pensioners and non-pensioners and the manner in which pre-97 accrued pensions are increased in payment. But the combined effect of these two changes would be an increase in the accrued (past service) MFR liabilities of between 6.5%-10%, i.e. a reduction in MFR funding levels of between 6.5% and 10%. This would, in the view of the profession, provide the same strength of the MFR as that which was intended at the time it was originally established.
4.219 The briefing then said that a transition period or a period of advance warning would be needed to enable sponsoring employers and schemes to adjust to the new MFR level that was proposed, which might involve increased contributions.
4.220 The briefing note concluded with the statement that:
…we recognise that the final decision as to whether to make any change to [the Guidance Note that set out the MFR basis] is for Government. Clearly there are political implications arising from any change to [it] which has a significant financial impact. On the other hand, if no change is made to [it] there will be implications for the degree of security of members’ benefits. The profession’s role, as agreed with the previous Government when MFR and [the Guidance Note] were first introduced, is to make recommendations to Government as to how it can best achieve its political objectives.
4.221 On 18 November 1999, a directing actuary at GAD wrote to the DSS to set out his view on the actuarial profession’s proposals. He set out arguments for and against both the proposed mortality change and the proposed interest rate change, and also set out some arguments as to whether any change should be made at all at that time.
4.222 On 26 November 1999, another DSS official wrote to an officer of the actuarial profession with a suggested draft outline for a discussion paper that might be issued by the profession in order to comply with its rule that any changes to the Guidance Notes it issued should be subject to consultation with relevant members of the profession. The discussion paper was later circulated in draft on 6 January 2000, for comment.
4.223 The DSS official offered a draft introduction to the proposed discussion paper, which set out the purpose of the MFR thus:
The current objective of the MFR is that a scheme fully funded according to the MFR would, if the employer became insolvent, protect fully pensions already in payment, and provide younger members with a transfer value that would give them an even chance of replicating scheme benefits if they transferred to an occupational or a personal pension scheme. This objective was decided by Government; the valuation method to meet the objective was devised by the Pensions Board of the Faculty and Institute of Actuaries.
4.224 On the same day, briefing was provided for a lunch meeting that the then Permanent Secretary of DSS would be having on 6 December 1999. It included the statement that ‘the MFR is intended to provide a reasonable level of security for members in the event of the employer becoming insolvent and no further funds being available to pay into the scheme’.
Parliamentary question on GMP delays
4.225 Meanwhile, on 24 November 1999, the then Economic Secretary to the Treasury answered a question from Christopher Chope MP, who had asked how many applications for the calculation of GMP entitlements had been awaiting decisions for more than one year, more than two years, more than three years, and more than four years.
4.226 She replied that ‘none of the 7,615 applications for GMP calculations presently awaiting decision are over one year old’.
The Actuaries’ report on communication and the MFR
4.227 Also in November 1999, a research working party of the Faculty and Institute of Actuaries produced a report entitled ‘Communication of MFR and Solvency’. The working party, which had been established by the profession in 1997, met between December 1997 and January 1999 and had the following as its terms of reference:
…to consider how best to communicate to relevant parties how solvency should be assessed, including the role of the MFR in this process. The work will therefore extend beyond the MFR to consider other aspects of communicating solvency and other aspects of communication in general.
4.228 The objectives set for the group were to prepare advice to members of the profession on the importance of communicating clearly to pension scheme members, trustees and sponsors about pension scheme solvency - especially in relation to the MFR; to consider what means should be used for communicating the solvency position of a scheme and solvency issues in general; to consider the terms and language which should be used to describe the solvency position of a scheme; to consider whether a general communication about the issues surrounding pension scheme solvency and the MFR was required and, if it was, to whom it should be addressed and what it should say; and, in the light of actual or proposed changes in the MFR, to consider what general communication should be issued by the profession.
4.229 The report noted that ‘in broad terms… the aim of the MFR test is to ensure a scheme has sufficient funds to keep paying benefits for members whose benefits are in payment and to pay minimum transfer values for other members’. The group also noted that true solvency was only achieved if a pension scheme had sufficient assets to secure all of its liabilities with an insurance company, that the MFR was not designed to achieve this, and that this was not widely understood.
4.230 Under a heading, ‘where are the MFR and solvency currently confused?’, the report listed a number of official, professional and other publications in which pension fund solvency was discussed. It also set out relevant actuarial guidance on the topic.
4.231 With reference to the OPRA booklet ‘a guide for pension scheme trustees’, the report said that one statement in it was factually correct but misleading. The report also noted that scheme communications to members ‘do not generally cover solvency’.
4.232 The report continued to express concern that, for the most part, press comment had equated funding to 100% on an MFR basis with having sufficient assets to meet a scheme’s liabilities in full in the event of a wind-up.
4.233 Section 4 of the report dealt with the ‘consequences of changing the strength of the MFR’.
4.234 It began:
The complexity of the MFR test means that few people understand it fully. This means that if changes go beyond simple adjustments to the specific actuarial assumptions, the consequences are likely to be difficult to understand. Even simple adjustments to the specific actuarial assumptions might mean that the MFR test is strengthened for some schemes and weakened for others. If the methodology and actuarial assumptions are altered it may be difficult to generalise about whether the test is stronger or weaker. There is also the likelihood that in some possible future conditions a revised MFR test will be weaker, but in other conditions it will be stronger.
Any changes to the strength of the MFR bring into question the level at which it was previously set and may undermine the public’s (including trustees’, employers’ and members’) faith in those who set the MFR. In addition, given the lack of understanding of the background to the MFR, some actuaries may be confused by the change.
4.235 The report continued by assessing the implications both of strengthening the MFR basis and of weakening it. The implications of weakening the basis were said to include a reduction in the value that would be given to those wishing to transfer their accrued rights to another scheme. In addition, another implication was that:
…a scheme which was winding up and which had a 100% MFR funding level after the weakening would be able to provide less by way of deferred annuities than one which had exactly the same liabilities and which had a 100% MFR funding level before the weakening.
4.236 The report argued that there needed to be greater general understanding of ‘what the MFR is and what it is not’.
4.237 Section 5 of the report was entitled ‘what needs to be communicated?’ and started with the statement that the group believed that ‘there are fundamental misunderstandings of the MFR throughout the pensions industry’.
4.238 In order to systematically correct these misunderstandings, the report concluded that there were four ‘key concepts that need to be addressed’. These were:
(i) that the MFR did not guarantee solvency;
(ii) the true purpose and nature of the MFR;
(iii) why changes might be made to the MFR and the consequences of any changes; and
(iv) that the MFR was set by the Government after consultation with interested parties.
4.239 In relation to the first concept, the report said that ‘arguably, the various parties involved with the creation and operation of the MFR have failed to address the confusion that has arisen since the idea was first proposed’.
4.240 The report went on to suggest that, because of the complexity of the MFR, efforts to communicate about it should be focused on the ‘concept’ rather than on the ‘detail’. It continued:
…irrespective of the reasons for the confusion between the MFR and solvency, we believe it is incumbent on the profession who are seen as the ‘guardians’ of the MFR to act to correct the confusion. All parties involved with pensions need to understand that the usual concept of solvency is not directly addressed by the MFR. A scheme 100% funded on the MFR basis does not necessarily have sufficient assets at any point in time to secure all guaranteed benefits. It is therefore not necessarily “solvent” as most people would understand the concept and as we have previously defined it.
4.241 The group continued to suggest that, if the confusion between the MFR and scheme solvency could be corrected, then what the MFR actually constituted should at the same time be addressed:
We need to ensure that relevant parties understand that the MFR provides no guarantees on the payment of benefits…; that it is possible to satisfy the MFR as an ongoing scheme but be mismatched so that there is a deficit on wind up…; that it is not definitive and immovable – it is simply a ‘line in the sand’… which attempts to balance members’ security with the desire of employers to avoid tying up working capital in a pension scheme; that it is one of a package of protections introduced by the Pensions Act 1995, and it cannot do the job on its own; that by taking a pragmatic approach to improving security as measured by scheme funding levels, the risk that final salary benefit provision will not be able to continue as a viable option in the face of competition from defined contribution alternatives is minimised; and that it is a complex calculation overseen as a result by the relevant body of experts - the actuarial profession.
4.242 The report then went on to explain that, if ever the MFR were to be changed, the reasons for the change should be clearly explained and quantified, as should the implications for scheme solvency and the fact that responsibility for the change rested with the Government.
4.243 Section 6 of the report went on to discuss the communication of the above, in terms of how such should be achieved and with whom.
4.244 After considering communication with the rest of the actuarial profession, the report went on to suggest redrafting of the OPRA guide referred to above ‘to avoid any ambiguity about the MFR’ and that the actuarial profession should take the lead in drafting simple factsheets that scheme trustees could issue to members to explain the statutory basis of scheme funding.
4.245 In a section dealing with communication with pension scheme members, the report noted that:
…it would be very difficult for the profession to communicate directly with scheme members in a systematic manner. Therefore, Scheme Actuaries should encourage trustees to provide members with the information necessary to address any incorrect perceptions of the MFR. This task is an onerous one for trustees, unless they can be provided with the material they require. It should always be borne in mind that all parties have an interest in ensuring that scheme members fully understand and appreciate their pension schemes. The material covered… above should be sufficient for this purpose if accompanied by clear instructions on the course recommended by the actuary. Members will also have access to the actuarial valuation, actuarial certificates and Annual Report as well as their Scheme Booklet.
4.246 The report then dealt with issues related to communication with sponsoring employers, trades unions, regulators (OPRA had been sent a copy of the report in draft), other professions and the press.
4.247 In relation to Government, the report said that:
The situation with Government requires sensitive handling. On the one hand we need to make it clear that the ultimate responsibility for the existence, shape and strength of the MFR lie squarely with the Government. On the other hand we want to influence them in order that the MFR works to best effect and to ensure that we continue to be consulted by them in advance of any changes to it. Given the heavy workload of relevant Government ministers, and the fact that they may not be technical experts in the Pensions arena, we suggest that regular briefings on relevant topics are the best approach. These could be built up from the Factsheets referred to earlier.
4.248 The report concluded:
Although there are a number of problems with the current understanding of solvency vis-à-vis the MFR and funding we do not think that they are, in any way, insoluble. While Pensions in general, and Final Salary/Defined Benefit Pensions in particular, will never be easy to understand we do not believe that the situation is hopeless either. If the Recommended Actions [we have] listed… are followed we feel that this important topic will be clearer to all concerned and the debate about funding of pensions will be a more informed one as a result.
Events during 2000
Press comment on MFR reform
4.249 On 6 December 1999, in the light of press interest in the rumoured changes to the MFR, further briefing was prepared for the DSS press team by the same official who had produced the November 1999 briefing. It replicated the explanation provided in earlier briefing (see entry for 16 November 1999, above) but added a further sentence. This stated ‘there has been concern that the valuation method is not as robust as originally expected under changing economic conditions and that it should be re-examined’. This briefing was also incorporated into more detailed briefing, provided on 9 December 1999 in response to an article in the Financial Times about the changes, and was also reproduced in later briefings.
Internal discussions on MFR review
4.250 On 13 December 1999, the actuarial profession responded to a DSS request to provide further explanation of their proposed short-term changes.
4.251 On 10 January 2000, a tripartite meeting – one of a series of such meetings - to discuss the MFR review was held between the Treasury, DSS and the Debt Management Office. The fifth item on the agenda was discussion of the actuarial profession’s proposals for short-term changes to the MFR basis.
4.252 According to the note of the meeting, a Treasury official expressed concern that the draft discussion paper (see above), circulated by the actuarial profession prior to issue to its members, ‘was recommending a strengthening of the underlying objectives of the MFR’. The meeting agreed to inform the actuaries that their paper needed ‘to be much clearer on whether a proposal produces a standard that is the same, stronger or weaker than the objectives of the current MFR’. This was done on 13 January 2000.
4.253 The note of the meeting ended with the statement that ‘DSS were proposing to recommend to [Ministers] that no changes are made to the MFR assumptions until the outcome of the MFR review is known and the review of contracted-out rebates has been carried out’. In a later tripartite meeting, it was suggested – in relation to the statement of the purpose of the MFR to be included in the published version of the MFR review – that the phrase ‘reasonable expectation’ should be avoided, as it had a particular meaning in the context of the regulation of life insurance.
4.254 On 28 January 2000, the actuarial profession sent its final version of the progress update on the MFR review to DSS (see above).
4.255 On 31 January 2000, a submission was made to Jeff Rooker, the then Pensions Minister, by DSS officials. This set out recent developments in the MFR review and it informed the Minister that the recently received progress report ‘reiterates the actuarial profession’s view that the public’s expectation of the MFR is that it is a solvency test (which it is not) and that in the light of this expectation there should be a much clearer disclosure of the true solvency position’.
4.256 When dealing with the proposed short-term changes to the MFR that had been proposed by the actuarial profession, the submission said:
There are strong arguments for incorporating these changes to the MFR… These changes are technical amendments and are simply restoring the strength of the MFR level to the level intended when the requirement was first introduced. Though they will not come as a surprise to occupational pension schemes, there are financial implications.
4.257 The submission then set these out. It continued that ‘if we introduce these changes to the MFR we are likely to come under pressure to similarly change the assumptions used in the calculations of rebates which would be to make them more expensive to government. We do not have Treasury agreement to this’.
4.258 After saying that it would seem sensible to consider any MFR changes together with the outcome of their review of contracted-out rebates, the submission then concluded with a recommendation that ‘we do not feel that now is the time to be introducing these short-term changes’ and sought the Minister’s approval for such a decision.
4.259 On 9 February 2000, the Minister’s Private Secretary wrote a minute that set out the Minister’s agreement to the recommendation that the short-term changes to the MFR basis proposed by the actuarial profession should not be made at that time.
Announcement of MFR review timetable
4.260 On 10 February 2000 in an answer to a question from Frank Field MP, the then Secretary of State, Alistair Darling, announced that the actuarial profession’s review of the MFR would be published ‘in spring this year’.
Stakeholder meetings
4.261 On 13 March 2000, a meeting – one of a series with key stakeholders - was held between officials of the Treasury, DSS and GAD and the TUC’s pensions officer. A representative of the actuarial profession also attended the meeting. The note of the meeting recorded the view of the actuary that he was ‘concerned about people’s lack of understanding of what the MFR could be expected to deliver’. The note continued:
He was concerned that companies could go to the wall, but schemes would be unable to pay benefits in full, when the inference was that they would be able to do so. He felt there should be more clarity in communication on the strength of the pensions promise. [The TUC officer] agreed, saying that misunderstanding of what the MFR represents does give people false expectations. [The actuary] added that before the Pensions Act responded to the Maxwell affair, schemes could in effect wind up and walk away.
4.262 The note recorded the response of the GAD official, who:
…pointed out that 100% MFR might, for example, buy only 70% of benefits. There was a trade-off here of costs as against security. He added that the CBI would not be happy with a MFR pitched at a level to produce 100% benefits (full solvency) – employers would just walk away from schemes.
4.263 On 22 March 2000, a similar meeting was held with the Confederation of British Industry. The note of the meeting recorded the view of a CBI representative that ‘it was not really clear what the MFR was intended to achieve and, to the extent that it was trying to achieve something, the current MFR was not doing so’. The CBI also acknowledged that a real solvency test would not be acceptable to most employers.
Parliamentary debate
4.264 On 3 April 2000, in a parliamentary debate on the Child Support, Pensions and Social Security Bill, Jeff Rooker, the then Pensions Minister, said:
A number of measures were introduced in the 1995 Act with the aim of promoting security for members of pension schemes, including the minimum funding requirement. It is important to protect members and the benefits that they are promised. There can be no objection to that.
4.265 The Minister continued:
The minimum funding requirement is not a guarantee of solvency. I freely admit that as a lay person I had thought it was. In the past eight months, since I have been at the Department of Social Security, I have looked at the issue in more detail. The lay person can get a false impression from the minimum funding requirement. It is not intended to force employers to contribute at a higher rate than is needed in the long term to meet the benefits promised.
4.266 He went on:
The minimum funding requirement should lessen the risk that a scheme is underfunded through, for example, an over-extended contributions holiday… the MFR is an on-going requirement on schemes to monitor their funding position and to have in place a contributions plan to ensure that the appropriate funding level is maintained.
4.267 The Minister then stated:
We are aware of the importance of protecting members’ rights. That is the bottom line. If we cannot do that, they have no-one else to look to. Where there are gaps in legislation we must block them. There is no evidence of major difficulties. Reviews are going on and we will report the results to the House as early as we possibly can.
Research by the FSA
4.268 In April 2000, the FSA published research it had commissioned in a report called ‘Better Informed Consumers’.
4.269 One of the findings of the research was that:
Most respondents in the… survey who had taken out or considered a [financial] product in the last five years were not dissatisfied with the information available, claimed that they did not want more information and were confident that they had all the information to make the right choice of product. The fact that so many consumers had confidence in recent financial decisions, despite the relatively low levels of shopping around reported, suggests that many would benefit from further information but are unaware that they need it. Therefore, a major task for the FSA is getting consumers to recognise that they have information needs in the first place.
4.270 In urging caution about their findings, the report’s authors suggested that there were problems with information and advice that were common across all groups. These were that consumers did not know what products were available or appropriate for their needs, that they were often overwhelmed and confused by information in leaflets, that they did not always understand the jargon and terminology used in the information or advice that they did receive, that they were often shocked by the ‘small print’ after having taken out a financial product, and that they were unaware of how to access comparative information.
4.271 The report went on to say that only 7% of the participants in their survey had mentioned information from a financial services regulator as a preferred source of information about financial products. However, four out of five respondents were aware that the FSA was able to provide generic advice and 45% (erroneously) believed that it was part of the FSA’s role to give individuals specific financial advice.
4.272 The report concluded by suggesting that the FSA capitalise on a high level of trust among consumers, a common view that independent advice was important, and that people were highly interested in the consumer services provided by the FSA - by using outreach (in the form of booklets, a helpline, the use of broadcasting and press opportunities, the FSA website, financial education course and public meetings) to increase the level of general financial awareness and knowledge.
Cabinet Office report
4.273 Also in April 2000, the Performance and Innovation Unit of the Cabinet Office published a report, with a Foreword by the Prime Minister, entitled ‘winning the generation game’. The focus of this report was on ‘improving opportunities for people aged 50-65 in work and community activity’.
4.274 In a section on occupational pensions, the report suggested that such opportunities were sometimes distorted in relation to work-based pension schemes and that this could be remedied by improvements to transparency, information, flexibility and incentives to stay in work.
4.275 It continued:
More transparent arrangements will help improve information. Alone, however, they are not sufficient for all parties to make fully-informed decisions. Pensions suffer from being complex, often thought of as far off, and people tend to place current consumption high above saving for future consumption. DSS are already pursuing an agenda for improving pension information.
4.276 After listing recent initiatives by DSS that formed part of this agenda, the report went on to suggest that the Government should promote information about how much an individual would need by way of their pension pot if they wanted to retire with a certain level of income - and that DSS should try to develop ‘extra information’ to make the content of the information required to be provided by schemes to their members ‘even more understandable’.
The actuarial profession’s review of the MFR
4.277 On 1 May 2000, the actuarial profession submitted a report by the Pensions Board of the Faculty and Institute of Actuaries to the Secretary of State for Social Security, entitled ‘Review of the Minimum Funding Requirement’. The review appears to have been informed by the earlier work of the professional working party (see above).
4.278 The terms of reference for the review, which had been determined by DSS, first set out the Government’s policy intention as regards the MFR.
4.279 This stipulated that the MFR was intended to be:
…a benchmark funding level for salary related occupational pension schemes to protect members' accrued rights in the event of the sponsoring employer becoming insolvent… [which would provide] protection at a level to enable pensions in payment to continue in full (excluding future discretionary increases) and give non pensioners a reasonable expectation of receiving benefits at a level that would have been paid if they had become deferred members and the scheme continued as an ongoing scheme… [This] benchmark funding level should be derived from an objective test which is independent of the circumstances of each scheme (except for gilt matched schemes). In most circumstances, meeting MFR should not require, in the long term, contributions which exceed the contributions produced by ongoing valuations for a scheme which is fully funded on the ongoing basis on reasonably prudent actuarial assumptions.
4.280 A ‘reasonable expectation’ was defined as meaning ‘an “even chance” on transfer to an appropriate alternative pensions vehicle’ and the terms of reference then set out the detailed issues to be covered by the profession as part of their review.
4.281 After dealing with concerns that the then current MFR test was arbitrary or perverse in its effects, the report, in a section headed ‘solvency and funding’, discussed another concern – ‘that the MFR test is an insufficient measure of the cost of buying out members’ benefits and is therefore too weak in relation to members’ security’.
4.282 The report’s analysis started by saying:
…it was inherent in the design of the original MFR test that it is not a “solvency test”. This is clearly reflected in the terms of reference for the current review, which refer to giving non pensioners a “reasonable expectation” of receiving their benefits. The MFR test is not designed to “guarantee” that members will receive their promised benefits. Moreover, the MFR test does not cover any benefits provided on a discretionary basis.
