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Comments from ACCA
October 2005

ACCA is pleased to comment on the consultation document on the above. ACCA is a professional body of accountants which represents over 100,000 qualified members, based both in the UK and overseas. These comments have been prepared by ACCA’s Pensions Committee, which comprises senior accountants with long experience of working in pensions from a number of different perspectives.

We welcome the publication of proposals for the extension of the Fund to incorporate the risk-based levy required by law. This is a crucial issue for the future of the occupational pensions sector and it is right that the question of the structure of the new levy be subjected to wide consultation with interested parties.

The intentions behind the establishment of the Fund are good. It is right that the Government is making appropriate provision for those long-standing scheme members who have seen their accrued rights disappear on the insolvency of their employer. We also accept the principle that, if the Fund is to be financed entirely by private means, those schemes whose members stand to benefit from the Fund should be required to make a proportionate financial contribution to it.

But we do have serious concerns about the long-term effect that the existence of the Fund, and in particular the planned risk-based levy, may have on the attitude of employers to pension provision. It seems evident that some will see the existence of the Fund as an opportunity to off-load their substantial pension liabilities – this has already happened in the US, where companies have sought Chapter 11 protection precisely in order to shed huge pension debts. The UK will need to take these experiences into account and put in place strong safeguards against the use of phoenix-style re-structuring arrangements whereby companies shed their pension liabilities and continue their business activities much as before.

But whether or not there is a concerted attempt to use the Fund as a means of corporate rescue, the original estimate that the Fund will need to recoup from DB schemes around £300 million pa in contributions seems certain to turn out to be a substantial under-estimate. Already, several large companies are reported to be close to calling on the Fund’s support. One of these companies alone is reported to have pension liabilities which would take up around 40% of the £300 million which the original estimate forecast the Fund would need in the current year. The widely-reported funding problems of the US Fund does not in fact inspire confidence that the new UK Fund will be able to proceed without large increases in funding levels from market participants.

Since the Fund is designed to be financed wholly by schemes themselves, it is inevitable that the more insolvent schemes seek out the support of the Fund, the greater will be the financial liability of those firms which are left. But the continuing support of schemes in this matter cannot be taken for granted in the long term, since companies will always have the option of exempting themselves from liability to the Fund completely by terminating their final salary schemes. Many companies, including well funded schemes, already consider that it is an imposition to expect them to pay a levy whose purpose is to help bale out members of schemes which have failed. They will be even less well disposed to the purpose behind the Fund if, as seems likely, the levy they are to be required to pay increases year on year.

Given the continuing current movement of employers away from final salary schemes, for whatever reasons, an increase in this trend would be a disastrous outcome, particularly at a time when the Government is preparing to give renewed attention to long-term policy planning issues.

One issue which the document does not consider, but which we suggest is worthy of attention in the context of financing the Fund, is the position of the public sector. Increasingly, private sector enterprises, especially SMEs, find themselves competing for business contracts directly with public sector bodies. This trend is particularly evident in the health sector. To some extent, such competition can be regarded as being unfair - public sector bodies are not subject to the same commercial constraints as are private businesses and this can be advantageous to their competitive position. We accept that the public sector has its own substantial pension liabilities to fund, but these are funded by direct taxation, not by income which must be generated in the marketplace by individual enterprises.

We suggest that the Board considers the feasibility of requiring the public sector to contribute to the Fund in respect of activities it engages in in which it competes directly with the private sector. This could in our view be a reasonable step to take in the name of ensuring a level playing field in the marketplace. The increasingly superior nature of public sector workers’ pensions, vis-à-vis the pensions of increasing numbers of workers in the private sector, is already becoming a political issue. We suspect that the divide between the two sectors on pensions might become even more of a problem if the involvement of the public sector in commercial activities was seen to play a part, even a small part, in the decisions of private businesses to end their final salary schemes.

Our comments on some of the specific questions posed in the document are as follows.

