Proposals for Pension Protection Fund and New Pensions Regulator

by Dr. Ros Altmann

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

Historical Background:

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

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

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

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

Why are new measures now needed?

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

The Government's proposals:

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

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

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

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

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