The general consequence of this is that, if a scheme winds up with assets equal to 100% of its liabilities on the MFR, the money available after securing immediate annuities for the retired members will only be sufficient to secure deferred annuities for the remaining members at less than 100% of their accrued benefits.
We have a particular concern that this is not understood by scheme members, trustees and employers, who believe that the benefits from a scheme which meets the MFR are fully secure.
4.283 The report continued:
Looking at the present situation, however, the picture is of even greater concern. When the current MFR test was originally established, it was designed so that the buy out costs for pensions in payment would be broadly equal to the value of the liabilities for those benefits under the MFR test. However, under current circumstances the buy out costs for pensions in payment are of the order of 10% to 20% higher than the MFR liabilities.
4.284 The report explained that this was due to recent improvements in pensioner mortality and that the MFR test did not take into account a proper allowance in a lower inflationary environment for pension increases which were subject to minimum and/or maximum percentage increases each year.
4.285 The report also said that, for members not yet retired, the buy out costs would also be greater than the MFR liabilities because the values of annuities would differ because of the factors outlined above and also because the MFR had been designed to deliver only a ‘reasonable expectation’ (rather than a guarantee) that benefits for non-pensioners would be secured.
4.286 Using a model scheme that was funded to 100% on the MFR, the report then showed that non-pensioners’ benefits in that scheme would only be 69% secure on wind-up and concluded that, if a scheme were only funded to the MFR level, members not yet retired would routinely receive ‘significantly less than 100% of their accrued benefits’ and that the shortfalls below 100% ‘could vary quite sharply over time’.
4.287 The report then went on to analyse the MFR and alternatives (including changed bases for MFR calculation). In section4.7.1 of the report, it was said that the then current MFR test was:
…therefore a “hybrid” test, being a full security test for pensioners but a much weaker, funding test for non pensioners. It is our view that the implications of this are not understood by members of schemes, who will almost inevitably assume that if they know their scheme is at least 100% funded on the statutory MFR test, then their benefits must be fully secure and protected. We strongly recommend that the new MFR test should be coupled with much clearer disclosure of the real position regarding the security of members' benefits in the event of the scheme winding up, for each class of member.
It is therefore a key conclusion of the review that there should be full and clear disclosure to members of the objectives and limitations of the MFR test and the consequences if their scheme should be wound up. We recognise that this enhanced disclosure could have major consequences, as almost all employers and trustees have, until now, tended to stress the security aspects of occupational pension schemes in their communications with members.
We believe it will be necessary to create a better understanding amongst members of the public of the issues involved. In particular, it will be desirable to gain acceptance that an investment strategy that attempts to eliminate all risks is unlikely to be the most appropriate for long term savings. The uncertainties of the future need to be explained, together with the steps being taken to mitigate (but not eliminate entirely) those risks. The actuarial profession is keen to work with Government, employers and pensions organisations to promote a greater awareness and understanding of these issues among scheme members.
4.288 In proposing a basis for disclosure, the report continued:
As mentioned above, it is important that members are not misled into thinking that an MFR level of 100% will ensure that their benefits are fully secured on winding up, since the MFR test is not designed to deliver this. We therefore distinguish between a “security level”, which should be disclosed to members, and the minimum funding requirement, which determines the controls placed on schemes to underpin the extent to which they are required to meet the full security standard. We recommend that the scheme actuary should be required to certify the level of scheme security, broken down by different liability categories, at the date of the triennial MFR valuation. This information should be disclosed to scheme members in the trustees' annual reports.
4.289 The report then considered the ‘debt on the employer’ provisions – relevant to situations in which schemes wound up with assets below the MFR level – and also issues related to the calculation of cash equivalent transfer values and other technical matters. It proposed a number of longer-term changes to the MFR, including longer deficit correction periods and the abolition of the need for annual recertification; a move in investments towards the use of a composite index of gilts and corporate bonds to ameliorate distortions in the gilts markets; and the removal of the equity market value adjustment as part of the MFR test.
4.290 In section 5 of the report, three proposals for interim changes to the MFR basis were set out. These were later to be set out in an annex to the Government’s consultation document (see below).
4.291 Section 6 of the report discussed the framework in which the current – and any revised – MFR operated.
4.292 In dealing again with the purpose of the MFR and the degree of security it gave to members’ pension rights, the report said:
…the security for members’ benefits rests partly on the assets built up in their fund, which the MFR legislation attempts to measure and control, and partly on the continuing financial strength of the employer who underwrites the eventual cost of the benefits promised to his employees. The point at which members' security becomes of vital importance is when the scheme is wound up, particularly if this event is caused by the insolvency of the employer. It is our contention that there may be a widespread misplaced public perception that a scheme which is 100% funded on the MFR test would provide full security for members' benefits.
Our proposals for clearer disclosure of the true position on security of benefits in the event of the scheme winding up should lead to a greater understanding of these issues…
4.293 The report then went on to consider the relative merits of three options for reform – the establishment of a central discontinuance fund, requiring schemes to take out solvency insurance, and a redefinition of members’ benefits on winding up to become their shares of the available assets.
Preparations for publication of MFR review
4.294 On 16 May 2000, DWP officials made a submission to Jeff Rooker, the then Pensions Minister, that provided briefing on the actuarial profession’s report and set out handling issues. After noting that one of the proposals would be the ‘disclosure to members’ of the degree of security they could expect from the MFR which would ‘highlight the fact that the objectives of the MFR mean that non-pensioners only have a “reasonable expectation” of achieving their benefits’, the submission then went on to discuss the key points to be considered.
4.295 In a section entitled ‘proposals for interim changes’, the submission noted that such changes were ‘designed to restore its strength to the level intended when the requirement was first introduced’ as ‘the MFR test is currently weaker than originally intended’. In a later paper, these changes were described as technical measures to take into account increased longevity, make allowance in the valuation of pension increases for the possibility that price levels may fall, and to change the equity market value adjustment factor to reflect recent changes in corporate activity.
Parliamentary question on MFR and venture capital
4.296 On 7 June 2000, the then Secretary of State, Alistair Darling, answered a parliamentary question from Claire Curtis-Thomas MP, who had asked what assessment had been made of the MFR with reference to the use of venture capital.
4.297 He replied:
The MFR does not prescribe how pension funds should invest their assets. Investment practice is a matter for pension schemes. The MFR is intended to provide a reasonable level of security for members in the event of the employer becoming insolvent and requires defined benefit schemes to hold a minimum level of assets to meet their liabilities, valued according to a prescribed methodology.
Child Support, Pensions and Social Security Act 2000
4.298 The Child Support, Pensions and Social Security Act 2000 received Royal Assent on 28 July 2000. Chapter II of Part II of the Act related to occupational and personal pension schemes.
4.299 This part of the Act:
(i) provided for procedures to ensure that the trustee boards of all schemes were constituted with at least one-third of their members having been nominated by scheme members;
(ii) gave powers to OPRA to make their register of disqualified trustees available to the public;
(iii) allowed OPRA to monitor schemes which were in the process of winding-up, thus implementing some of the proposals contained in the winding-up consultation (see above);
(iv) extended the remit of the Pensions Ombudsman;
(v) enabled Regulations to be laid at a later date which would require money purchase schemes to provide members with a statement of their likely future pension entitlement; and
(vi) changed the way in which schemes discharged contracted-out pension rights, effected scheme transfers, and dealt with other technical matters.
4.300 In relation to the measures related to the winding-up of schemes, the Explanatory Notes to the Bill said:
The measures aim to ensure that a trustee is in place following the insolvency of the employer so that decisions can be made about the future of the scheme. Where winding-up has started, trustees or managers will be required to make reports to OPRA if winding-up is not completed within a specified period of time and OPRA will be able to direct action to speed the process along. OPRA will also be able to modify scheme rules where they need to be changed to allow winding-up to proceed.
Report of the Pension Forecasting Advisory Group
4.301 In the meantime, in July 2000 the Pension Forecasting Advisory Group published a report, entitled ‘Planning Your Future’. The Group had been formed following a Ministerial announcement on 22 July 1999 with the remit of considering how best to implement the Government’s proposals for combined state and non-state pension forecasting (see above).
4.302 Two of its recommendations were that, first, DSS should supply a general leaflet about state pension provision which would be used by employers and pension providers to provide an introduction to the combined forecasting service and to explain the state element of an individual’s forecast pension entitlement. Secondly, while noting that employers and pension providers had a key role to play in providing further information to individuals, the Group recommended that DSS should look at mechanisms for ensuring that any advice given was made readily available, kept up to date, and explained in plain language.
4.303 The Group also recommended that DSS, employers and pension providers consider together what warnings might be needed to be provided with the combined forecasts.
Final preparations for publication of MFR review
4.304 On 31 August 2000, as part of the final preparations for the publication of the actuarial profession’s report and the Government consultation document published in parallel to it, the Minister’s Private Secretary recorded the Pensions Minister’s view that the interim change in relation to the assumptions about future pension increases should only be an option for consultation, with no commitment that the Government would actually implement it. The reason given for this view was that there had been no ‘serious evidence/economic forecasts indicating that there will be a fall in prices over the next 10-20 years’. His support for the other proposed interim changes to the MFR was also recorded in this note.
Security for Occupational Pensions – the MFR consultation
4.305 DSS and the Treasury published a consultation document on 14 September 2000 entitled ‘Security for Occupational Pensions’. On the same day, DSS published in parallel the actuarial profession’s report on the MFR outlined above.
4.306 Paragraphs 3 to 6 of the consultation document explained:
To provide for their liabilities, defined benefit occupational pension schemes build up funds. These are subject to the Minimum Funding Requirement introduced under the Pensions Act 1995. Schemes whose assets fall below the minimum set by the MFR test have to make up the shortfall within prescribed time periods.
However, the MFR does not provide a guarantee that, in the event of an employer becoming insolvent, its pension scheme members’ rights will be honoured in full. And there have been indications that the MFR also adversely influences the investment decisions of scheme managers. This could damage the longer term prospects for such schemes, which remain an important way of providing for retirement. Further to that, in the last budget the Chancellor announced that he was asking Paul Myners [then chairman of Gartmore Investment Management and subsequently chairman of Marks and Spencer] to review the factors that influence institutional investment decisions. Responses to his review, for example from the National Association of Pension Funds, suggest that the MFR has distorted investment decisions.
In March 1999 the Department of Social Security commissioned a report on the MFR from the Faculty and Institute of Actuaries, which is published alongside this consultation document. It contains proposals for reform and identifies a number of wider issues concerning the security and costs of defined benefit pensions. But it also suggests that the current MFR may not be the most appropriate approach for the future. This document therefore seeks to explore these wider issues with a view to achieving security for defined benefit pensions from well performing schemes. A number of options are put forward and the Government welcomes comments on the alternatives specifically discussed as well as other suggestions.
Paul Myners has also been asked for his views on the MFR and the possible alternatives as part of the consultation process. He will report at the time of the Pre-Budget Report.
4.307 Following the introduction, the document had seven sections and a conclusion. These were entitled ‘the importance of occupational pensions’; ‘existing protection for scheme members’; ‘the MFR review’; ‘how the current MFR works’; ‘the Actuaries’ report’; ‘a wider debate’; ‘options for protecting pension rights’; and ‘updating the current MFR’.
4.308 The document noted the importance of occupational pension provision within the UK and said that the Government ‘wants to help people understand their pension rights and appreciate the value of saving for pensions’.
4.309 In relation to the security of current final salary schemes, it said that ‘there is no intrinsic guarantee that the accumulated funds will be able to deliver members’ pension rights’. The documents then stated that the intention behind the MFR was:
…to provide protection for pensioners and other scheme members’ rights by setting a benchmark for the acceptable level for the scheme’s assets. With this floor in place, there is a reasonable chance that if the employer becomes insolvent, the pension scheme’s assets will be able to meet the cost of paying out pensions for those already retired and provide for other scheme members’ rights. It is not a solvency test as such and it is sometimes misunderstood to offer a more powerful guarantee about payment of pension rights than it actually delivers when a scheme winds up.
The previous Government set the objectives for this MFR test. The valuation method and assumptions for the MFR were then developed by the Faculty and Institute of Actuaries in 1995/1996 to meet the objectives set by Government.
4.310 The document went on to explain the context in which the actuarial review of the MFR had been undertaken and that the consultation process was intended to launch a wide ranging discussion on the issues that had been identified within the actuaries’ report.
4.311 It then set out what the MFR had been designed to deliver - namely, regardless of whether the sponsoring employer was solvent, that existing pensioners would have their pensions paid in full and non-pensioners would have ‘a reasonable expectation of receiving the value of their pension rights when they come to retire’.
4.312 The document went on:
…the amount of reassurance the MFR can deliver is commonly misunderstood to be a good deal greater than it really is. Some people think the MFR test amounts to a full guarantee of scheme members’ pension rights. It is not a solvency test. A funding requirement that gave full protection to members when their scheme ceased would lead to significantly higher costs than is the case under the MFR.
4.313 It also reaffirmed that the Government’s objective was to ‘protect the immediate interests of pensioners and other scheme members without damaging the longer-term prospects for current and future members’.
4.314 The document recognised that the actuarial profession, in its review, had discussed ‘the case for bringing home to scheme members the scale of protection which the MFR can deliver, perhaps by disclosing to scheme members what benefits could be delivered should the scheme wind up’.
4.315 The Government explained that it wanted to consider a wider range of options for reform than those set out in the actuarial profession’s report, including prudential supervision and either compulsory mutual or compulsory commercial insurance.
4.316 In relation to the actuarial profession’s recommendation for disclosure to scheme members, paragraph 56 of the report stated:
One of the key recommendations in the Actuaries' report is for disclosure to members about the security of their benefits. Their concerns stem from the fact that the MFR is not a solvency test but that this is not always fully understood by members. The report recommends that there should be disclosure to members of, broadly, the extent to which their benefits could be secured by means of annuity purchase if the scheme were to wind up. This approach could be considered whatever policy is adopted. The Government would welcome views on this idea and how it might be achieved.
4.317 In the list of specific questions on which responses were sought by DSS, question 13 asked ‘are there any reasons why there should not be disclosure to members of the scheme’s solvency position and of what this might mean should their scheme cease? How might such information be best communicated to members?’
4.318 The press notice which accompanied the publication of the consultation, which was issued under the title ‘Darling launches consultation paper on pension protection’, quoted the then Secretary of State as saying:
This government is determined to protect the long-term security of pensioners and other pension scheme members. In the light of [the actuaries’ review] it is right to look at whether the current MFR is the best approach… It is therefore sensible to explore whether there is a more effective or reliable way of protecting scheme members’ rights.
4.319 Paragraphs 3 and 4 of annex one to the press notice explained that:
The MFR is intended to provide a reasonable level of security for members in the event of the employer becoming insolvent and no further funds being available to pay into the scheme. The underlying objectives of the MFR were decided by Government; the valuation method to meet the objectives was devised by the Pensions Board of the Faculty and Institute of Actuaries.
The objective of the MFR is that a scheme fully funded according to its requirements would, if the employer became insolvent, protect fully pensions already in payment, and provide younger members with a transfer value that would give them a reasonable expectation of replicating scheme benefits if they transferred to another pensions vehicle…
4.320 Paragraph 14 of the annex set out the proposed interim changes to then current MFR arrangements that had been recommended by the actuarial profession and which the Government said it was considering. The notice said that these included:
…adjusting the way in which MFR liabilities are assessed to reflect:
- an extra two years longevity;
- for pension increases - that price levels may fall;
- changing patterns of corporate activity; and
- generally lower market dividend yields since the current scheme was introduced.
4.321 Responses to the consultation were sought by 31 January 2001. According to a subsequent parliamentary answer, 73 responses had been received by 7 February 2001.
4.322 OPRA’s response to the consultation was submitted in January 2001 and in it OPRA commented:
Risk is not generally understood by members of defined-benefit schemes, who are exposed to a different form of risk - that of the assets of the scheme on termination being insufficient to deliver the accrued benefits. These different risks need to be explained clearly to members.
4.323 It continued:
…taken as a whole, the provisions of the Pensions Act 1995 may give scheme members grounds to believe that they have more security than they actually have. As with all forms of investment, membership of [defined benefit] schemes carries a degree of risk. It is unacceptable for scheme members not to have access to a clear and simple explanation, by category of member, of the level of security afforded by the current MFR. There is a parallel here with the ‘Key Features’ documents required in relation to certain financial products. Scheme members should have access to a realistic assessment of the extent to which the pension rights which they have built up are secure. On balance, it is better that members are provided with such a realistic assessment, even if it does give rise to member concerns.
4.324 In response to question 13, OPRA said:
We very much support the disclosure to members of the scheme's solvency position… This might usefully be incorporated in the scheme's annual report or in the annual benefit statement issued to members. In our view, it would be critical that the solvency position should be explained in a clear and straightforward way and that the solvency position should be indicated separately for each membership category. This explanation should also seek to address concerns that may be raised in members’ minds about the security of their accrued rights, if the scheme was not fully “solvent”. Indeed, simply disclosing the scheme’s solvency position to members may not achieve much if members are unable to exert pressure on the sponsoring employer to improve the scheme's financial position or if the upshot is that members leave the scheme. If handled correctly, the disclosure to members of the scheme’s solvency position could help members to understand the nature and costs of the pension promises made to them.
4.325 The actuarial profession’s response to the consultation was also submitted in January 2001. In appendix 6 to their response, the Faculty and Institute of Actuaries dealt with the proposed interim changes to the MFR basis.
4.326 In relation to the proposed change to the equity market value adjustment, the actuaries said:
We have performed further analysis of the changes to the levels of equity dividends and market value adjustments over the period since May 2000 [when the interim changes were first proposed] and confirm that a reduction to 3.0% would remain appropriate at the current time but this should be re-examined at the time any change is put forward, as the trend has continued and a different figure may by supportable on the basis of subsequent movements.
DSS research on the role of trustees
4.327 In the meantime, on 28 September 2000, DSS published a report of research it had undertaken into pension scheme trustees’ experience of their role. The report was entitled ‘the changing role of occupational pension scheme trustees’.
4.328 Among the research’s key findings was one that trustees’ knowledge of their duties varied, with those in smaller schemes appearing to be much less knowledgeable and heavily dependent on advice.
Events during 2001
Revised Actuarial Guidance Note
4.329 On 1 December 2000, the actuarial profession issued a revised version (1.5) of their guidance note, ‘Retirement Benefit Schemes - Minimum Funding Requirement’. These made minor technical changes to professional guidance which are not of relevance to the heads of complaint.
Parliamentary question on member protection
4.330 On 26 February 2001 in response to a question from Desmond Browne MP, who had asked what provisions were in place to protect employees whose pensions had been affected detrimentally by the insolvency of their employer, Jeff Rooker, the then Pensions Minister, replied that:
…the Pensions Act 1995 brought in a number of measures to promote security for members of pension schemes, including the Minimum Funding Requirement which requires defined benefit schemes to hold a minimum level of assets to meet their liabilities.
In the event of a sponsoring employer's insolvency, the legislation requires that an independent trustee must be appointed. The role of the independent trustee is to ensure that the interests of the members are represented in insolvency proceedings and to make any necessary decisions about winding up the scheme. If on wind up the scheme is not fully funded on a Minimum Funding Requirement basis, the amount outstanding becomes a debt on the employer and the trustee must pursue recovery of this amount.
Where the scheme finds itself in deficit due to fraud, compensation may be payable under the Pensions Compensation Scheme. Unpaid employer and employee contributions may be payable from the National Insurance fund through the Department of Trade and Industry's Redundancy Payments Service.
Westminster Hall debate on the Basford Group Pension Scheme
4.331 On 28 February 2001, Desmond Browne MP initiated a debate in Westminster Hall on the circumstances surrounding the winding-up of the Basford Group Pension scheme, which had commenced on 26 May 1999.
4.332 The then Pensions Minister, Jeff Rooker, in answering the debate, said:
When I started to get to grips with the minimum funding requirement, I mistook it as a solvency test. It may appear that way to a lay person, but there is no doubt that it is not. Pension schemes must be adequately funded to cover their liabilities. The 1995 Act introduced the MFR, which requires defined benefit schemes - schemes based on final salary - to hold a minimum level of assets to meet their liabilities.
4.333 He continued:
We recognise that matters have changed since the minimum funding requirement was introduced. It came into force in 1997. As my hon. Friend acknowledged, many of the issues that affected his constituents are not covered by the 1995 Act, which had not come fully into force at that time. The Government consulted on the future of the minimum funding requirement and are currently studying the responses.
4.334 The Minister concluded by saying:
Coupled with that was the Myners review, set up by my right hon. Friend the Chancellor of the Exchequer. Given that he is about to make a major speech in the House in the not too distant future, he may or may not have something to say about that. The report has been received, and the consultation on the minimum funding requirement concluded at the end of January. We have been considering the responses to that consultation, because we must make an early statement about whether we will do nothing or do something, so that people know what is happening.
The Myners Report
4.335 The Government published Paul Myners’ report, ‘Institutional Investment in the United Kingdom: A Review’, on 6 March 2001. His review had been commissioned by the Chancellor of the Exchequer at the time of the 2000 Budget to consider whether there were factors that were distorting the investment decision-making of financial institutions - in the light of the Government’s concern that such institutions were investing too much on quoted equities and gilts and too little in small and medium-sized enterprises and other smaller companies because of industry-standard investment patterns.
4.336 As noted above, Myners had been asked in September 2000 to include an analysis of the MFR in his review and he had submitted his interim views on the MFR to the above consultation on the MFR in November 2000.
4.337 In his covering letter to the Chancellor of the Exchequer, Myners said:
Diagnosis of… problems is easier than cure. I do make a number of suggestions for legislative and tax change. I propose that trustees should, as in the US, have a legal requirement to be familiar with the issues when they take investment decisions. I propose replacing the Minimum Funding Requirement, which distorts investment and fails to protect scheme members, with a long-term approach based on disclosure and openness instead of an artificial uniform yardstick.
But I do not suggest that these alone are enough. Further change is needed. My strong preference, however, is for the industry – if it is willing – to drive change forward itself. Legislation, though it might in the end prove necessary, is likely to be a blunt instrument to tackle the kinds of problem I have described.
4.338 In paragraphs 10 and 11 of the summary of his report, Myners explained:
Most occupational pensions are organised on a trust basis, with a board of trustees responsible for determining how their assets are invested. As a survey conducted for the review confirms, many trustees are not especially expert in investment:
- 62 per cent of trustees have no professional qualifications in finance or investment;
- 77 per cent of trustees have no in-house professionals to assist them;
- more than 50 per cent of trustees received less than three days’ training when they became trustees;
- 44 per cent of trustees have not attended any courses since their initial 12 months of trusteeship; and
- 49 per cent of trustees spend three hours or fewer preparing for pension investment matters.
This is not true for all pension schemes, however. Larger schemes are more likely to have the resources to recruit and train more knowledgeable trustees, and the use of professional trustees has grown in recent years. But generally speaking, pension fund trustees, whether of defined benefit or defined contribution schemes, are able to bring limited time and expertise to the investment decision-making aspects of their work.
4.339 After dealing with institutional investment and the context for investment decision-making, the roles of trustees, actuaries, investment consultants and fund managers, the position in relation to defined contribution pension schemes, and pension fund surpluses, chapter 8 of the report dealt with the MFR.
4.340 This chapter first set out the background to the MFR, saying that it was:
…designed to underpin the employer’s commitment to support a defined benefit scheme it sponsors, so that in the event of the scheme having to cease, whether the employer is insolvent or not, scheme members already retired can expect their pensions to be paid in full, and scheme members who are not yet retired have ‘a reasonable expectation’ of receiving the value of their pension rights when they come to retire.
4.341 After describing in broad outline how the MFR worked, it continued:
Providing security for members of defined benefit pension schemes is an essential objective for any responsibly run pensions system. While there is no reason to doubt that the overwhelming majority of pension funds are run both properly and effectively, it is essential to have effective safeguards to ensure that members of defined benefit pension schemes can have confidence in the system.
4.342 The report then discussed the effects of the MFR on institutional investment decision-making. On turning to the issue of member risk, the report continued:
The MFR applies only to defined benefit pension schemes, not defined contribution schemes, because members of defined contribution and defined benefit schemes are subject to very different kinds of risk. Defined contribution members bear the investment risk of the contributions. Defined benefit members bear no risk at all unless the employer becomes insolvent; if this does occur, then they bear a mixture of investment risk and an additional ‘trustee risk’ – that the trustees could have incompetently or dishonestly managed the fund and left it under-funded.
4.343 Myners’ critique of the MFR was that:
Most fundamentally… a funding standard such as the MFR, by its nature, does not address properly the question of protecting defined benefit scheme members. The MFR is concerned to prevent a situation where a defined benefit pension fund is insufficiently funded and then, because of employer insolvency, is unable to meet its obligations. Yet to determine whether such a situation is likely to arise requires one to take a view of what the future investment returns of the fund will be. Whether or not the pension fund will in practice be able to pay its pensions will depend on future investment returns. A true system of protection for beneficiaries should focus on the issue of the reasonableness of that assumed return.
This the MFR fails to do. Rather, it seeks to establish whether a pension fund is ‘under-funded’ or not using assumptions which are:
- the same for all funds, albeit with adjustment factors for maturity;
- fixed by legislation; and
- treated as a technical question, for resolution by the actuarial profession.
None of these points is justified. The assumptions should differ with the maturity of the scheme, the strength of its sponsor, and the views of the trustees on a suitable investment strategy. They should be free to change with changing circumstances. They are not an obscure technical question, but the very heart of the question of whether the fund is adequately funded or not.
It follows that the MFR does not provide the protection that many assume it does, as the standard assumptions it makes may prove to be wrong. Indeed, its effects could well be counterproductive to the extent that it gives trustees a spurious sense of certainty about funding levels and weakens the fiduciary responsibility that should be at the heart of protection for members of defined benefit schemes.
4.344 The report then set out a proposed alternative to the MFR – a scheme-specific funding standard that would seek to afford effective protection for members of defined benefit pension schemes through appropriate investment strategies and would be designed to enable the differences between smaller and larger schemes to be taken into account. Such a standard would be based on transparency and disclosure and schemes would be required to report publicly on the current financial state of their fund and on future funding plans.
4.345 Myners’ other recommendations, insofar as they are relevant to this report, were that:
(i) the level of compensation available for non-pensioner members of schemes who qualified for compensation should be increased from 90% of MFR liabilities to something closer to the cost of securing members’ accrued rights (or the amount of the loss, whichever were the lesser);
(ii) there should be a statutory requirement for funds to be placed in the custody of someone independent of the sponsoring employer; and
(iii) each defined benefit scheme should be required each year to set out in clear and straightforward language such matters as the current value of its assets and in what classes these assets were invested, the assumptions used by the scheme to value its liabilities, planned contribution schedules and asset allocations, and an explanation of the implications of economic volatility for the value of the assets of a scheme.
4.346 The chapter concluded by expressing concern that the then proposed EC Directive on the prudential supervision of occupational pension schemes, which had been published in draft on 11 October 2000, might, if adopted without amendment, have the effect of replicating some of the faults of the MFR.
The Government’s response to the MFR consultation and Myners
4.347 On 7 March 2001, the Government published its proposals for reform of the MFR, in the light of the responses to the MFR consultation and the Myners report, in a document entitled ‘Security for Occupational Pensions: The Government’s Proposals’.
4.348 After explaining why the Government had rejected proposals for a central discontinuance fund, requirements for commercial insurance or compulsory mutual insurance, and prudential supervision, the document set out two models that had received significant support in earlier consultations: a common funding standard and a long-term, scheme-specific funding standard underpinned by a regime of transparency and disclosure, as had been recommended by Myners.
4.349 The Government explained that it had decided to reject the common funding standard approach, as it was:
…not satisfied that a practical regime can be devised which avoids the drawbacks affecting the current MFR. A common funding standard does not take into account the scheme’s specific circumstances and can therefore worsen protection. Assumptions that are right for one scheme are not necessarily right for another scheme. Further, the process of valuing liabilities on the basis of a common funding requirement inevitably leads to actuarial conventions driving and distorting investment, leading to increased costs. This option would be fundamentally no different to the current situation and is likely to damage the long-term future of defined benefit pensions or risk reducing the benefits that they provide. It does not provide the best protection for pensions and brings with it the risk of damaging consequences for investment like the current MFR.
4.350 The document explained that, instead, it would seek to implement the scheme-specific funding standard with additional measures to strengthen protection further. These included the placing of a statutory duty of care on scheme actuaries, stricter conditions on voluntary wind-up, and an extension to the fraud compensation scheme.
4.351 The document ended by noting that the Government’s proposals would require primary legislation to implement them but that, in the meantime, the Government would work with the pensions industry and other interested parties to develop proposals for legislation to be introduced when parliamentary time allowed.
4.352 It also announced that, as the MFR was to be abolished and as most of the respondents to the September 2000 consultation had not supported them, the Government had decided not to implement the proposed changes to the MFR that had been recommended by the actuarial profession in its May 2000 report.
4.353 Paragraph 33 of the document set this decision out thus:
Most of those who responded to the consultation document did not support the package of interim changes to the MFR and many commented that they should not be made if the MFR was to be replaced in the near future. The Government is proposing to replace the MFR and feels that it is not sensible to introduce these changes now.
4.354 The decision not to implement the recommendations for interim reform of the MFR included the proposal for disclosure to members of the risks to their pension rights should their scheme wind up without sufficient assets to meet its liabilities. However, it was said that what information would be required to be disclosed to scheme members would be considered as part of the discussions about the detail of the new legislation to be introduced in due course.
4.355 On the same day, the Chancellor of the Exchequer announced the proposed replacement of the MFR as part of the statement he made to the House to outline his economic and fiscal strategy report and Budget.
4.356 The press notice which accompanied the publication of the document quoted the then Secretary of State, Alistair Darling, as saying:
The Government is determined to protect the long-term security of pensioners and other pension scheme members in occupational pension schemes. It is clear that most people believe that the MFR does not provide effective protection and the Government therefore proposes a radically different approach.
4.357 OPRA confirmed subsequently, on 25 July 2001, that the MFR would continue to operate until the enactment and commencement of its replacement.
Commons debate on occupational pension schemes
4.358 On 3 July 2001, David Watts MP initiated an adjournment debate in the House of Commons on ‘employee pension schemes’.
4.359 He reiterated earlier concerns he had had about the placing in administration of a company in his constituency, whose pension scheme had subsequently gone into wind-up despite the fact that the company had had a contributions holiday not long before the relevant events.
4.360 He then continued to ask whether the Government would consider establishing a ‘pension protection fund so that the liabilities from pension schemes that are discontinued would pass to a mutual company that would protect the funds of affected pensioners?’ and also whether the Government would consider reform to prevent companies from taking contributions holidays.
4.361 The then Parliamentary Under-Secretary of State for Work and Pensions, Maria Eagle, replied to the debate. After expressing sympathy for those former employees of the company who had suffered ‘the double blow of not only losing their jobs and being reduced to statutory redundancy pay but also finding a hole in the pensions in a defined benefits scheme that they had every right to expect would provide them with a well known, fixed amount when they retired’, the Minister continued:
Pensions law is tremendously complex, and issues that might seem to hon. Members, outsiders and members of pension schemes to be relatively straightforward and simple can be devilishly complex because of the law and how the schemes work.
4.362 She went on to explain the role of the MFR thus:
One of the central features of the Pensions Act 1995 was the introduction of the minimum funding requirement. It was designed to promote security for scheme members. It requires defined benefit schemes to hold the minimum level of assets to meet their liabilities. The aim of the minimum funding requirement is to ensure that a scheme that is funded to at least the level of that requirement will, in the event of the employer becoming insolvent, be able to provide pensions. It is also intended to provide younger members with a fair value of their accrued rights, which they can then transfer to another occupational pension scheme, or to a personal pension…
It is right that measures should be in place to protect the interests of members of a scheme whose funding has gone wrong. If a scheme is not fully funded on a minimum funding requirement basis when it winds up - which has happened in this case - the outstanding amount becomes a debt on the employer, and the independent trustee is responsible for pursuing recovery. The debts amount to the sum required to bring the scheme back to full funding on the minimum funding requirement basis. That is all very well if the employer is solvent, but it does not help if the employer is insolvent, as in the case under discussion. The provisions will not guarantee that the money owing to the scheme can be recovered. They are directed a fairly long way down the list of creditors as are the other obligations that the firm may have had.
4.363 Ms Eagle ended by saying that the Government would consult on a pension protection fund (while noting that such an idea had in the past had little support in the industry) and that compulsory mutual insurance as suggested in the debate would be an option on which views would also be sought.
4.364 Further parliamentary debates on the subject matter of this investigation were held subsequently on 22 January 2002, on 2 July 2002, and on 23 October 2002.
‘A Guide to your Pension Options’ by DWP
4.365 DWP published a revised introductory 34-page guide in July 2001 called ‘a guide to your pension options’ (leaflet PM1 – first published in December 2000). Its introduction stated that ‘these guides can give you helpful information, but only you can make decisions about your pension’ (emphasis in original). The revisions to the guide had been made to take into account the introduction of stakeholder pensions and the other sections of the guide were identical to earlier editions.
4.366 After describing the main features of state pension provision, the guide went on to set out the main features of occupational, personal and stakeholder pensions, while referring the reader to other publications by DWP – including leaflets that dealt with occupational pensions – if they wished more information. The guide also signposted the reader to other sources of information, including the then Citizens Advice Bureau and the Pensions Advisory Service and also publications by the Inland Revenue and others by DWP.
4.367 Pages 14 to 16 of the guide dealt with occupational pensions. Under a section entitled ‘should I join my employer’s occupational pension scheme?, the guide explained:
Most members of an occupational pension scheme will be better off when they retire than they would be if they did not join it. This is because most employers pay something towards an occupational pension on top of the payments you may have to make. Generally, this means you will get a bigger and better pension that you could get for the same money anywhere else.
4.368 It continued (with original emphasis):
If your employer runs an occupational pension scheme, you should think carefully before you decide not to join it. If you are in any doubt, get as much information as you can (for example, by reading information from the scheme provider or by talking to a union representative or financial adviser) before you decide.
4.369 The guide then said that if the reader wished to know more about how occupational pension schemes worked, they should ask for a copy of the DWP leaflet that dealt specifically with such schemes.
4.370 In a section called ‘what else do I need to think about?’, pages 24 to 28 of the guide set out ‘other things that could affect your pension’. It listed change to the state pension age for women, the effects of divorce, the new system of bereavement benefits, and the implications of living abroad.
Letter from Actuarial profession
4.371 On 5 September 2001, the Chairman of the Pensions Board of the actuarial profession wrote to the Head of Private Pensions at DWP to inform him that the actuarial profession proposed that an interim change – the lowering of the dividend yield in the equity market value adjustment – should be made prior to reform of the MFR. The Chairman said in his letter that:
…the lack of any dividend from companies such as [a big multinational] would indicate that some change should be made to the MVA factor which produces a weakening of the basis at the point it is changed. Note however that this is aimed at bringing its strength back to that originally intended rather than an actual weakening. On the other hand, improvements in longevity would indicate a strengthening of the basis.
4.372 He continued:
The extent to which these two effects cancel each other out in terms of the total for the MFR liabilities will depend on the maturity of each particular scheme. We are of the view, however, that the overall position has changed sufficiently to require a lowering of the dividend yield in the MVA from 3.25% to 3%. If we had considered more detailed changes in the form of our earlier proposals we would now be proposing a larger change to the MVA factor, to something of the order of 2.75% rather than 3%. However, in order to keep the proposal simple and to take some account of the underlying need for a change to the mortality assumption, we are suggesting that a smaller change is made which implicitly can be taken as making some allowance for the mortality change.
Actuarial paper on post-MFR framework
4.373 On 14 September 2001, the actuarial profession wrote to DWP to submit a paper it had prepared which set out the thoughts of the Institute and Faculty of Actuaries about the issues that would ‘need to be addressed in the coming review of the framework to follow the MFR’.
4.374 In relation to ‘transparency and disclosure’, the actuarial profession said that:
Solvency on winding up is not yet a required disclosure [to scheme members] and we would propose that an approved measure reflecting the solvency position of a scheme should be a requirement. We are also aware that this fuller and wider disclosure has the potential to cause some confusion to members but we are equally concerned that lack of disclosure may hide important information. To that end we encourage full disclosure with greater consumer education.
Further consultation on the MFR
4.375 On 18 September 2001, DWP and the Treasury published a joint consultation document called ‘The Minimum Funding Requirement: The Next Stage of Reform’.
4.376 The then Secretary of State for Work and Pensions and the then Economic Secretary to the Treasury, in a joint Foreword to the document, explained that, since the publication of the Government’s proposals (see above), the Government had received comments and suggestions from interested parties as to what should be done in the period prior to the enactment of new legislation to give force to their proposals.
4.377 The Ministers announced the formation of a Consultation Panel to assist with reform of the MFR. This would include issues related to what should be disclosed to scheme members about the security of their pensions and the solvency position of their scheme.
4.378 Membership of the panel was drawn from the National Association of Pension Funds; the Association of British Insurers; the Faculty and Institute of Actuaries; the Association of Consulting Actuaries; the Association of Pension Lawyers; the Society of Pension Consultants; the Fund Managers’ Association; the Trades Union Congress; the Confederation of British Industry; the National Consumer Council; and the British Chambers of Commerce.
4.379 The terms of reference for the panel were to:
…assist in developing the detailed policy for legislation on the replacement for the MFR, in particular to:
(i) assist officials in assessing the practical implications of a proposed policy or course of action, that is, to act as a sounding board of experts;
(ii) work through the detailed policy package and draft legislation to ensure that it is coherent and workable across a wide range of occupational pension schemes but does not have adverse effects on investment behaviour or have unintended effects; and
(iii) facilitate a two-way communication process between the policy makers and the pensions industry.
4.380 The document then set out the principal comments that had been received in relation to its longer term proposals and went on to set out the package of measures that it proposed should be introduced in the interim.
4.381 The interim reforms, which were described as being ‘a balanced package that is good both for members and for employers’, consisted of three main proposals.
4.382 The first measure involved extending the deficit correction period to 3 years for seriously under-funded schemes to reach 90% of the MFR funding level - and to 10 years for under-funded (including seriously under-funded) schemes to reach 100% of the MFR funding level. The document said:
This change modifies the current MFR rules in a way that is consistent with the Government’s proposals to replace the MFR with a long-term funding standard. It will allow schemes to fund and invest in a more optimal way and smoothes out some of the short-term volatility associated with the current MFR regime.
4.383 The second measure removed the requirement for automatic annual recertification of schedules of contributions where a scheme’s last MFR valuation showed that the scheme was fully funded on the MFR basis. The document explained:
Again, this change is consistent with the Government’s proposals to move to a long-term funding standard. It takes the focus, for a fully funded scheme, from the short-term to a more long-term basis. Consideration is also being given to the addition of a requirement for an out of cycle valuation where it appears that there has been a significant change in the funding position of the scheme - by bringing into force regulation 11 of the current Minimum Funding Requirement Regulations. This would mean that, although annual checks are being removed for fully funded schemes, security would still be re-assessed should there be a significant change in the funding position.
4.384 The third measure introduced stricter conditions on voluntary wind-up. The document said:
The Government has said it will legislate to make it clear that employers must meet in full the accrued entitlements of scheme members as they fall due. And the proposed policy for the longer term is that the method of calculating the debt on the employer when a scheme winds-up should be strengthened by including:
(i) the actual costs of winding-up the scheme;
(ii) the actual costs of annuities for pensioner members; and
(iii) cash-equivalent transfer values for non-pensioner members calculated on the new long-term funding basis.
4.385 The document then explained that the Government proposed to move towards the third policy outlined above in the period prior to the replacement of the MFR by immediate action to strengthen the debt on the employer provisions by using actual costs rather than the MFR basis, while continuing to use the MFR to calculate cash-equivalent transfer values.
4.386 Responses to the consultation were sought by 10 December 2001 and the proposed Regulations to give effect to the interim proposals were attached to the document in draft. According to a later parliamentary answer, 140 responses were received.
GAD advice on actuarial profession’s proposal
4.387 On 25 September 2001, following ‘discussions’ held with DWP officials, a chief actuary at GAD emailed DWP.
4.388 The purpose of the email was, at DWP’s request, to:
…set out GAD’s views on the following matters:
(a) does GAD consider that events in the financial markets since 11 September mean that there is a case for taking action to change the MFR regulations to extend the deficit correction period in advance of the planned date of March 2002?
(b) does GAD consider that the DWP should accede to the request from the actuarial profession that the MFR equity MVA should be amended, by replacing the assumed long-term dividend yield of 3.25% with 3%?
4.389 The chief actuary continued by explaining that it was GAD’s view, in relation to (a) above, that ‘the increased market volatility experienced since 11 September and anticipated in coming months would support taking early action to extend MFR deficit correction periods, given that Ministers have already indicated that this change will be implemented next spring following consultation’.
4.390 He then explained the work – described as ‘approximate calculations’ – that GAD had undertaken in support of this view and set out a number of scenarios to put this in context.
4.391 In relation to the request for advice marked (b) above, the chief actuary’s full advice on this specific request was as follows:
In our view, recent events – in and of themselves – do not undermine the thrust of the argument of the actuarial profession. Accordingly, GAD would agree that the change to the equity MVA proposed by the profession is justified as a simple change which adjusts the MFR to a level of protection consistent with that applying when the equity MVA was last adjusted in June 1998.
DWP response to actuarial profession
4.392 On 23 October 2001, DWP replied to the actuarial profession’s letter of 5 September 2001.
4.393 After having noted that wholesale reform of the MFR required primary legislation and that the Government was currently consulting on a number of proposals for shorter-term reform of the MFR, the letter stated:
Our view is that we need to take a considered and balanced view as to the next stage of reform of the MFR, and that we should not make piecemeal changes. As such we would propose to give full consideration to your suggestion alongside others which we receive as part of the current consultation on the interim package of measures. Whilst we note the arguments you have put forward for an immediate change to the equity MVA we do not believe that such a change should be made in isolation, but should be considered as part of a coherent and balanced package arising out of the current consultation.
Parliamentary questions on occupational pensions
4.394 On 8 November 2001, in response to a question from Professor Steve Webb MP, who had asked what plans the Government had to discuss trends in occupational pension provision with the pensions industry, the then Minister, Ian McCartney, replied that the Government regularly discussed these matters with the pensions industry. Those discussions included ‘the role that Government can play in supporting and encouraging pension provision’.
4.395 He continued:
The Government acknowledges the contribution that occupational pension schemes play in the provision of income in retirement and want to encourage continued employer involvement.
4.396 The Minister then went on to explain the Government’s proposals for pension reform.
4.397 In response to a further question from Stephen Hepburn MP on how DWP planned to ‘encourage private pensions provision’, the Minister replied:
This Government are committed to encourage private pension provision – through pension education, making saving pay, providing appropriate savings vehicles, and better regulation…
Our pension education campaign has been driving home the message that those who can afford to save have an obligation to do so.
4.398 Later, in response to another question, from Gillian Merron MP, the Minister confirmed on 29 January 2002 that MFR reform through the proposed new Regulations would not have retrospective effect.
OPRA announcement on MFR
4.399 Following speculation in the wake of the events in the US on 11 September 2001 about the effects of the stock market fall on pension schemes, OPRA made an announcement on 6 December 2001 to confirm that, contrary to such speculation, OPRA was not intending – nor did it have the power – to suspend the operation of the MFR.
4.400 After drawing attention to the fact that, under existing legislation, schemes could apply to OPRA for an extension to the normal time allowed for an ‘under-funded’ scheme to make up MFR shortfalls, the then Chairman of OPRA was quoted as saying:
These applications are complex and involve difficult decisions for [OPRA]… We may be presented with a case where payment of the required level of contributions could seriously damage the business. But we have to balance that against our assessment that such an employer, already in financial difficulty, is likely to be able to continue in business.
Members of final salary schemes should be aware that their benefits are not guaranteed in the event that their employer becomes bankrupt, even if the scheme is funded to 100% on the MFR basis. Pensions in payment are usually protected, but those members who have not retired could get reduced benefits. We advise members to take an active interest in their scheme and to find out about its funding position.
Consultation panel discussion on disclosure
4.401 In the meantime, the Consultation Panel appointed on 18 September 2001 (see above) had met to discuss the disclosure of information to scheme members on 16 November 2001.
4.402 The record of that meeting reported that:
A discussion then followed as to the importance of educating members of the risks involved in their defined benefit scheme. If the employer remained in existence there would be no problems but members should be made aware of what happens should their employer become insolvent. However, the point was made that there were a range of risks, only one of which was the insolvency of the employer. And that these risks must be set in context.
4.403 The note continued:
Even with these risks, a defined benefit scheme was less risky than a defined contribution scheme and that wind-up with an insolvent employer is rare and is only one of a range of risks. Disclosure of the winding-up position must not make people think this will happen - this must be set in context. It was pointed out that whenever you enter a contract you should know the exit terms. What happens in wind-up should be disclosed to members, that there must be ways of overcoming the fear of members being frightened by this information, that it should be possible for members to understand that this situation is rare, and that we should not assume that members will act in an ill-informed way if this information is disclosed to them.
4.404 It went on:
However, [one member] expressed the view that everything should not hang off the winding-up position. But that members should be given a reassurance that the standard being used by their scheme is reasonable and that their scheme is being looked after. Or if it is not meeting this standard, then members should be told how this is being fixed. What happens should the scheme wind-up should be a secondary piece of information. The emphasis should be that their security is an ongoing employer. [Another member], agreed but said that this does not explain the risks involved, one of which is insolvency.
4.405 The Panel decided to establish a sub-group to specifically look at the issue of communication with scheme members. This sub-group met later on 16 May 2002. According to the note of this meeting:
There was then a discussion but no overall conclusion about what type of information should be disclosed to members. How much emphasis should there be on short-term market conditions that may effect the security of member benefits? It was suggested that members could be made aware of the risks to the security of their benefits - such as the under performance of scheme investments. Information about risks sent to members needs to be balanced because the greatest risk to the security of their benefits is the employer going out of business.
A comment was made that it is not enough to tell members about investment returns and contributions because on its own this information could be misleading. There needs to be an appropriate balance between providing information that is too bland to be of use and disclosing information that is too technical to be properly understood. It was noted that currently the only automatic disclosure item in relation to scheme funding was the requirement to disclose non-payment of scheme contributions in certain circumstances.
Ministerial speech to NAPF conference
4.406 On 22 November 2001, the then Pensions Minister, Ian McCartney, delivered a keynote speech to the annual conference of the National Association of Pension Funds.
4.407 The press notice issued by DWP announcing that speech said that the Minister had emphasised the importance of stakeholder pensions but that ‘just as important is educating people to help them make an informed decision’.
4.408 The press notice then quoted the Minister as saying:
It is crucial that we provide better information. People need to see in black and white just how much they may or may not have in retirement, so that, if appropriate, decisions to secure additional pensions are made in good time.
Submission to Minister on interim MFR reform
4.409 On 11 January 2002, Ministers had been invited to approve the actuarial profession’s further recommendation, made on 5 September 2001 (see above), to reduce the equity market value adjustment factor from 3.25% to 3%.
4.410 This was to be part of a wider package of reform to the MFR, which included an extension of the deficit correction periods, during which sponsoring employers had to make up shortfalls in scheme funding, the removal of the requirement for certain schemes to obtain annual certifications of the adequacy of the scheme’s schedule of contributions to enable it to meet the MFR, and the introduction of stricter conditions on voluntary scheme wind-up.
4.411 The submission to the Minister said, in relation to the equity MVA proposal, that this aimed at ensuring ‘that the assets which schemes have to hold relative to their MFR liabilities under current economic conditions remains consistent with the original intentions of the MFR’.
4.412 The submission, in its detailed treatment of this proposal, stated that:
As part of its role in reviewing the actuarial basis for the MFR, the Pensions Board of the F&IoA have concluded that changes are needed to the equity MVA in order to align the MFR more closely to the level of protection originally envisaged. The changes are considered necessary mainly because of the trend towards reduced levels and non-payment of dividends by companies (which has the unintended effect of causing the MFR to operate at a level in excess of its original strength), and the increase in life expectancy.
4.413 The submission continued:
Increased life expectancy requires an increase in MFR liabilities. The reduction in dividend yields requires a lowering of the MVA. The F&IoA recommend that the overall impact of these factors can be addressed by lowering the dividend yield in the MVA from 3.25% to 3%. You will recall that the Pensions Board wrote to officials on 5 September 2001 recommending this change. Our response [given on 23 October 2001] explained that we were currently consulting on a balanced package of changes to the MFR and did not propose to make piecemeal changes. But that we would consider this suggestion along with any others we received as part of the consultation exercise.
4.414 It went on:
GAD’s advice is that adjusting the MVA now in the way proposed by the F&IoA is justified under current circumstances. This change will lead to an estimated reduction in MFR liabilities of 7.7% in respect of scheme members who are more than 10 years below pension age, with more modest reductions for those closer to normal pension age. This returns things to the level when the MFR was introduced.
4.415 This part of the submission then set out officials’ recommendation that the Minister ‘agree to adjust the MVA in line with the F&IoA’s suggestion’.
Events during 2002
Consultation on Myners
4.416 On 4 February 2002, the Government issued three ‘consultation documents on recommendations in the Myners Report’.
4.417 These related to Myners’ recommendations:
(i) that where trustees were taking a decision, they should be able to take it with the skill and care of someone familiar with the issues concerned;
(ii) that there should be a statutory requirement for funds to have independent custody; and
(iii) that UK law should incorporate an activist duty (similar to one imposed under US legislation) on those responsible for the investment of pension scheme assets.
Responses to the September 2001 consultation
4.418 Also in February 2002, DWP and the Treasury published a summary of the responses they had received to the consultation on the draft Regulations to make interim changes to the MFR (see above).
4.419 In the light of those responses, the Government said:
(i) that it had decided to proceed with the extension of the deficit correction periods, although this proposal was modified so that the extended periods would apply to new schedules prepared following an MFR valuation, irrespective of the date of the valuation;
(ii) that it had decided to proceed with the removal of the annual recertification requirement for schemes that were 100% funded on an MFR basis, although it was now proposed that, in order to qualify for exemption from the requirement, a scheme had to be ‘fully funded’ both at the effective date of the last MFR valuation and at the time of the funding estimate undertaken for the purposes of certifying the subsequent schedule of contributions;
(iii) that it had made a number of revisions to the detailed draft Regulations to implement the proposal to impose stricter conditions on voluntary wind-up and that the Government would continue to examine what arrangements should apply in areas linked to the MFR as part of the work to develop its replacement.
4.420 While recognising that this had not formed part of the draft Regulations that had been issued for consultation, the Government also announced that it had accepted a recommendation from the Faculty and Institute of Actuaries to amend the MFR equity market value adjustment from 3.25% to 3%. The Government said:
This change would take account, in a simple and straightforward way, of the overall impact on the strength of the MFR test caused by reductions in dividend payments made by companies, and of mortality improvements, and align the strength of the MFR test more closely with its original intended strength.
4.421 The document ended with the statement that the Government would feed other comments it had received during the consultation process into the work it was doing to work up proposals for the replacement of the MFR, assisted by the Consultation Panel.
The Occupational Pension Schemes (Minimum Funding Requirement and Miscellaneous Amendments) Regulations 2002
4.422 The Regulations to put the interim changes to the MFR basis into effect were made on 22 February 2002 and laid before Parliament on 26 February 2002.
4.423 The Regulatory Impact Assessment that accompanied the Regulations noted that there had been widespread criticism of the MFR since it had been introduced. It then set out again the specific interim measures being implemented by the Regulations and argued that the risks of not taking this action would have been:
(i) that schemes would have continued to have had to respond to short-term market fluctuations over an inappropriately short time frame. This would have distorted investment behaviour by encouraging extra investment in gilts (to reduce volatility), or led to short-term cash injections, which may have damaging consequences for the employer, and would have acted against the long-term interests of members;
(ii) that well funded schemes would have continued to have had to invest time, energy and money every year on complex checks which were of doubtful value; and
(iii) that scheme members would not have benefited from the greater security which would be provided by the changes to the calculation of the debt on the employer when a scheme wound-up voluntarily.
4.424 The Assessment then set out the rationale for the Government’s decision not to impose debt on the sponsoring employer in scheme wind-ups of the full amount needed to buy out the pension liabilities of all members through traditional or guaranteed deferred annuities:
While the Government is keen to strengthen protection for members when their schemes wind up, moving to such a stringent requirement would lead to high and uncertain costs hanging over ongoing schemes. This could be unsustainable for many UK companies and could have damaging consequences, including scheme closures in some cases. This would be in no-one's interest.
It should also be realised that guaranteed deferred annuities are not necessarily the most appropriate vehicle for younger scheme members, who might do better over the long period before retirement by investing the value of their existing pension rights in a stakeholder pension or other arrangements.
Finally, the very large size of some schemes is such that movement to an annuity buy-out basis for wind-ups might simply be impractical: there are doubts as to whether the insurance industry could deal with what might be required.
4.425 The Assessment then considered the relative costs and benefits of the Government’s proposals.
4.426 In note 4 to the press notice which accompanied the laying of the Regulations, DWP confirmed that it had approved, on the recommendation of the actuarial profession, the reduction in the equity market value adjustment associated with the MFR test (see above).
4.427 In the debate in the House of Commons Standing Committee on the Regulations on 14 May 2002, the then Minister, Maria Eagle, explained that ‘the Regulations were introduced to improve the way in which the MFR operates in the period up to its replacement’.
4.428 When asked whether the Regulations would speed up the wind-up of insolvent employer schemes, the Minister replied:
The hon. Gentleman should not go away thinking that the regulations apply to the winding up of insolvent schemes. They do not. Delays often occur in respect of insolvent companies but the regulations do not apply to such situations.
4.429 In relation to concerns about the increasing number of final salary schemes that were closed to new entrants, the Minister replied that ‘some 8 million people remain in defined-benefit schemes, so we should not overplay the seriousness of what has happened’. She continued:
Reading the newspapers, one might get the impression that schemes are closing every day and that people in schemes that close no longer have pensions, but that is not the case. Most schemes close to new members alone; very few close to existing members, although that has happened… the situation is not all doom and gloom.
Press notice by actuarial profession
4.430 On the same day as the MFR changes were announced, the actuarial profession released a press statement, which had been seen by DWP in draft, under the heading ‘actuarial profession welcomes Government’s changes to MFR’.
4.431 This statement began:
Today's government changes to the Minimum Funding Requirement (MFR) are a helpful easing of the burdens on employers. We hope the changes will encourage employers still to sponsor occupational pension schemes - particularly those of the defined benefit type.
[The then] Chairman of the actuarial profession’s Pensions Board warned that the Government does need to be honest and open about the impact of any such measures on member security, particularly if, as a consequence, there is an increased chance for some members that the pension they expect will not be delivered.
We recognise that the government’s task is not an easy one - it isn’t possible to bolster member protection in occupational pension schemes and at the same time reduce the cash burdens on employers. These are conflicting objectives.
4.432 The statement continued to outline the changes that it specifically welcomed, which it listed as being:
- the ‘acceptance of the change we recommended to the… [equity] MVA - to recognise current market conditions and the lower dividend payouts in recent years. This change eases the burdens on employers by reducing the amount needed to meet the MFR. But it also reduces the amount of minimum transfer values for people changing schemes’;
- the ‘extension of the "deficit correction period" giving employers the extra flexibility which they have been seeking in funding patterns and their own cashflows, but still within a disciplined framework for funding their schemes’; and
- the ‘reduced administrative burdens on trustees and employers by removing annual recertification for schemes that pass the MFR test. However this could give a lower level of member protection for such schemes and this should be recognised by the government’.
4.433 However, the profession went on to:
…caution that:
- the removal of these annual funding checks means that, for as long as 3 years, there will be no statutory mechanism to check that contributions by the employer are still sufficient when the next actuarial valuation is due;
- the fact that a scheme is funded at the level of 100% on the MFR basis is no guarantee that it will continue to be so over the next three years. A significant proportion of schemes have seen reducing MFR funding levels over the past three years. In current conditions an interval of 3 years between valuations is one in which funding levels can decline rapidly. Scheme trustees and their advisers will need to continue to be watchful in carrying out their duty towards pension scheme members; [and]
- we also recommended that the government should not implement the removal of annual funding checks, if no workable solution could be found to provide compensating provision to protect members. In the event the government has introduced the dispensation but has decided to apply it to schemes with funding levels lower than we believe wise, especially in current conditions. This causes us concern.
4.434 The statement concluded by saying:
The interim amendments to the MFR made by the Department for Work and Pensions today follow consultations in which we participated actively. We also co-operated closely with the DWP in making the necessary changes to two of our professional guidance notes, which we are also releasing today.
Revised Actuarial Guidance Note
4.435 On 7 March 2002, the actuarial profession formally issued a revised version (1.6) of their guidance note, ‘Retirement Benefit Schemes - Minimum Funding Requirement’ to reflect the above changes to the MFR basis.
Actuarial profession’s briefing statement on abolition of the MFR
4.436 Also in March 2002, the actuarial profession issued a briefing statement entitled ‘reform of the MFR: consequences of the abolition of the MFR’, which ‘set out the thoughts’ of the Faculty and Institute of Actuaries on these matters.
4.437 After noting that the precise form of replacement had yet to be determined, the statement continued:
..there is an advantage in linking the amount payable by the employer when a scheme winds up and the priority order. This would help ensure that, when a scheme winds up and the employer pays any debt in full, the assets of the scheme would be sufficient to satisfy any priorities set by Government. This would improve on the current situation where an employer can satisfy the debt on the employer regulations by ensuring that the pension scheme has assets to cover both pensions in payment and deferred pensions. However, when pensions in payment are secured, the priority order allocates them funds equal to the cost of purchasing annuities. Annuities currently tend to cost more than the value of a pension in payment on the MFR basis. Hence, currently, where an employer pays this debt in full, the assets remaining after purchasing annuities for pensioners, tend to be insufficient to pay full transfer values for deferred pensioners.
Parliamentary questions on scheme wind-up and under-funding
4.438 On 18 March 2002, the then Minister, Malcolm Wicks, replied to a question from Colin Pickthall MP, who had asked what mechanisms were proposed by the Government to prevent companies from winding-up, closing down or fundamentally altering pension schemes without the consent of scheme members; what measures the Government proposed to introduce to encourage the continuation of final salary schemes; and whether the Government would bring forward proposals for legislative reform to increase member protection.
4.439 The Minister replied:
Occupational pension schemes are provided voluntarily by employers, and they are therefore free to decide whether to continue to provide such pensions in the future. The legislation that is in place is to ensure that the pension rights that individuals have already built up in schemes are protected…
The Government have already announced proposals to replace the minimum funding requirement (MFR) with a long-term scheme specific funding standard in the context of a regime of transparency and disclosure, with additional measures to strengthen security. This will be taken forward as soon as parliamentary time is available. Meanwhile the Government announced a package of changes on 26 February to improve the way the MFR operates in the period leading up to its replacement, and increase protection for pension scheme members where an employer decides to wind a scheme up voluntarily.
We have asked Alan Pickering and Ron Sandler, in two separate studies to review the regulation and operation of the pensions, and the wider market of savings products, including final salary schemes. Alan Pickering will report, with recommendations for reform, in June and Ron Sandler will also report around that time.
The Government will then set out its proposals, which will build on the reforms put in place since 1998, and on which it will consult, to simplify the regulatory system, to look at how the Government and employers encourage and support pension savings, and to make sure that the most appropriate incentives for savings in retirement are in place.
We have already announced last month an interim package of measures to improve the way the minimum funding requirement works, which will reduce compliance costs for employers with defined benefit pension schemes.
4.440 On 21 May 2002, in response to a question from Peter Duncan MP, the Minister explained that, in 2000, 13% of private sector final salary schemes had been under-funded on an MFR basis, made up of 6% which were funded at a level below 90% of the MFR level and 7% funded at between 90% and 99% of that level. He also explained that, by February 2002, it was estimated that the total proportion of under-funded schemes had risen to one in six.
Revised Actuarial Guidance Notes
4.441 Meanwhile, on 19 March 2002, the actuarial profession had issued a revised version (4.2) of their guidance note, ‘Retirement Benefit Schemes - Winding-up and Scheme Asset Deficiency’ and also a revised version (2.0) of their other guidance note, ‘Retirement Benefit Schemes - Minimum Funding Requirement’.
Accuracy of information project
4.442 On 22 March 2002, the DWP departmental board signed off the final report of its ‘Accuracy in Information’ project.
4.443 The project had been established in April 2001 in the light of critical reports by my predecessor and the Comptroller and Auditor General, both issued in March 2000, concerning the quality of the information that had been provided by DSS in relation to changes made by legislation to the arrangements for the inheritance of SERPS.
4.444 The National Audit Office report had said:
Where the Department provide publicity about legislative changes, they have a responsibility to ensure that the information is correct and not misleading. We consider, therefore, that:
a) the Department’s new procedures for ensuring the contents of leaflets are complete and accurate should in the future be applied systematically to all publicity material, including electronic sources. Although the Department are responsible for the quality of their publicity, they should also consider how they can engage pressure groups and other interested parties more in consultation on the text of new leaflets and other publicity material. They should also ensure that the new arrangements allow for the handling of ad hoc corrections notified to the Department outside the regular review process;
b) particular attention should be paid to ensuring that information about changes to legislation that do not come into effect for some years is included in publicity material;
c) given the potential consequences of incorrect and incomplete leaflets, this area remains high risk, and we suggest that the Department’s Internal Audit Service undertake a regular review to ensure that the new arrangements for ensuring complete and accurate leaflets are being implemented effectively; and
d) the current work to develop the information provided in state pension forecasts (the means by which citizens are able to obtain a projection of what pension they will receive at state retirement age, based on a series of assumptions), and the amount of explanatory material accompanying it, should be progressed as soon as possible as part of the wider improvements to the information about pensions available to citizens.
4.445 Legal advice provided to the project team on 26 May 2000 had confirmed earlier advice, given on 17 November 1999, that the Government was not under a general duty to provide information or advice. It also said that, if it did so in circumstances where the recipient could be expected to rely on it, the Government would be liable for loss resulting from the information or advice ‘being incorrect’.
4.446 The adviser noted that ‘being incorrect’ included ‘telling only part of the story’. The legal adviser continued (with my emphasis):
On the face of it, the best general approach would seem to be for the Department to concentrate on administering the system and providing appropriate information about it. We should leave the task of giving advice to the professional advisers like CABx and Age Concern and make sure that to the extent that they have information from the Department it is clear and reliable so that they can perform their functions most effectively.
4.447 On 31 May 2000, the Policy Director of DSS had stated that ‘in the pensions context, the department believes that its role should be to give accurate information on the options available but to avoid giving advice on which option to choose’.
4.448 Further legal advice had been provided on 8 March 2001, which had confirmed the earlier advice and which, in a DWP official’s summary of it, had said that ‘where we choose to give information it is incumbent on us to ensure it is accurate, complete and can be relied on’.
4.449 On 11 September 2001, the Executive Team of DSS had been invited to agree a Departmental objective on accuracy which was defined broadly as being that ‘all information provided to customers by any part of the DSS, by any method, should be accurate and up-to-date, with no significant omissions’ (with original emphasis). This objective had been agreed and the minutes of that meeting had stated that further consideration of the impact of this objective ‘was particularly relevant to the development of the Working Age Agency [later to become JobCentre Plus] and new Pensions organisation [which later was named the Pensions Service]’.
4.450 The project led, in line with its aims, to the development of agreed definitions of ‘information’ and ‘advice’ and of the department’s role in relation to both; to the adoption of information and advice standards frameworks within each part of the department and implementations plans for each; to a DWP Information Strategy; and to a content review process for public information leaflets.
4.451 It also led to the revision of ‘Financial Redress for Maladministration’ to, among other things, incorporate the agreed role of the department in relation to information and advice and also the new definitions of both.
The work of the Consultation Panel
4.452 On 7 May 2002, the MFR Consultation Panel met to discuss ‘reform of MFR: consequences for allocation of assets on wind-up and scheme asset deficiencies’ as part of its series of themed meetings. It discussed possible ways of requiring the disclosure to scheme members of various types of information about their scheme within the new statutory regime to be implemented, and what that information should contain.
4.453 The minutes of the Panel’s meetings make clear that there was little general agreement about how best to communicate scheme funding issues to scheme members in terms which were accurate or ‘fit for purpose’ while being at the same time generally understood.
Occupational Pensions: Your Guide
4.454 In May 2002, DWP published a leaflet called ‘occupational pensions: your guide’ (PM3). This 28-page leaflet began by stating (with original emphasis):
Everyone needs to plan ahead for retirement. The basic state Retirement Pension will give you a start, but you’ll need to build up a second pension to make sure you have the lifestyle you want in retirement. And the sooner you take one out, the better.
To help you, this guide tells you how occupational pensions work. It looks at some of the questions you may need to think about and it tells you where you can find more information…
These guides can give you helpful information, but only you can make decisions about your pension.
4.455 After describing what an occupational pension is and the links between such a pension and the state additional pension, in a section headed ‘is an occupational pension a good choice for me?’, the guide continued:
For people in work, occupational pensions are usually a very good way of saving for a second pension. But the effectiveness of any occupational pension will depend on your working patterns and your personal circumstances, such as your pay.
Generally, if you work and your employer offers you an occupational pension scheme… you would be better off joining it… If you are already a member of an occupational pension scheme, you may already be in the most beneficial pension arrangement. Occupational pensions are usually a very good deal, so… check it out carefully when you are looking at your pension options.
4.456 The guide continued with an explanation of the different types of scheme, the tax relief arrangements and the possibilities for making additional contributions to schemes. It then went on to discuss ‘how do I know my money is safe?’:
Although your employer pays into the scheme and may be a trustee, the assets of the pension scheme belong to the scheme and not to your employer. As a scheme member, you are protected by a number of laws designed to make sure schemes are run properly and to make sure funds are used properly.
In particular, there are laws about:
- the way occupational pension schemes must be run;
- the information you must be given;
- people who are not eligible to be trustees…;
- some of the trustees being nominated by the members;
- who the trustees should be…;
- the way the funds are invested;
- the records that the scheme provider must keep; and
- who is authorised to manage pension investments.
4.457 In relation to regulation, the section continued:
OPRA is responsible for regulating occupational pension schemes. They can act quickly to protect your interests if the trustees who run the scheme, or your employers, do not meet their obligations.
4.458 After dealing with the position if the reader changed employment, the guide informed them of other sources of useful information provided by DWP and the Inland Revenue and also explained the rules regarding scheme dispute resolution procedures and the arrangements for pension sharing on divorce.
4.459 The back of the guide stated that ‘this leaflet is for guidance only: it is not a complete statement of the law’.
The Sandler Review
4.460 The Treasury published the report of the Sandler Review on 9 July 2002, which had been led by Ron Sandler, a former chief executive of Lloyd’s of London. The Review, whose report was entitled ‘Medium and Long-Term Retail Savings in the UK’, had been announced on 18 June 2001, with a remit to ‘identify the competitive forces and incentives that drive the industries concerned, in particular in relation to their approaches to investment, and, where necessary, to suggest policy responses to ensure that consumers are well served’.
4.461 While noting that there was much positive about the financial services industry, the report identified a number of causes for concern. These were the high degree of complexity (including the wide use of ‘technical terms which are largely incomprehensible to the layman’), considerable opacity and a resulting inability to compare products and providers, consumer detriment caused by commission-driven selling, and problems with institutional investment decision-making. The report considered that these had contributed to a problem of consumer reluctance to save, particularly among the lower-paid.
4.462 After considering these concerns in detail, the report then set out its view as to what a well-functioning market for retail savings might look like. It said that such a market would be one in which, among other features, consumers had a reasonable understanding of retail savings products, where proper competition for authoritative, high-quality and reasonably priced advice flourished, where products were simple and straightforward, and where consumers, particularly in lower income groups, could reasonably easily access the markets for products and advice.
4.463 The report then went on to recommend the development of ‘stakeholder’ savings products to realise the aim of maximising the saving potential of all groups in society.
ASW goes into receivership
4.464 On 10 July 2002, Allied Steel and Wire went into receivership. The official receiver for the company, which employed about 1,000 workers in Cardiff, 400 at Sheerness in Kent, and 30 in Belfast, began to wind up its two final salary pension schemes one week later. This followed BUSM in 2001; Dexion went into receivership in 2003.
4.465 Early estimates were that the ASW schemes would only be able to meet approximately ten per cent of their liabilities towards non-pensioner members. At the same time, the ASW Sheerness scheme was reported as being 104% funded on the MFR basis.
The Pickering Review
4.466 The Government published the Pickering Review on 11 July 2002. The Review – whose report was entitled ‘A Simpler Way to Better Pensions’ – had been announced by the Government on 26 September 2001 and had been led by Alan Pickering, a former head of the National Association of Pension Funds.
4.467 Its terms of reference had been to carry out a comprehensive review of DWP private pensions legislation to identify a ‘package of options for simplification and the reduction of compliance costs’; to consider the principles behind the legislation as well as its supporting processes and ensure that the law was proportionate to the policy purpose; to consider the means by which the regulatory framework was enforced; to identify areas of simplification which could be achieved by secondary legislation and identify more fundamental reforms to be achieved by primary legislation; and to report to the Secretary of State by July 2002 with proposals for simplifying the regulatory framework that did not compromise the security of individuals’ investments.
4.468 The review was to have regard to the need to maintain effective protection for pension scheme members; wider economic and exchequer effects; the links with and impacts on tax rules and work being done on this by the Inland Revenue; the separate work to implement the recommendations of the Myners review and to reform the MFR; and the work of the forthcoming five-yearly review of OPRA.
4.469 The Review’s objective, the report said, was to identify ways to make it easier for employers to provide good quality pensions for their employees, easier for commercial providers to sell appropriate products to appropriate people, and easier for individuals to accumulate pension benefits.
4.470 The report identified three key themes: first, the ‘need for a proportionate regulatory environment’; secondly, ‘a pension is a pension is a pension’; and, finally, ‘more pension, less prescription’.
4.471 The key proposal of the Review was that a new Pensions Act was required to consolidate all existing pensions legislation and to deliver reform.
4.472 In relation to the provision of information to scheme members, the report suggested that too much emphasis had been placed on the provision of information by schemes and that, whilst this was an important issue, such disclosure was not a panacea. The report acknowledged that communication had a role to play in alerting members to risks and enabling them to take action to protect their interests, but asserted that the provision of information had much more to do with consumer enlightenment than with benefit security.
4.473 The report concluded that the provision of too much, poorly targeted information had resulted either in information being ignored or in people failing to take action which it had been in their interests to take.
4.474 It recommended that any communications should be based on the following principles:
(i) communication should be aimed primarily at influencing behaviour. The information should give individuals the facts they needed to decide whether to join, stay in or leave a scheme;
(ii) communication should provide members with basic information about their likely pension - including setting out (in broad terms) the risks;
(iii) individuals should be properly informed of major events which might affect members and their options on leaving or retiring or what would happen to their pension if they die;
(iv) it was also necessary to provide information to assist the protection of members - people in defined benefit schemes should have access to information about their scheme’s funding position; and
(v) all communication with members should be tested to see whether it was understandable and would work.
4.475 The report recommended that only key pieces of information should be sent automatically to members, with all additional information being available on request.
OPRA guide to winding-up
4.476 On 6 August 2002, OPRA published a guide which outlined the new arrangements for, and its new powers to speed up, the process of winding-up pension schemes, which had been introduced in April 2002. The guide was published as an ‘exposure draft’.
4.477 In appendix 3 to the guide, OPRA said:
Some time ago [NICO], in consultation with the pensions industry, made plans to deal with the delays in providing membership listings and relevant calculations… Most reconciliation issues centre on agreeing the scheme membership and the main reason for the problem is the provision of inconsistent information to both the scheme administrator and [NICO]. Part of the solution is good record keeping during the lifetime of a pension scheme and regularly updating [NICO] and administrators about changes. OPRA and [NICO] work closely together to ensure a consistent approach.
DWP evidence to Select Committee
4.478 On 4 October 2002, DWP submitted a memorandum to the parliamentary Select Committee on Work and Pensions, which oversees its work. This set out the background to, and the detail of, the Government’s reform agenda.
4.479 In a section entitled ‘role of the state’, DWP said that:
The immediate role for the state is to provide help and encouragement for people to save, providing the right rewards for saving, and making sure it pays to save. It must also ensure proper protection for savings. As part of that role, the Government is examining ways to strip away some of the layers of regulation that have built up around some pension and savings products; and provide clear and accurate information about what pensions will provide so that people will understand how much they can expect at retirement before it is too late to do something about it.
4.480 In explaining the role of the recently established DWP agency, the Pensions Service, the memorandum explained that one of its roles would be to ‘improve the service to future pensioners, by providing accurate information to help them make decisions about saving for their retirement’.
4.481 It continued:
The Department is actively promoting a pension education publicity campaign that is supported by a range of simple, impartial guides. The purpose of the campaign is to promote awareness of the importance of saving for retirement with the objective of encouraging people to save. The main elements of the campaign include media and TV advertising, and direct marketing to specific target groups such as young people, women and the self employed.
4.482 The memorandum went on to state the Government’s intention to ‘continue to encourage people to take out private pension provision as part of its overall savings strategy, by making people more aware of the “need” to save and how much pension a given level of saving will guarantee, and by increasing people’s knowledge of the options available’.
4.483 It then explained that the provision of final salary schemes was something that ‘the Government will want to continue to positively encourage in the future’ although ‘it is not the Government’s role to champion the cause of either defined benefit or defined contribution schemes’.
4.484 In the subsequent Select Committee report, which was published on 14 April 2003, the Committee recommended, in relation to financial education, that the FSA pass some of its functions, especially those related to the marketing of - and education about - pensions, to the proposed new regulator; that the Government support a pilot scheme to improve financial literacy; and that, with each substantive change to state benefits, an impact assessment of these changes on savings patterns should be produced and published.
The NAO report on OPRA
4.485 On 6 November 2002, the Comptroller and Auditor General published a report by the National Audit Office (NAO) called ‘OPRA:
Tackling the Risks to Pension Scheme Members’.
4.486 The NAO report found that the then current regulatory arrangements addressed only some of the risks to pension provision. It continued:
There is little, however, that any regulator could do directly about one of the biggest risks to pension scheme members receiving the pension they expect, that of the employer going out of business or closing the scheme. Employers are not obliged to provide an occupational pension scheme and incur significant cost in supporting one. Scheme trustees are volunteers, mostly unpaid, whose dedication and goodwill is essential to good governance. The burdens of regulation, including Opra's actions, could increase the risk of employers closing their schemes to the detriment of the members concerned.
4.487 A footnote to the above paragraph explained further:
If the employer closes the scheme, it is still liable to fund for pension rights already accrued. If an employer becomes insolvent, then insufficient funds may mean that all members may suffer - pensioners and, more probably, employees (future pensioners). The risks to members once a scheme is closed relate to pension rights that an employee would have expected to gain in the future.
4.488 The report also set out the NAO’s findings that OPRA had encouraged better governance of pension schemes; that it had little information on the outcome of its work; that such work had focused on reports about matters that posed a low risk to scheme members; that it had taken a long time to develop its approach to the identification of high risk schemes; and that its objectives did not clearly articulate how its work should protect scheme members.
4.489 It recommended that OPRA should:
(i) become better informed of the risks facing pension scheme members as the lack of information it possessed constrained its ability to identify risks to members’ pension rights;
(ii) produce a document that set out its regulatory functions and objectives clearly so that it could be seen to perform those consistently and transparently;
(iii) develop different communication approaches for different types of scheme, including guidance on the features of a well-administered scheme;
(iv) utilise distinct but proportionate regulatory approaches for different types of scheme;
(v) shift their resource allocation to target schemes and common weaknesses posing the greatest risks;
(vi) focus more regulatory effort on providers and third-party administrators; and
(vii) raise the threshold for the reporting by whistleblowers of breaches of pensions legislation so that only material breaches were reported.
4.490 The report also recommended that DWP, in developing proposals for a new regulator, should be clear about what it expected from the new body and how it should report performance against this expectation - and should consider whether the new regulator should act as the centre of expertise on occupational pensions.
4.491 In the Committee of Public Accounts report which resulted, published on 31 March 2003, the Committee came to four ‘main conclusions’. These were:
(i) that OPRA and DWP had been slow to develop objectives and tackle legislative constraints and as a result had failed to address major risks to pension scheme members;
(ii) that OPRA did not consider that it had the power to prevent another Maxwell case;
(iii) that OPRA had done little to check the suitability of trustees or the appointment of advisers to pension schemes; and
(iv) that OPRA had focused on trivial cases.
4.492 The Committee also commented:
Many pension schemes have been closing to new members, reducing the benefits they provide, or are insufficiently funded to meet all members’ entitlements if they are wound up. Many scheme members are concerned about the security of their retirement income and others may be making insufficient provision. OPRA has little role at present in tackling these concerns, since its focus is on the way pension schemes are governed, but its expertise could be used to inform the future of pension provision. A new regulator would be more effective with a wider-ranging role in advising the Government on pensions-related issues in general, such as the closure of schemes with insufficient assets to meet their commitments to all members, and educating employees and trustees on how to make pension choices.
Select Committee on Work and Pensions hearing
4.493 On 4 December 2002, the parliamentary Select Committee on Work and Pensions took evidence from OPRA, from the Pensions Ombudsman, and from the Chief Executive of the Occupational Pensions Advisory Service (OPAS) as part of its inquiry into the future of pensions in the UK.
4.494 In a discussion on the MFR, the Chief Executive of OPAS said:
There is a great deal of misunderstanding about the minimum funding requirement; certainly as far as scheme members are concerned, if they have heard of the phrase at all, they think that it is some sort of solvency test, some sort of guarantee that in the event of something going wrong, they will get their full pension entitlement.
4.495 He continued:
The minimum funding requirement is not that, it is simply a requirement that a scheme has to be funded over a period of time to match a level which will guarantee the pensions in payment and some part of the pensions entitlement of those who have not yet retired. It is a very imprecise measure of funding. One of the great problems is that many employers are now seeing this as a maximum funding requirement as distinct from a minimum funding requirement. We have seen one or two quite bad examples recently of very large employers who have decided to close down, to wind up their pension schemes and they have been content to limit the funding at that point in time to the level of the minimum funding requirement. This has meant that the pensioners have continued to get their pensions, but the active and deferred members, people who have not yet retired, are only getting 50 to 60% of what they believed to be their pension entitlement.
4.496 The Chief Executive then said:
There is a fundamental problem there with a minimum funding requirement and if we are going to have a funding requirement, it should be a proper one and should attempt roughly to match the anticipated liabilities of the scheme so that in the event of an employer choosing to wind up a scheme, and that is his decision and I am not challenging that in any way, then the money is guaranteed to meet most if not all the pensions in payment. That is a situation where the employer is solvent. Where the employer is insolvent, you have a very different situation. It is often the case in my experience, that an insolvent employer will leave behind him an insolvent pension scheme below the minimum funding requirement or even only at the minimum funding requirement in the best cases.
In that situation you have a real problem because the members, even pensioners, are not guaranteed to get all the pensions. What happens in practice is that all the funds are then used based on a priority order which is laid down in regulations to try to fund the pensions in payment, leaving very little for anyone else.
The example I quoted in my submission to you is of a man who paid into a final salary scheme for 38 years and was on the brink of retirement when suddenly the employer went bust, the pension scheme was found to be underfunded and he ended up after 38 years with a fraction of the pension he was expecting to get. That is a devastating situation for somebody in that position.
Something needs to be done to address that. If we cannot amend the minimum funding requirement to guarantee a level of pension, and it might be very difficult with an employer who has gone insolvent, then it may be the approach is the other way round, some sort of insurance.
BBC story on Sea-Land wind-up
4.497 On 13 December 2002, the BBC ran a story – under the heading ‘Did the Maxwell affair change nothing?’ - about the winding-up of the pension scheme for staff at Sea-Land - a division of Maersk, the Danish shipping group.
4.498 After setting out the background to the case and its similarities with other examples – including that of the scheme of which Mr J was a member – the article quoted a spokesman for OPRA as saying:
When a pension [scheme] is 100% funded for the minimum funding requirement there may only be money in there for 40% of the benefits.
4.499 The article then quoted work done for the BBC by a leading actuarial consultancy which estimated that, since the beginning of 2002, the level of funding in employer schemes which invested most of their money in shares had shrunk by an average of 15% to 20% and that three-quarters of the UK’s pension schemes were in deficit, compared to less than half in January 2002.
The further Green Paper on Pensions
4.500 DWP, the Treasury and the Inland Revenue published a further Green Paper on Pensions, entitled ‘Simplicity, Security and Choice: Working and Saving for Retirement’, on 17 December 2002.
4.501 The then Secretary of State for Work and Pensions, Andrew Smith, in the Foreword to the Paper, said that the Government’s aim was to ‘help people choose how they plan for retirement, how much they save and how long they keep working’.
4.502 In the words of its summary, the Paper set out:
…the Government’s proposals to renew the partnership between the Government, individuals, employers and the financial services industry which has long been a strength of the UK pensions system.
The new proposals will:
- help people make better informed choices about their retirement;
- reaffirm the role and responsibilities of employers in the pensions partnership, improving saving through the workplace, and providing greater protection for members of occupational schemes;
- encourage simple and flexible savings products, broadening access to the financial services industry; and
- introduce measures to extend working lives.
4.503 The Paper set out the ‘background of increasing concern’ over the adequacy and security of pension provision in the UK. The main concerns it discussed were increased longevity, signs of a decline in work-based pension provision, the complexity of pension products, the cost of financial advice, the legacy of personal pensions mis-selling, and a trend towards earlier retirement. It also referred to the fact that ‘employee confidence has also suffered due to the action of a few companies, who have let their employees down when they have become insolvent with an under-funded pension scheme’.
4.504 Under a heading ‘informed choice for individuals’, the Paper continued:
The Government provides the foundation of pension income, but in a voluntary system the amount people should save in addition to the basic State Pension will depend on their own circumstances and preferences… Current estimates show that up to 3 million people are seriously under-saving for their retirement – or planning to retire too soon. In addition, a further group of between 5 and 10 million people may want to consider saving more, working longer, or a combination of both, depending on their expectations for retirement.
The Government believes this reflects the fact that choice is currently frustrated by complexity and confusing flows of information which do not relate clearly to an individual’s circumstances, by hard-to-compare products and by expensive advice. The Government wants to help people make better informed choices about their retirement and believes that those who seem to be saving too little will save more if:
(i) there is a simpler framework to help people understand their choices; and
(ii) individuals are equipped to understand financial choices and receive clear information tailored to their own circumstances.
4.505 After setting out the Government’s proposals to simplify the tax regime for pensions, the Paper continued:
The Government recognises the value of good information in helping people to make informed choices, and will continue to work with the FSA to improve basic financial literacy and make sure that individuals are equipped to understand financial choices.
But the Government also believes that providing tailored information based on an individual’s circumstances will make the biggest difference and encourage people to save more.
4.506 It then set out the proposed approach to achieve this, which included strategies:
(i) to increase the number of people receiving forecasts of their pension income - for example by working with employers and scheme providers to increase the uptake of the combined state and non-state forecasting service; and
(ii) to improve the range of services providing tailored information – by offering integrated telephone and internet services and by issuing information at key points in people’s lives to encourage greater awareness and understanding of savings options.
4.507 The Paper also set out the Government’s aim to make it easier for employers to set up and run good pension schemes. This would be complemented by a strategy to simplify the complexity in pensions legislation and the associated tax regime.
4.508 Key elements of this approach would be the removal of unnecessary administrative and tax burdens, the replacement of the MFR with a scheme-specific funding standard, the simplification of the structure of contracted-out benefits, and the consolidation of existing legislation. The replacement of the MFR was described as being able to ‘make the funding position more transparent for members’.
4.509 The Paper went on to note that these simplifications could save employers between £150 million and £200 million a year in administrative costs but that there was a balance to be struck in the reform process with the need for better protection for scheme members.
4.510 It continued:
The Government is determined to ensure that reduced regulation and red tape around pensions is married with greater protection for consumers to give them the confidence they need to join schemes. This is why the Government is proposing a new pensions regulator that will focus on protecting the benefits of scheme members. The new regulator will operate proactively to anticipate problems, concentrating its effort on schemes where it assesses that there is a high risk of fraud, bad governance or maladministration. To reinforce this approach the Government is also looking at proposals to protect members when problems do arise, such as when employers become insolvent or when there is insufficient funding in the pension scheme to meet all the pension liabilities.
4.511 The Paper summarised the proposals set out in the Green Paper as being ‘better information, simpler pensions, simplified tax treatment, better protection, and more flexible retirement’ which were ‘designed to enable people to make their own choices for retirement’.
4.512 Chapter 3 of the Paper dealt with ‘informed choice in pensions – choices for individuals’. It started with the recognition that there were a ‘range of barriers’ to pension saving in the UK and that these barriers needed to be addressed. It then stated the Government’s belief that people would be more likely to make adequate provision for their retirement if there was a simple framework of law and regulation governing pension provision, if they were equipped to understand financial choices, if they were provided with ‘clear information tailored to their own circumstances’, and if they were offered a choice of suitable products.
4.513 In relation to the role of official publicity in attempts to remove barriers to being able to navigate the pensions system, the Paper said, in paragraphs 31 to 33 of Chapter 3, that:
The current government awareness campaign, supported by a series of pensions information guides, has been running since January 2001. More than 2 million copies of the guides have been distributed. The campaign so far has focused on making people aware of the need to save for retirement whilst also providing simple and impartial information on pension options.
The Department for Work and Pensions’ research suggests that it is having the desired effect on public attitudes: more people agree that it is better to start saving sooner rather than later for retirement than did before the campaign began. However, similar campaigns (such as those on drink-driving or wearing seat belts) have historically taken a significant length of time to change public attitudes in a major way. The campaign must therefore be sustained over the long term.
We intend to build on the work that has already been done, by moving the emphasis of the campaign away from promoting simple awareness of the need to save, and towards information that will prompt people to take action. We will also ensure that the publicity campaign is linked into other initiatives, such as life events marketing…, that might be developed as part of this Green Paper.
4.514 With respect to the detailed discussion in Chapter 4 of the Paper about the security of final salary pensions, the Paper noted that:
…if they are to join schemes, prospective pension scheme members will want to have confidence that the pensions they are promised will actually be delivered. Most people receive the pension they are promised, but sadly there are exceptions. There has been a lot of concern in recent months about pension schemes that are being wound up, either through the decision of a solvent employer or as a result of the employer becoming insolvent.
We are determined to act to increase protection for scheme members. We will increase security but we will aim to ensure that in doing so we do not increase the overall burden on employers providing pensions. Employers provide schemes voluntarily, and we need to ensure that they continue to choose to do so. We want this consultation to inform our strategy so that we can provide greater protection without risking scheme existence. We recognise this is a difficult balance to achieve.
4.515 The Paper then discussed the detailed proposals for inclusion in a new Pensions Bill. These included the establishment of a proactive regulator whose objectives and resources would be focused on protecting the benefits of scheme members; greater protection for accrued pension rights on wind-up through changes to the priority order in which liabilities would be met; a central organisation or form of insurance to protect scheme members whose sponsoring employer became insolvent; increased compensation in the case of fraud or dishonesty; and measures to ensure that members had the right to be consulted about changes to their scheme.
4.516 The Green Paper also sought views on whether insolvency law should be amended to give pension schemes higher preference than other unsecured creditors when the assets of an insolvent company were being shared out.
4.517 In relation to solvent employers who chose to wind up the scheme that they had been sponsoring, the Paper said:
When [employers] do this they need to make arrangements to meet the pension promise they have made to their past and present employees. There have been instances recently in which members have lost out substantially under these circumstances. The Government believes that members need greater protection against such losses.
In March 2002, we increased the amount of money that solvent employers have to put into the pension fund if they choose to wind up the scheme. This means that employers are required to put enough money in to buy annuities with an insurance company for pensioners (guaranteeing their full pension) and for people who had not retired, the value of their accrued benefits, worked out on the MFR basis (which they can transfer to another pension arrangement). It does not guarantee the full pension they were expecting as the transfer value is calculated by making assumptions about the level of investment growth between the time of wind-up and when the individual retires. If investment growth is more or less than assumed then the value of the pension fund at retirement could be similarly greater or smaller. With transfer values, therefore, the risks are borne by the individual.
After the replacement of the MFR with scheme-specific funding requirements, it will be for schemes to determine their own transfer values on a basis that is fair to all. As the MFR has provided a minimum measure of funding, we might expect that in many cases transfer values would be higher than the minimum amount that they were under the MFR.
4.518 The Paper then went on to seek views on whether the then current arrangements for buy-out should be strengthened and, if so, whether this should be done on a full or partial basis, with the latter only relating to existing pensioners and those close to retirement. Responses were sought to the issues summarised in annex 1 to the Paper by 28 March 2003.
4.519 The Paper was accompanied by a technical paper, published at the same time. A separate Inland Revenue consultation document, ‘Simplifying the Taxation of Pensions: Increasing Choice and Flexibility for All’– on detailed proposals to simplify the tax treatment of pensions – was also launched that day.
4.520 The Paper also announced the establishment of two bodies – the Pensions Commission, chaired by Lord Turner – a former Director-General of the Confederation of British Industry - and the Employer Task Force, chaired by Sir Peter Davis – then Chief Executive of the Sainsburys Group. The Commission produced its final report on 30 November 2005, following an interim report published on 12 October 2004 - and the Task Force reported on 13 December 2004.
The technical paper
4.521 The technical paper set out in more detail the Government’s proposals concerning changes to contracting-out, greater flexibility for schemes, the revaluation of preserved pensions, simplification of the rules surrounding pension transfers, pensions on divorce, transfer of undertakings legislation, transfers without consent, and the re-introduction of compulsory scheme membership in certain situations.
4.522 It also dealt with two issues relevant to this investigation: communication with scheme members (although the focus of this was on the communication of information to them by the schemes themselves) and the protection of pension rights in the case of wind-up.
4.523 In relation to communication with scheme members, the technical paper set out the relevant findings of the Pickering Report (see above) and the Government’s view on them, which was to accept most, but not all, of the Pickering recommendations.
4.524 In relation to the protection of pension rights during wind-up, the technical paper first set out the Government’s decision that pensions legislation should retain a statutory priority order and then asked for views on whether such a continued order should be based on either increasing the priority given to people who were approaching retirement age or basing the level of protection on the number of years an individual had contributed to the scheme, regardless of age, as had been proposed by Frank Field MP.
4.525 The technical paper continued with a discussion of the options for reform of the statutory priority order of creditors of insolvent companies. It set out the circumstances in which certain debts owing to pension schemes were treated as preferential debts and then explained that, in relation to other debts not covered by those circumstances, pension schemes were unsecured creditors who were categorised at the bottom of the list of creditors that could make a claim on the assets of the relevant company.
4.526 In relation to any reform of the priority order to give pension schemes higher priority, the technical paper sought views on what the right balance should be between the potential impact of such reform on business and the need to provide adequate protection for scheme members.
The quinquennial review of OPRA
4.527 The Government also published the report of the quinquennial review of OPRA on 17 December 2002. The review had been undertaken by Dr Brian Davis – a former Chief Executive of the Nationwide Building Society - with the purpose of commenting on the performance by OPRA in the discharge of its statutory functions and to make recommendations for the future.
4.528 The report’s findings were that OPRA was an organisation that had performed well within the limitations of the powers it had been given; that it had potential to take on a new and different role and to develop further; and that it was seen to be open and accessible. It reported that OPRA would welcome a more pro-active role.
4.529 The principal recommendations made in the review included:
(i) that occupational pension schemes would continue to require supervision by a regulator and that a ‘new kind of regulator’, to operate at ‘arms length’ from the Government, was needed to deliver the regulation of future revised pensions legislation;
(ii) that the current pensions environment and public expectation suggested that a pro-active regulator was needed - within a revised legal framework which set out its objectives clearly;
(iii) that the new regulator’s objectives should reflect the need to focus on the key risks to pension scheme members – and the need to be seen to be doing so;
(iv) that the current legal framework had meant that OPRA had processed high volumes of relatively low value reports and breaches - which was not consistent with a risk focused and pro-active approach and that this should be remedied in the revised legislative structure;
(v) that the new regulator’s guidance to scheme advisors should direct them to ‘blow the whistle’ only on breaches that were likely to have a direct impact on the security of members’ benefits;
(vi) that a pro-active regulator would not only investigate and sanction, but also encourage compliance through education and guidance;
(vii) that the number of bodies involved in the fields of pensions authorisation, sales, marketing, advice and regulation had led to confusion, which should be addressed;
(viii) that OPRA had produced ‘good quality publications and a popular website’ – and that the new regulator should build on this foundation; and
(ix) that OPRA had a low public profile but was well known amongst pensions professionals – the new regulator would need to decide on its key audiences for publications and other communications and to co-ordinate this with information issued by other bodies.
Events during 2003
Parliamentary exchanges on scheme funding
4.530 In oral questions to Work and Pensions Ministers on 13 January 2003 in the House of Commons, John Bercow MP asked, in the light of ‘widespread and justified concern about companies which, in choosing to wind up their final salary schemes, universally [reneged] on their pensions obligations to their staff’, whether the Government’s proposals for reform of the MFR would lead to greater or lesser protection for scheme members.
4.531 A then DWP Minister, Maria Eagle, replied, referring to a then recent high-profile case, that such actions were currently lawful if ‘pretty disreputable by any standards’ and that the Government’s proposals would lead both to a more fair sharing of assets between the different categories of scheme member on wind-up and to enhanced protection for all members’ rights.
Revised Actuarial Guidance Note
4.532 On 13 January 2003, the actuarial profession issued a revised version (2.1) of their guidance note, ‘Retirement Benefit Schemes - Minimum Funding Requirement’, which made only minor technical changes to their guidance.
Parliamentary answer on scheme wind-up
4.533 On 11 February 2003, Ian McCartney, the then Pensions Minister, replied to a question from Frank Field MP, which had asked about the number of pension schemes then in wind-up.
4.534 The Minister replied that:
- during the period from 1 April 1997 to 31 March 1998, 24,974 pension schemes had completed wind-up (these schemes had 541,298 members);
- in 1998-1999, 7,388 schemes (with 165,572 members) had done so;
- in 1999-2000, the figures were 8,151 schemes with 343,365 members;
- in 2000-2001, the figures were 6,047 schemes with 158,118 members; and
- in 2001-2002, the figures were 4,388 schemes with 230,406 members.
4.535 He also said that, during each year, the figures for schemes (and members) who had notified OPRA that they were commencing wind-up were:
- in 1997-1998, 94 schemes with 9,485 members;
- in 1998-1999, 154 schemes with 5,732 members;
- in 1999-2000, 4,623 schemes with 107,397 members;
- in 2000-2001, 1,771 schemes with 76,156 members; and
- in 2001-2002, 2,263 schemes with 77,642 members.
DWP report on the communication of information
4.536 On 27 February 2003, DWP published a report of research it had commissioned into the communication of information to scheme members.
4.537 The research examined how members of such schemes might react to the receipt of detailed information about the funding of their scheme. In particular, the focus of the research was on seeking to establish whether members would read and understand the information provided and what action, if any, they might be prompted to take as a result.
4.538 A sample of thirty people had been selected to receive a specimen letter, drafted by DWP officials, which related to a fictitious scheme. The letter set out the scheme’s funding position following a full valuation, the level of employer and employee contributions, an outline of the actuarial assumptions on which it had been based, and a description of what would happen should the scheme close with funding at its current level.
4.539 The key findings of the research were set out in a DWP press notice that accompanied publication of the report as being thus:
(i) that nearly all respondents said they would read such a document and several commented that it was clearer than other pensions material they had been sent about their own scheme;
(ii) that the general understanding of the document was reasonably good, including those sections relating to the funding position of the scheme. Nevertheless there was some confusion about the purpose of the document;
(iii) that several people did not understand what would happen to the money they had contributed to a defined benefit scheme. They thought they had an identifiable pot of money they could control and alter by, for instance, increasing their contributions if the scheme had a shortfall. It was not clear whether they would seek appropriate advice before taking such steps;
(iv) that the information about the circumstances under which the scheme might close had caused some concern and, for many, was new information; and
(v) that a small number suggested such information might lead them to consider leaving the scheme. All of these respondents said they would consult someone first, but some said they would speak only to colleagues.
4.540 One of the topics covered in the face-to-face meetings with pension scheme members that formed part of this research was their understanding of scheme closure. Discussions with scheme members were organised around testing the participants’ understanding of messages in sample material which discussed three questions: ‘Is my pension guaranteed?’, ‘Why might the scheme close down?’ and ‘Will I get my full pension if the scheme did close down?’
4.541 It was reported, in section 7.1, that, while those who read the sample material ‘had no difficulties in understanding’ that the message was that their scheme could be closed, ‘this was new information for around half’ of the participants. With respect to the others, the report continued:
Some had witnessed their scheme closing to new members or were aware that this could happen but very few were aware that the scheme could actually be closed to active members. Several found this a worrying message:
…“What it states is that the pension is guaranteed so long as they are in existence unless they change the scheme. If it closes down before you retire you won’t get the amount you expect.
It is a worry – I don’t remember ever seeing anything like this in the documents I have read before.
It is very alarming because I didn’t think pension schemes could close down. I thought that it was law that all companies must have a pension scheme.”
4.542 Other comments made by participants in the research included that the material ‘lets you know that your pension is not 100% safe – something I’d never thought of before’ and that, if such information was provided with respect to an actual scheme, they ‘would try to get some information in writing as to the actual likelihood of the scheme closing down and what safeguards there are in place’.
4.543 When material was shown to participants that indicated that, were a scheme to wind-up not ‘fully-funded’, they might not receive their own personal full entitlement, the research reported that ‘many active members were concerned by this… and a good number felt that they would be angry if they received such information about their own scheme’. The report continued:
The respondents who stated that they would be angry were those who did not comprehend how such a situation could have come about… they felt that if they did not receive their full entitlement then they would have been ‘robbed’ by their employer. Some simply felt it could not possibly be the case that they would not receive their full entitlement if their own scheme were to close down.
“It is just rubbish. You have built up the fund and you are guaranteed the pension because of your years of service and for an insurance company to say that they have lost money because they are incompetent and the fund hasn’t made the money it should do – that’s not my fault and I shouldn’t be penalised.”
4.544 The research report came to some ‘key points to consider’ about this material. These included:
(i) that ‘discussing circumstances whereby schemes may close can alarm people and this can become the central message that they take from the document. The alarm partly comes from their lack of knowledge about the possibility that schemes can close’;
(ii) that it is ‘difficult to communicate to members that their pension is not fully guaranteed. This may serve to galvanise people to check on how their schemes are performing but it may also alarm some and/or lead them to take action that is not necessarily in their best interests’; and
(iii) that ‘discussion of how much of the accumulated pension that a member might expect should the scheme close may encourage members to consider supplementary investments’.
Letter from actuarial profession
4.545 The new Chairman of the Pensions Board of the Faculty and Institute of Actuaries wrote to DWP on 28 February 2003. In his letter, the Chairman said:
We last proposed amendments [to the MFR basis] in September 2001 and in the following February the Government approved a change to the basis in GN27. The main driver for recommending a weakening of the MFR at this time was a reduced level of the non-payment of dividends. The extent of this weakening was, however, mollified by an allowance for improvements in mortality.
Since then, MFR has weakened substantially. This is mainly as a result of falling stock markets. We believe that further changes are now needed if the Government wishes to align the MFR more closely to the level of protection originally envisaged. The strength of the MFR is a decision for Government…
Our advice is that retaining the MFR at its current strength in the meantime [i.e. prior to the replacement of the MFR] would represent materially less security of members’ benefits, especially where schemes are funded at the MFR minimum level, compared with the security implicit in the MFR when it was originally introduced.
Revised DWP guide to pension options
4.546 In April 2003, DWP issued a revised version of their leaflet PM1 – ‘a guide to your pension options’ (see entry for July 2001).
4.547 In the section that dealt specifically with occupational pensions, the revised guide repeated the first part of the earlier edition but then, in a new second paragraph, set out amended text which advised:
Occupational pensions are usually a very good deal, so if your employer runs an occupational pension scheme, check it out carefully when you are looking into your pension options.
4.548 In a new section, entitled ‘keep an eye on your pension arrangements’, the revised guide went on to explain that:
…you need to keep an eye on your pension arrangements regularly to make sure you will have the income you want when you retire. If you become better off, you may want to pay in more to build up your pension.
4.549 The revised guide then explained that, in such a position, an individual might make additional voluntary contributions to their occupational scheme or to another scheme, change to a stakeholder pension to take advantage of tax concessions, or make additional contributions to other savings vehicles.
4.550 The revised guide repeated the text about ‘other things that could affect your pension’ that had been set out in the earlier edition.
4.551 In a new addition to a section entitled ‘what do I need to do now?’, the revised guide included a statement that ‘if your employer offers access to an occupational scheme, it is usually worth joining’.
4.552 In addition to the sources of information set out in the earlier edition, the revised guide signposted readers to FSA consumer publications. As with the earlier edition, on the back cover of the leaflet, it was stated that ‘this leaflet is for guidance only: it is not a complete statement of the law’.
Revised DWP guide to occupational pensions
4.553 DWP at the same time also issued a revised edition of their leaflet ‘occupational pensions: your guide’ (PM3). The only relevant substantive changes to the text from the earlier edition (see above) were in the updating of possible sources of information and advice.
DWP guide to contracting-out
4.554 DWP also published in April 2003 a leaflet (PM7) called ‘contracted-out pensions – your guide’.
4.555 In the section dealing with final salary schemes, after explaining that the rules related to Guaranteed Minimum Pensions had been changed, the guide said ‘any GMP that you built up before April 1997 will still be paid when you retire, but pension entitlement you earned from that date will be assessed and paid under the new rules’.
4.556 In a section entitled ‘what else do I need to think about?’, the guide explained the tax relief provisions and the possible effects of living abroad when a person retired. It ended with a list of other official publications or organisations that might be helpful.
Government response to second Green Paper
4.557 On 11 June 2003, DWP published a White Paper or ‘action plan’ – ‘Working and Saving for Retirement: Action on Occupational Pensions’ – which set out its proposals, following the consultation on the most recent Green Paper on pensions (see above), to drive forward its agenda of ensuring that individuals could ‘plan for their retirement and make real and informed choices’ about work, saving and pensions.
4.558 The document set out its proposals for the improvement of member protection thus:
The Government will protect consumers and improve the future security of pensioners by:
(i) introducing a Pensions Protection Fund to guarantee members a specified minimum level of pension when the sponsoring employer becomes insolvent;
(ii) requiring solvent employers who choose to wind up their pension schemes to meet their pension promise in full; and
(iii) revising the priority order which applies on wind-up to ensure the fairest possible sharing of assets.
In addition, the Government will introduce new protection to deal with anxieties arising from the demands of an increasingly dynamic economy where companies are taken over and people move between jobs more frequently.
We will:
- increase protection when firms are bought out by extending the protections offered by the Transfer of Undertakings (Protection of Employment) regulations to the pension schemes of workers in the private sector;
- help people build up rights in short-stay jobs by introducing a new approach to vesting. At the moment, rights are only protected after two years’ employment;
- in future, employees who have been scheme members for at least three months and leave during the vesting period will be offered the choice of a refund of contributions or a Cash Equivalent Transfer Value. This will be of particular benefit to women, who are more likely to change or leave jobs during the period; and
- introduce a requirement on employers to consult before making changes to pension schemes to ensure changes are developed in partnership.
The Government will introduce a new system of private pension regulation with a new Pensions Regulator. The new Pensions Regulator will concentrate on rooting out fraud and bad practice so that everyone has confidence in the system. It will do so in a way that supports our objectives of simplicity and reduced burdens on business.
4.559 In relation to ‘making pension provision easier for employers’, the document reaffirmed the Government’s commitment to replacement of the MFR with a scheme-specific funding arrangement. It also set out proposals to reduce the cap on mandatory indexation, to increase the scope for flexibility for schemes to rationalise the structure of their benefits, and to simplify the legislative framework.
4.560 The Government said that in parallel it would be taking steps to enable people to ‘make their own decisions about how and when to save’.
4.561 The press notice which accompanied publication of the document quoted the then Secretary of State for Work and Pensions, Andrew Smith, as saying:
We have listened to the pension scheme members, employers and the pensions industry - and it is now time for action. This balanced package strengthens protection for scheme members whilst reducing the burden on companies who run schemes. The new Pension Protection Fund will ensure that, where company pensions have been promised, pensions will be delivered. I want to end the scandal of workers being denied the pensions they have built up over many years, or pensioners seeing their pension cut if their firm goes bust and their scheme winds up.
4.562 In his statement to the House on the same day, Mr Smith said that:
…examples of good practice are too often over-shadowed by cases where employers have gone back on promises, causing anxiety. People also worry about the get out clause which lets solvent companies – who could afford to keep their pension scheme running – wind it up with inadequate compensation.
In the cases where firms have done this, it has inflicted damage on confidence in the whole system. People worry that other schemes will follow suit.
We need to act to make sure that a pension promise made by employers is a pension promise honoured by employers. We will therefore strengthen member protection where solvent employers decide to wind up their pension scheme…
Sometimes – when firms go bust – the money isn’t there to meet pension commitments. Recent cases have shown the terrible injustice when this happens, and I believe the public are right to demand action. We should not accept that just because a firm goes out of business workers can find that a pension they’ve saved in for all of their working life is worth next to nothing.
Parliamentary questions on the MFR
4.563 On 14 July 2003, Malcolm Wicks, the then Pensions Minister, replied to a question from Oliver Heald MP, who had asked what changes had been made to the basis for the MFR since May 1997 and what effect such changes had had on the demonstrated level of funding of a typical pension scheme.
4.564 The Minister replied:
The actuarial basis for the MFR is kept under review by the Faculty and Institute of Actuaries. They have recommended two substantive changes to the basis since May 1997, and both were implemented.
From 15 June 1998 the factor for the equity market value adjustment, which generally applies to the calculation of liabilities for scheme members below pension age, was reduced from 4.25 per cent to 3.25 per cent and the gross yield on the FTSE Actuaries All-Share Index was replaced with the net yield on the same index.
From 7 March 2002 the factor for the equity market value adjustment was further reduced, from 3.25 per cent to 3.00 per cent.
The changes were intended to address movements in the strength of the MFR test resulting from changing economic and demographic trends. In addition to these changes there have been a number of minor technical amendments to the actuarial guidance which governs the calculation of a scheme's MFR liabilities.
It is not possible to define a typical pension scheme, but estimates about the effect of these changes on the aggregated MFR funding levels of all schemes subject to the MFR have been prepared by the Government Actuary's Department. These indicate that the change which took effect from 15 June 1998 may have increased aggregate funding levels against the MFR by around 5 per cent and that the change which took effect in March 2002 may have further increased aggregate funding levels against the MFR by around 3 per cent.
4.565 In reply to another question by Mr Heald, the Minister said that, as at June 2003, it was estimated by the Government Actuary that 50% of schemes were funded below 100% MFR level and that this equated to an aggregate £30 billion shortfall. He continued that, if judged against the MFR basis that had existed in May 1997, the respective figures would have been 75% and £60 billion.
OPRA update on winding-up
4.566 On 18 August 2003, OPRA published its ‘update 3’ on winding up. Aimed at trustees, advisers and insolvency practitioners, the update set out OPRA’s views on the issues that often arose during the winding-up process. These included defining when wind-up began, investment issues, MFR valuations, defining and certifying scheme deficits, cash equivalent transfer values, GMP equalisation, employer insolvency, and the appointment of independent trustees.
Revised OPRA guide to the MFR
4.567 In October 2003, OPRA issued a revised version of its guide to the MFR (see the entry for May 1999, above).
4.568 In the revised section ‘about the MFR’, the guide stated that ‘the MFR is not, however, a guarantee of members’ benefits. It is not intended to ensure that members’ benefits will be met in full if the scheme is wound-up’.
4.569 Page 31 of the revised guide introduced a new section called ‘what if the scheme goes into wind-up?’ After explaining the role of trustees during the winding-up process, the guide continued:
If a scheme in wind-up is under-funded, trustees may need to instruct the scheme actuary to formally certify the amount of the under-funding as a debt on the employer. This may not be necessary if the employer is solvent and makes adequate funds available to the scheme to enable benefits to be fully secured.
Once the amount of the under-funding is certified, it then becomes a formal debt on the employer and the trustees should consider taking action to enforce it.
4.570 The guide warned:
However, if the employer is insolvent, the debt is not a preferential debt and it only ranks with debts owed to other unsecured creditors of the employer. This means that the debt may be unlikely to be paid in full and the amount of money the trustees will receive from the employer will depend on the extent of the employer’s liabilities when it became insolvent.
Government announcements on GMP and priority order
4.571 On 20 October 2003, the then Secretary of State for Work and Pensions, Andrew Smith, announced in the House that the Government intended to introduce measures to permit contracted-out final salary schemes to convert Guaranteed Minimum Pension entitlements into scheme benefits on the basis of actuarial equivalence.
4.572 Two days later, Malcolm Wicks, the then Pensions Minister, made a written statement concerning the priority order for the distribution of scheme assets on wind-up. It read:
Today we have published proposals to amend the statutory priority order when a defined benefit pension scheme subject to the minimum funding requirement is wound up and draft regulations to bring these proposals into effect.
The draft regulations are intended to ensure that, where there are insufficient assets to meet all liabilities, they are shared as fairly as possible between non-pensioner and pensioner scheme members.
As outlined in “Action on Occupational Pensions” the degree of protection offered by the new priority order reflects the length of time a member has been contributing to a scheme and also gives priority to the rights of non-pensioners over the future indexation of pensions in payment.
We are consulting on the draft regulations and proposed new priority order and should welcome views on both by 3 December 2003. We aim to lay these regulations by early 2004 so that they come into force as soon as practicable.
Consultation on EC Directive
4.573 On 28 October 2003, DWP published a consultation document on its proposals to implement the EC Directive on Occupational Pensions. The Directive required the implementation of a ‘prudent person’ approach to investment, competent regulation by a public authority, measures to oversee cross-border activity by pension schemes, the disclosure of information to scheme members, and that final salary schemes should hold ‘sufficient and appropriate assets’ to cover accrued liabilities and to adopt a recovery plan if there were under-funding.
Early Day Motion
4.574 On 3 December 2003, Kevin Brennan MP tabled an Early Day Motion, which in due course attracted 300 signatures from Members of Parliament. The motion stated:
That this House acknowledges the plight of workers who have lost their final salary occupational schemes through company insolvency despite being promised by firms and successive governments that their pensions were guaranteed and in many cases having been compelled to join their scheme as a condition of employment; further believes that the Government has a moral and possibly legal obligation to help those workers who have been stripped of their pensions through no fault of their own; and further calls upon the Government to introduce legislation to compensate victims of this singular injustice.
Parliamentary question on contributions holidays
4.575 On 8 December 2003, Malcolm Wicks, the then Pensions Minister, was asked by Shaun Woodward MP what plans the Government had to review the policy of unlimited pension contribution holidays in final salary pension schemes.
4.576 He replied:
Since pension provision by employers is voluntary, the levels of contributions are a matter for agreement between pension scheme trustees and sponsoring employers.
Under the new scheme-specific funding regime, which is intended to replace the Minimum Funding Requirement, trustees and sponsoring employers will be required to develop and agree, with the scheme actuary's advice, the funding principles for their scheme - including a determination of whether the level of contributions is sufficient to meet a scheme’s long-term pension commitments.
The new proposed, simpler tax regime for approved pension schemes (set out in the document “Simplifying the taxation of pensions: increasing choice and flexibility for all” (December 2002)) would abolish the rules requiring approved occupational pension schemes to run off their surplus funds (for example by agreeing contributions holidays) or lose their full tax-exempt status. In addition, the document “Action on Occupational Pensions” announced that pension funds will be able to make payments to employers from an actuarial surplus only where the scheme is funded above a level sufficient to secure full buy-out of scheme liabilities.
Events during 2004
Informed Choices for Working and Saving
4.577 On 3 February 2004, DWP published a document, ‘Informed Choices for Working and Saving’, which set out the Government’s plans for steps to support informed decision making by individuals.
4.578 The document noted that the Government was ‘committed to opening up options for people to extend their working lives and to ensure that people have sufficient information to plan and to provide for their retirement’. It then set out the three elements of its proposed ‘Informed Choice Strategy’:
the activation of the current system to maximise provision and to ensure that everyone had access to ‘good choices’; the continuation of work with the FSA to raise overall levels of financial education and awareness of the need to plan and to provide for retirement; and further work to ensure that all people of working age had access to personalised information to help them understand how the choices available to them related to their own retirement prospects.
4.579 The document lamented a position where:
…there are still too many people who, because of a lack of understandable and trusted information, do not engage with the choices they have, and, as a consequence, make no choice at all. This is a very high-risk approach. We believe the public will be better served by a more fail-safe system where people do not cut themselves out of a pension scheme by inertia alone.
4.580 After reiterating that ‘for most people, their employer’s pension scheme is the best form of saving for retirement’, the document continued by setting out three options to change pension schemes to increase employee membership and contribution, on which further views would be sought.
4.581 In relation to the raising of awareness and developing financial education strategies, the document said:
It is key that the Government and its agencies work together to provide education appropriate to people’s needs at different points in their working lives. We want to move to a position where people approaching retirement are better informed about the choices they face. For example, their options around when to retire, opportunities for flexible working, or the timing and nature of annuity purchase, as well as understanding the implications of those choices on their potential retirement income. We want all people of working age who are contemplating career breaks, working part-time or retiring early to be better informed about the implications for their pension saving.
4.582 The document then noted the Government’s recognition that DWP ‘can do more to provide better information’ and then set out proposals for an integrated retirement planning service, which would include improved marketing based on ‘leaflets giving information on all types of pension and the services government and others offer to support people in making choices’.
4.583 Chapter 4 of the document was entitled ‘giving people the right information’. It began by stating that:
We want to make sure that people get the right information at the right time, in the right way. Many people say that they want to plan for retirement but do not know where to start. There is a lot of information available to individuals about pensions and retirement planning. This quantity of information can be confusing and some individuals will not necessarily trust it. Individuals may not always be able to understand whether the information is impartial or is geared to marketing a particular product or group of products.
We know that people want help from an impartial source they can trust which is specifically about their own status, prospects and options. We think that personalised information makes a difference and prompts people to think about their retirement planning.
4.584 It continued:
We are keen to ensure that all of our communications are as clear and effective as possible. Therefore, we propose to commission new research on effective pension communications. This will help us to further improve our messages and ensure we get the right information, to the right people in the right way.
4.585 The document concluded by stating the Government’s view that their strategy would ‘help to renew further the pensions partnership between government, employers, individuals, the financial services industry, trade unions and the voluntary sector. These measures will help to empower individuals to make their own decisions about retirement and the level of income they want in retirement’.
4.586 In the press notice which accompanied publication of the document, the then Secretary of State for Work and Pensions, Andrew Smith, was quoted as saying:
I have met with many employees and employers who have said that it is the quality and relevance of information that is crucial in allowing them to take key decisions about their pension. I believe that through this package of measures we will have taken a major step towards changing people's attitudes towards their pension and helping them plan properly for their retirement.
Publication of Pensions Bill
4.587 The draft Pensions Bill, designed to enact the Government’s reform agenda and to consolidate existing legislation, was published on 12 February 2004.
4.588 The then Secretary of State was quoted in the press notice which accompanied publication of the Bill as saying:
Where companies with under-funded pensions have gone bust, workers have found themselves severely short-changed on the pension they were expecting. With the Pension Protection Fund, people in pension schemes can be much surer that they will get the pension they were promised. The Fund will be complemented by a flexible Pensions Regulator which will make it easier for businesses to get on with running good pension schemes. It will focus on the under-funding, fraud and maladministration that can threaten members' benefits, whilst minimising interference for well run schemes.
Parliament begins consideration of the Pensions Bill
4.589 The House of Commons gave the Pensions Bill its Second Reading on 2 March 2004.
4.590 In the Commons Standing Committee debate on 23 March 2004 on the proposed replacement of the MFR, Malcolm Wicks, the then Pensions Minister, said, in response to a request from the Official Opposition spokesperson to explain why the MFR basis had been changed twice:
The hon. Gentleman also asked why the Government have twice cut the value of the MFR, in 1998 and 2002. I am bound to say that this is a highly technical arena that concerns the actuarial basis for the MFR, which has, as he said, been adjusted twice. The relative strength of the MFR test is affected by a range of factors, including economics and demography and covering issues such as longevity, changes in yields from equities and other investments, which were mentioned, and changes in the costs of buying annuities and deferred annuities. Perhaps it is inevitable that such factors will change over time and, therefore, the strength of the MFR will fluctuate relative to prevailing market conditions.
4.591 The Minister continued:
The Faculty and Institute of Actuaries monitors the actuarial basis for the MFR, with a view to recommending changes when appropriate. That basis was adjusted in 1998 and 2002, following its recommendations, because the MFR was operating at a higher strength than originally intended. As I said, those changes represented technical adjustments, which were recommended by the actuarial profession and were intended to realign the MFR closer to the strength that was originally intended. They did not involve any change in policy regarding its strength. These are profoundly difficult matters. Although one is occasionally tempted into partisanship, it is normally sensible to listen to what the actuarial profession advises.
4.592 In response to a further question from Nigel Waterson MP, for the Official Opposition, who had asked whether he accepted that those who had lost out on their pension rights would have had more to show had the changes to the MFR basis not been made, the Minister said:
Hindsight is a wonderful thing. All I can say is that that was the recommendation of the Faculty and Institute of Actuaries at the time and it was sensible of the Government of the day to follow that advice. It all adds up to us - not just to the Government, but to others, too - thinking that we need to move ahead in a different direction, hence the proposals that we are discussing today about scheme-specific funding.
4.593 Pressure continued to mount during parliamentary scrutiny of the Bill to do something to provide compensation to those who had suffered due to scheme wind-ups. In Prime Minister’s Questions on 21 April 2004, in response to a question from Tony Lloyd MP, Mr Blair said:
…we are actively considering the position of people who, having been forced to contribute to occupational pension schemes, find that all the money that they have invested yields absolutely nothing. We are examining what we can do in such special cases, and, in the context of the current debate on pension protection issues and legislation, I hope that we can come forward with the solution.
Publication of revised DWP guide to contracting-out
4.594 DWP published a revised edition of its guide to contracted-out pensions in April 2004.
4.595 In a new section called ‘what happens if a contracted-out salary related scheme has to wind up?’, the guide first explained the circumstances in which schemes might wind up. It continued:
When a salary-related scheme winds up, the trustees of the scheme have to pay what is owed to scheme members using the scheme’s current funds (or assets). Sometimes there may not be enough funds to do this. When this happens, any shortfall becomes a debt the employer owes the scheme…
But there is still a chance that you may get less than you expect if your salary-related scheme winds up. That is why the Government has announced its plan to introduce a new Pension Protection Fund and a new pensions regulator.
4.596 The guide then explained the role of the PPF and the new regulator, before informing the reader that, if they wanted to find out more about the protection of their pension during wind-up, they could talk to scheme trustees or an authorised financial adviser.
Further revision of DWP guide to occupational pensions
4.597 Also in April 2004, DWP issued a further revision of their leaflet ‘occupational pensions: your guide’ (PM 3 - see above).
4.598 The principal revisions of relevance to this report were:
(i) the renaming of the section that formerly asked ‘how do I know my money is safe?’, which now became ‘is my money protected?’; and
(ii) the inclusion of a new section called ‘what happens if a salary-related scheme has to wind up?’
4.599 The latter section, which it is worth here quoting in full, said:
Winding up is the process of ending an occupational pension scheme. This may happen for a number of reasons depending on a scheme’s rules. For example:
(i) an employer may decide to stop contributing to a scheme;
(ii) an employer may become insolvent and this may lead to the scheme being wound up; or
(iii) the scheme’s trustees may decide to wind up the scheme.
4.600 It went on:
When a salary-related scheme winds up, the trustees of the scheme have to try to pay what is owed to scheme members using the scheme’s current funds (or assets). Sometimes there may not be enough funds to do this.
When this happens any shortfall becomes a debt the employer owes the scheme. This allows trustees to take action to chase the debt. Regulations also make sure that assets are shared out as fairly as possible. Some unpaid contributions can be claimed when employers become insolvent. And, in certain circumstances, members may have some or all of their SERPS or State Second Pension restored for the period they were contracted-out. All of this helps to protect the pension that you have built up. But there is still a chance that you may get less than you expect if your salary-related scheme winds up.
4.601 The guide continued:
That is why the Government has announced its plan to introduce a new Pension Protection Fund and a new pensions regulator. The Pension Protection Fund will pay compensation to scheme members when an employer becomes insolvent and there are not enough assets in the scheme to pay the Pension Protection Fund level of benefits. The Pension Protection Fund level of benefits is broadly equal to the amount of compensation that would be paid by the Pension Protection Fund. For most schemes this will be based on 100% of benefits to those over the scheme’s normal pension age and 90% of benefits to members below the scheme’s normal pension age. However, there will be a limit on the benefit that can be paid.
The new pensions regulator will focus on protecting the benefits of scheme members by concentrating on schemes if it considers that there is a high risk of fraud, poor management, or poor administration. If you want to find out more about how your salary-related pension is protected during winding up, you can contact your scheme’s trustees. If you are in any doubt about your position, you can also contact an authorised financial adviser. But, remember, if you do see a financial adviser, you may have to pay for their advice.
GAD survey on occupational pensions
4.602 Also in April 2004, the Government Actuary published his twelfth in a series of surveys of occupational pension provision in the UK that had been undertaken by his Department since the 1950s.
4.603 In Chapter 8 of the survey, which was a new addition and contained analysis of those schemes which were winding-up at that date, the Government Actuary said that there were around 470,000 members of schemes in wind-up, of which approximately 120,000 were existing pensioners and 70% of the total membership were in final salary schemes.
4.604 It also said that approximately 230,000 people (both pensioners and those yet to retire) were in final salary schemes where the sponsoring employer was insolvent.
4.605 Paragraph 8.5 of the survey noted that only 78% of its respondents who were winding-up had notified OPRA that they were so doing.
Reform of the priority order
4.606 On 19 April 2004, Regulations were laid before Parliament to reform the statutory priority order in which the liabilities of a scheme must be discharged on wind-up by placing the rights of non-pensioners before increases for pensions in payment. This reform would have effect from 10 May 2004.
Announcement of Financial Assistance Scheme
4.607 On 14 May 2004, Andrew Smith, the then Secretary of State for Work and Pensions, announced that the Government would be providing £400 million of public money, to be paid over 20 years, to create a scheme to provide ‘assistance’ to some of those who had lost part or all of their pension rights due to their scheme winding up under-funded.
4.608 In a BBC radio programme, Money Box, that was broadcast on 15 May 2004, Malcolm Wicks, the then Pensions Minister said, in relation to the proposals to establish a ‘financial assistance scheme’ that those proposals were ‘a major step forward that we’ve announced this week in terms of helping this group of people, they’ve effectively had their money stolen from them and through no fault of their own and we think it’s right that the public should support them and that’s what we’re going to do’.
4.609 During further consideration of this proposal, Mr Wicks said in the House of Commons on 19 May 2004 that:
The pension protection fund is a major social policy advance that will bring protection and security to more than 10 million pension scheme members and their families… but it is overshadowed by a cloud — the plight of the tens of thousands of workers who have already lost their pension rights or a large percentage of them, which is debilitating for those affected and undermines confidence in the idea of saving for a pension.
4.610 Mr Wicks continued:
Most of those people expect to receive a much reduced pension. I have been deeply moved, as we all have, by the distress and bewilderment of many people who, after long years of paying into a pension scheme, have been told that, after all, the pension they are relying on, and which they have paid for, will not be there.
4.611 The Minister then went on to formally propose an amendment to the Bill that would provide for the establishment of a ‘financial assistance scheme’ to ‘assist people who have lost out severely as a result of the winding-up’ of an ‘under-funded’ scheme which would not be covered by the PPF.
4.612 He explained:
The Government have put forward £400 million over 20 years to help address the serious losses that some now face. It is open to industry to offer further support. We hope that that support will be forthcoming. This money will not cover everyone who feels aggrieved, nor will it give those it does help everything they might want, but it represents significant help to those who have lost the most.
4.613 The Minister went on to say that:
The coverage must ensure that those suffering losses are helped according to the principles of openness, fairness and, very importantly, operational practicability. The role of the industry, employers, actuaries, trustees and trade unions in resolving those issues is as great as that of the Government… I would like briefly to take the House through how we intend to turn our commitment into reality. It involves four phases of work: first, we shall engage with our partners and industry experts, including the trade unions; secondly, we shall design the detail of the policy and the operational framework; thirdly, we shall prepare to implement the scheme; and, fourthly, we shall go live and make payments.
Pensions Information Pack
4.614 DWP launched a new pensions information pack for employers and employees on 29 June 2004, which had been devised by the Association of British Insurers.
4.615 At the launch event, the then Financial Secretary of the Treasury said:
Informed choice is an essential part of the Government's strategy, reaffirming the essential partnership in pensions between employers, employees, providers and the Government. It builds on the work we are doing to increase protection through the Pensions Bill and the simplification of the pensions tax system.
DWP research on schemes affected by wind-up
4.616 On 30 June 2004, DWP published research it had undertaken to establish the number of people affected by pension schemes which had wound up under-funded since 1997 with insolvent sponsoring employers. The report provided estimates based on information gleaned from trustees responsible for winding-up the relevant schemes.
4.617 It reported that:
(i) the number of people facing losses of 20% or more of their pension totalled 75,000;
(ii) the number who faced losses of 30% or more were 70,000;
(iii) the number who faced losses of 40% or more were 60,000; and
(iv) those who faced losses of 50% or more numbered 40,000. This included 35,000 people who were facing losses of more than £5 per week.
4.618 The research did not cover those in solvent employer schemes who might be facing similar losses.
4.619 In the press notice which accompanied publication of this research, Andrew Smith, the then Secretary of State, was quoted as saying:
…for the future our new Pension Protection Fund will provide cover to ensure that even where a firm goes bust employees can still be sure they'll get a worthwhile pension. The £400 million scheme for those who have already lost out is another step that will help to boost confidence in occupational pensions and I hope industry will play its part in that by making a contribution to the scheme. We hope to have the legislative framework of the scheme in place by spring of next year and making payments as soon as it’s practical.
OPRA update for under-funded schemes
4.620 OPRA published its ‘update 9’ on 26 August 2004, which provided information about its expectations in the light of the announcement of the FAS. It urged trustees of schemes in wind-up to advance the process so that the relevant liabilities could be determined as soon as possible.
Early Day Motions and parliamentary questions
4.621 On 11 October 2004, the Government reiterated, in response to a parliamentary question, that it would have the legislative framework in place for the FAS by Spring 2005 and that it hoped to make payments from the FAS as soon thereafter as was possible.
4.622 Sandra Osborne MP tabled an Early Day Motion on the FAS on 23 November 2004, which subsequently received 158 signatures from Members of Parliament. It read:
That this House recognises the suffering of those members of final salary schemes who have lost their pensions when their schemes were in wind-up and their need for urgent assistance; welcomes the provision of £400 million for the Financial Assistance Schemes but is concerned that this is not a sufficient sum to provide the substantial assistance promised by the Government; asks the Government to consider pooling the assets of winding-up schemes, rather than purchasing annuities, and paying pensions on an ongoing basis, as will be the case with the Pension Protection Fund, so that costs to the Exchequer can be spread over a long period of time which would provide an affordable option without overburdening the public funds; notes that if the Financial Assistance Scheme lasts 20 years those people currently in their fifties will only be in their seventies when the Scheme runs out; further notes that estimates suggest that if the Government will commit to pay a sum of £75 million a year, index linked, for 40 years into a central fund and pool all the assets of the schemes which have not yet bought annuities, promised pensions to non-retired members could be paid to at least the level of the Pension Protection Fund; calls on the Government to acknowledge that further resources will be required to fulfil the Government’s desire to rectify this injustice and restore confidence in pensions; and finally urges the Government to settle this matter as soon as possible and in advance of a general election.
4.623 Two days later, David Willetts MP tabled another Early Day Motion on the FAS, which in due course received 91 signatures from Members of Parliament. It read:
That this House welcomes the creation of the Financial Assistance Scheme; notes with concern that people who have already been affected by the wind-up of a pension scheme do not know whether they will be eligible for assistance, what level of assistance they will receive, or when assistance will commence; is very concerned that £400 million will not provide the level of assistance that many might be expecting; calls on the Government to reveal details of the scheme at the first possible opportunity; and urges the Government to consider using unclaimed assets to boost the funds available for assistance.
4.624 On 29 November 2004, the Government confirmed, in response to a parliamentary question, that the FAS would be funded out of existing spending commitments from April 2005 to March 2008. For later years, the Government said it would take account of their commitment to the FAS in future spending reviews.
4.625 As part of a series of answers to parliamentary questions given on 6 December 2004, DWP Ministers stated that the Government did not accept that they had any liability for the losses that had been or would be incurred by scheme members due to the winding-up of their scheme without sufficient funds to meet all liabilities.
FAS eligibility and Royal Assent for the Pensions Act 2004
4.626 In the meantime, on 12 November 2004 DWP had issued a press notice regarding the FAS, shortly after it had announced the eligibility criteria for assistance from the PPF. This stated that work to determine eligibility for the FAS continued.
4.627 On 18 November 2004, the Pensions Act 2004, which incorporated provisions for the establishment of both the PPF and the FAS and the replacement of the MFR, received Royal Assent. The previous day, the Occupational Pension Schemes (Minimum Funding Requirement and Actuarial Valuations) Amendment Regulations 2004 had been made by the Secretary of State and were laid before Parliament on 23 November 2004. These Regulations came into force on 21 December 2004.
4.628 On 2 December 2004, Malcolm Wicks, the then Pensions Minister, made a further announcement about eligibility for the FAS. He said:
Since the Financial Assistance Scheme was announced in May we have made good progress in scoping what is an extremely complex problem, involving hundreds of pension schemes, with differing scheme rules and in different stages of winding up. Following an initial data-gathering exercise, we laid a report before the House in June, setting out an estimate of the numbers affected.
Ministers and officials have since consulted with scheme members, trade unions and industry experts to gather and analyse more data, and explore options for the best way to get assistance to those who need it most.
Obviously, the full extent of the problem can be known only once all potentially eligible schemes have been identified and information obtained on the individuals affected and the extent of their losses.
In September, we launched a second, more detailed data-gathering exercise to identify potentially eligible schemes. It is important that all scheme trustees and actuaries who think their schemes might be eligible respond by 10 December. Data-gathering on the position of individuals will follow.
While we continue to seek industry contributions to the Financial Assistance Scheme, full participation in this exercise is an immediate opportunity for the pensions industry to provide valuable practical help and assistance in kind.
4.629 He continued:
As we have previously said, the scheme will not give everyone all of what they want. Nor will the scheme provide the same assistance levels as the pension protection fund, which provides cover going forward, funded by a levy. The primary objective is to provide significant help to those who have lost the most.
The available funding is set. People who are younger have more time to work and save for a pension to replace one that has been wholly or partially lost. Therefore we are minded to gear assistance levels with reference to the number of years an individual is from their retirement. To further focus resources, we are considering making payments for all individuals at age 65.
The pension protection fund has a benefit cap for those below scheme pension age, and it makes sense that the FAS should also have one, which we intend to set at a lower level.
4.630 Mr Wicks went on:
To minimise bureaucracy and to maximise payments to those facing the most serious losses, Ministers intend that, other assistance criteria aside, the FAS will include only those who will receive at least £10 a week, or equivalent, from the scheme.
Information already gathered makes clear that the vast majority of those that had started winding up with significant funding shortfalls did so after January 1997. We can therefore confirm that members of schemes that commenced winding up from 1 January 1997 will potentially be eligible, subject to the other FAS entry rules. Schemes starting to wind up right through to the introduction of the pension protection fund (6 April 2005) will also be potentially eligible.
Solvent employers have a duty to support their schemes and provide the benefits that members were expecting. So, it is right that the FAS focuses on insolvent employers. Nevertheless, issues concerning the definition of “employer solvency” remain under active consideration.
Those who have lost out due to their scheme winding up under-funded have already seen their expectations for retirement upset once. It is therefore important that the resources available for FAS are deployed in a way that ensures that any new promise made to those eligible will be delivered. This points to providing assistance by means of top-up to the occupational pension that individuals would otherwise receive. Trustees should therefore fulfil their duty to wind up schemes in an expeditious manner, including annuitisation where appropriate. We will consider further the precise means of delivery - options include a top-up pension, a cash lump sum, or purchase of an annuity at age 65.
4.631 He concluded:
Early next year we would hope to be in a position to announce what we propose by way of indicative assistance levels to those facing the most urgent difficulties, as well as an indicative list of schemes that are likely to be eligible for assistance if those schemes are subsequently shown to comply with the FAS rules.
The complexity of the issue, the amount of data that has had to be collected, and the level of consultation undertaken, means that the formal regulatory consultation will begin in the spring.
In April we will set up the body to administer the scheme and following the formal consultation we will lay regulations before Parliament, making payments as soon as practicable thereafter.
Events during 2005
4.632 In response to a parliamentary question on 20 December 2004, the then Pensions Minister confirmed that no assessment of an average payout to affected scheme members had underpinned the Government’s decision to make available £400 million to the FAS.
4.633 A further announcement about FAS eligibility was made on 22 February 2005. The written statement to the House said:
In December 2004 we said that our priority was getting help to those facing the most urgent difficulties being closest to, or already at, retirement age and therefore less able to make provision to replace their lost pensions.
At that time we had asked independent trustees to provide data on the pension schemes that they thought might be eligible for the financial assistance scheme. We had a very good response and from the information provided it appears that there are at least 380 schemes in which members might be potentially eligible for financial assistance. The precise scale of the financial shortfalls in these schemes cannot be known until the winding-up processes are close to completion.
4.634 It continued:
A list of these potentially eligible schemes has been placed in the Library. It is a provisional list which broadly confirms earlier estimates of the scale of the problem, and the number of individuals affected. The detailed eligibility criteria for both schemes and members will be set out in regulations that we expect to publish for wider consultation in the spring. Once finalised these will need parliamentary approval, which we hope to obtain by the end of July.
As solvent employers have a duty to support their schemes and provide the benefits members were expecting, it is right that the FAS focuses on insolvent employers. We expect employers to stand by their pension promise to their employees, and will take a dim view of the solvent employer who seeks to avoid their responsibilities to their employees or the employees of a company for which they have been a parent company. We have consulted widely on how we should define “employer insolvency” and concluded that for FAS purposes we should have a sufficiently general definition of insolvency to capture schemes where the sponsoring employer no longer exists and also where insolvency may have occurred some time after scheme wind-up had started. This definition will be similar to that used by the PPF but with the additional inclusion of some companies which have undergone members' voluntary liquidations - where a declaration of solvency was made at the time of wind-up but where the company is now no longer solvent and so no employer exists to support the scheme.
We are minded to judge the insolvency position for multi-employer schemes on the principal employer of the scheme.
4.635 The statement continued:
The list contains those pension schemes on which we received information in the latest data collection exercise and which, from the information provided by trustees, appear potentially eligible under the criteria set out above. The list provides an early indication of scheme eligibility for members of the schemes we have been told about. But I need to make clear a number of caveats. First, it will take time to establish the final position, but as wind-up progresses we will become clearer on the size of the gap between assets and liabilities of these schemes. Second, presence on this list does not guarantee individuals will receive support from the FAS. Third, it does not mean trustees should stop their duties of securing the best possible outcome for their scheme members.
After the FAS regulations have come into force, there will be a six-month period during which we shall accept formal notification from the independent trustees of other under-funded pension schemes, which may in due course be added to the list, so absence from this list does not preclude eligibility.
Whilst we have sought industry contributions, it is very disappointing that no financial contribution has been forthcoming. As a result the available funding stands at £400 million over 20 years, which the Government have committed on behalf of the taxpayer.
4.636 The statement went on:
As we have explained before, in many cases the trustees are not yet able to provide detailed information on the scale of individual losses and in practice this may not be available until they are close to completing the winding-up of each pension scheme. But those scheme members who have already retired or expect to retire within the next few years need to know where they stand now.
I can therefore announce today that the financial assistance scheme will provide help to those within three years of their scheme pension age on 14 May 2004. The assistance will top up individuals to a level broadly equivalent to 80 per cent of the core pension rights accrued in their scheme. That means that those within three years of their pension scheme age on 14 May 2004 should expect to get 80 per cent of their core promised pension. As we previously announced, payments will be subject to a de minimis level and a cap on assistance provided. Further information on these will be provided when the draft regulations are published.
The assistance will be paid as a monthly pension. FAS payments will be treated by the tax and benefit system in broadly the same way as payments from an occupational pension scheme.
4.637 The statement concluded:
We have already committed ourselves to review the financial assistance scheme after three years. Government funding is already fixed for the current spending review period up to and including 2007–08. But as with all our spending plans, we will review the funding for the FAS in the next spending review alongside other spending priorities.
A dedicated team of DWP officials, based in York, will administer the scheme and aim to get payments to recipients as soon as possible once the regulations are in place.
4.638 In oral questions to DWP Ministers in the House of Commons on 28 February 2005, the FAS was discussed at length.
4.639 Alan Johnson, the then Secretary of State, said, as part of those discussions, that it was the intention of the Government to set the FAS cap at the same level as that for the PPF (but then corrected this statement to explain that the cap for the FAS would in fact be less, at £12,000 per annum); that it was intended to lay the FAS Regulations in the Spring, with approval of them by July 2005 and then to give a six month period in which individuals would apply for ‘assistance’; and that the sum set aside would be ‘on the basis of our original calculations enough to give proper compensation’ to the affected people.
4.640 The spokesperson for the Official Opposition argued that the FAS was insufficient to remedy the losses incurred by those affected by insolvent scheme wind-ups, as £20 million a year would only provide approximately £1,300 per year to 15,000 people.
4.641 On 4 April 2005, DWP issued draft Regulations to establish the FAS and sought views on them by 16 May 2005.
4.642 An additional announcement was made on 22 June 2005, as a result of the consultation exercise on the draft Regulations (see above). Revised Regulations were also tabled that day and it was announced that terminally ill members and those already over the age of 65 would receive advance, interim payments from the FAS. In addition, it was announced that those schemes where the sponsoring employer was not technically insolvent, but where it was also clear that it no longer existed, would be included within the scope of the FAS.
4.643 In the press notice that accompanied this announcement, the Pensions Minister, Stephen Timms, was quoted as saying:
We have always said that the aim of the Financial Assistance Scheme is to get money out as quickly as possible to those who need it most, and today's regulations will put those words into action.
The ability to make early payments to qualifying members who are terminally ill and those reaching 65 before their scheme has completed winding up, will provide vital help to people suffering the worst difficulties.
4.644 At the same time, the Government published its response to the representations it had received in the consultation exercise on the draft FAS Regulations. In relation to the continued exclusion of members of solvent employer schemes, DWP said:
The Government believes that solvent employers have a duty to support their schemes and to provide the benefits that members were expecting. We recognise the difficulties which members of such affected schemes face. Nevertheless, we believe that it is right for FAS to focus its help on those schemes where there is no solvent employer at all.
4.645 In relation to opposition to the proposed ‘cut-off’ date, which meant that FAS ‘assistance’ would be available only to those within three years of their scheme’s normal retirement age at 14 May 2004, the Government said that it:
…acknowledges the strength of feeling that having such a ‘cut-off’ date arouses but believes that, given the funds available for the Financial Assistance Scheme, help must be focused on those who are facing the most urgent difficulties and are closest to, or have already arrived at, retirement age and therefore less able to replace their lost pensions. The FAS will be reviewed after three years and its funding will be considered in the next spending review alongside other spending priorities.
4.646 Finally, in relation to opposition to the proposal that ‘assistance’ would be available only from an individual’s 65th birthday, regardless of normal scheme retirement age, the Government said:
The FAS provides assistance to some of those who have lost out by the failure of their occupational pension scheme. It does not attempt to compensate for that loss or to reflect the rules and conditions of individual schemes: to do so would introduce administrative complexity and substantially increase costs. The Government considers that backdating FAS payments to the later of the 65th birthday or 14th May 2004 means that taxpayers’ money made available for the scheme can assist the widest range of people.
The Government acknowledges that it would not necessarily be appropriate to delay FAS payments to eligible scheme members who reach their 65th birthday but whose schemes have not completed wind-up and for whom, therefore, a definitive award cannot be calculated. The Financial Assistance Scheme manager will, therefore, have the discretion to make initial payments at a ‘safe’ rate of 60% of expected pension entitlement to eligible scheme members who have attained the age of 65. This award will be recalculated and any arrears paid when their scheme completes wind-up. The Government believes that this approach ensures that members are not grossly penalised for delays in the winding-up process and reflects the approach of many pension schemes in making similar ‘safe’ payments to members in similar circumstances.
The Government has also decided that in cases where a scheme member aged under 65 is eligible for the FAS, suffering from a terminal illness and not expected to live for longer than six months, then FAS payments will be made with immediate effect.
4.647 On 1 September 2005, DWP announced that scheme trustees who had not yet submitted information to the FAS had six months to apply for registration. It also published guides to the FAS – one for scheme members and another for trustees, their advisers and other pensions professionals.
Other developments during 2005
4.648 In the meantime, on 10 January 2005, the then Pensions Minister, Malcolm Wicks, had urged employees to consider seriously their pensions options. According to the DWP press release:
…one of the easiest ways to do this is to check what options your employer can offer you. There are approximately 4.5 million people who have access to company pension schemes but have not joined them. Where an employer makes a contribution to the scheme, these individuals are missing out on a significant employee benefit.
4.649 On 24 February 2005, DWP published a document, entitled ‘principles for reform - the national pensions debate’, that set out the principles that the Government had decided would guide pension reform. The principles set out were that:
(i) the pensions system must tackle poverty effectively;
(ii) the opportunity to build an adequate retirement income should be open to all;
(iii) affordability and economic stability must be maintained;
(iv) the pensions system should produce fair outcomes for women and carers;
(v) reform should seek to establish a system that people should understand; and
(vi) reform should be based around as broad a consensus as possible.
4.650 On 11 March 2005, DWP issued a consultation document that set out the Government’s proposals to allow contracted-out benefits to be paid as part of a cash lump sum.
4.651 On 22 March 2005, DWP issued a further consultation document that set out its detailed proposals related to the new scheme funding requirements which would include a new statement of funding principles and the requirement for trustees to keep members informed about the funding of their schemes.
4.652 On 5 April 2005 – almost eight years to the day since the commencement of the relevant provisions of the 1995 Act - many of the relevant provisions of the Pensions Act 2004 came into force, including the establishment of the new regulatory body to replace OPRA and the beginning of the operation of the PPF.
4.653 On 14 June 2005, DWP published its research report, entitled ‘effective means of conveying messages about pensions and saving for retirement’. While this research had largely focused on money purchase schemes, in relation to tackling a lack of understanding and awareness of pension choices relating to final salary schemes the report concluded that, for those respondents who had trust in Government or banks, they would seek information from them about their pension options. Those who had no such trust would rely on information from family members or friends.
4.654 On 20 July 2005, a Memorandum of Understanding between DWP, the PPF and the Pensions Regulator was agreed and published.
4.655 On 1 September 2005, DWP announced that the new funding framework for defined benefit pension schemes would come into force on 31 October 2005.
NAO report on DWP leaflets
4.656 On 25 January 2006, the National Audit Office published a report by the Comptroller and Auditor General entitled ‘Department for Work and Pensions: using leaflets to communicate with the public about services and entitlements’.
4.657 The report examined ‘how effectively the Department manages the risk of providing inaccurate information in its leaflets’ and also considered ‘whether the Department communicates clearly and effectively’ in its public information leaflets.
4.658 The NAO recognised that ‘it is vital that customers can rely on the accuracy of this information to make informed choices about their lives’. It also recognised that ‘the need to convey often complex information in accessible formats is a constant challenge for the Department, on the one hand ensuring that information is complete and accurate, but on the other, that often complex information is concise and accessible’.
4.659 The report said that the impact of inaccurate and incomplete information in DWP leaflets would impact on its efficiency and might lead to ‘inappropriate decisions by customers’, to ‘inappropriate claims by customers’, and to ‘social exclusion and confusion’.
4.660 In noting that ‘a key objective of the Department for Work and Pensions is to ensure that accurate and timely information is provided to its customers and the wider public’, the NAO said that DWP:
… identifies and records its risks via a strategic risk register, which is reviewed routinely… This register lists “providing unreliable advice or information to the public” as one of its 17 key corporate risks.
4.661 In a section of the report dealing with managing the risks of not communicating clearly, the NAO said that:
Citizens should be able to rely on the accuracy and completeness of information provided by all government departments. Citizens use the information government departments supply to judge the performance of schools and hospitals, make benefit claims, make arrangements to travel abroad, complete tax forms and much more. Written communication (in particular leaflets, letters and paid-for advertising) is regarded by the public as the most trustworthy source of information from Government.
4.662 One of the report’s recommendations was that DWP should ‘ensure all its agencies treat inaccurate and incomplete information as a key risk’. The NAO said that DWP:
… must better identify the risks associated with communicating with the public and ensure all its agencies include the issue on their risk registers and monitor actions to manage the risks regularly.