Chapter 2

Do you agree that the Board should construct the risk based levy in a way that combines the principles of fairness, simplicity and proportionality?

The levy should certainly be fair, given the option which will be available to all schemes to simply exempt themselves from liability if they think that the demands of the Fund are too great. It should also be proportionate, taking into account the relative circumstances of each fund. We welcome the commitment given in the document to framing the levy in a way which reflects the materiality of a charge’s impact on the finances of individual schemes and employers. But we think it would be a mistake for anyone to expect the structure of the levy to be made simple – the nature of the exercise means that it cannot be other than a complex calculation: this is evident from reading the document.

The Board should bear in mind that the rating of individual employers’ schemes on the proposed risk basis will give rise to issues of sensitivity. It may be considered to be in members’ interests if their scheme is rated as being at a high risk of underfunding, but knowledge of a poor rating will doubtless cause alarm nevertheless. Companies themselves will have an interest in what rating they have been given as regards insolvency risk. If this information is made public, it could have knock-on effects on a company’s trade reputation and hinder its ability to resolve any financial problems it may have.

Another point concerning the issue of fairness concerns those employers which have a high ratio of pensioners to active members. The figure given on page 23 of the consultation document suggests that the UK norm is for a scheme to have 27% of active members, 40% deferred members and 33% pensioners. There are some very young schemes which have few pensioners and many active members. But there are others whose members include as few as 10% of active members and 60% pensioners. A scheme in this position – it may have been caused by high levels of outsourcing - may be rated as having a high risk of underfunding under the proposals. But if the employer’s continuing support remains substantial, a high ratio of pensioners to active members should not in itself result in financial penalisation.

Chapter 4

Do you agree that 104% should be the cut-off point above which schemes’ underfunding risk would be based on a fixed percentage of PPF liabilities?

We agree that there should be a cap and 104% seems appropriate.

Chapter 5

Do you agree with the proposed approach to measuring insolvency, including measuring the insolvency risk of all eligible schemes?

We accept that the risk of sponsoring company insolvency will be highly relevant to an assessment of whether its pension scheme will receive the employer contributions due to it and consequently remain solvent. The proposed use of private sector measuring mechanisms appear to be helpful. But we suggest that the proposed ‘uniform’ approach to assessing risk may not, by itself, turn out to be fair or proportionate. We understand that the experience of the US equivalent of the Fund has been that the great bulk of the demands made of it have come from just two business sectors. It is reasonable to suggest that the financial demands made of the UK Fund may be similarly influenced by prevailing market conditions in different business sectors.

We suggest therefore that the approach adopted in relation to the assessment of insolvency risk should take into account this element of sectoral risk. The Fund should also take into account that in some cases insolvency can be brought about by factors which are beyond the capacity of individual companies to control. Where there is the case it may be unfair to penalise companies (and their shareholders and pension scheme members) financially by making no distinction between bad or reckless stewardship and ‘honest failure’ – this is in fact the very distinction which the Government has expressly adopted in its recent reform of bankruptcy legislation.

Chapter 7

Do you agree that there is a strong imperative to move to a risk-based system as quickly as possible?

We do not think that there is an overwhelming need to move to the risk-based system any sooner than is practicable. The document proposes that schemes should be required to bring forward their first s179 valuations to December 2006 rather than 2009 under the current regulations. We doubt whether the actuarial market will be able to cope with this level of demand. We consider therefore that to move towards the new valuation basis by the end of 2006 would be too ambitious.

Chapter 8

Do you agree that it is reasonable to use adapted MFR valuations as an estimate of s179 valuations?

We agree this would be the most appropriate basis.

Do you consider that an adapted MFR valuation could be used beyond the financial year 2006/7 if all schemes were not required to complete a s179 valuation by 31 December 2006?

Yes.

Chapter 9

Do you think that the Board should include asset allocation risk as a factor for setting the risk based levy as early as practicable?

We agree that asset allocation strategies can be a relevant factor. But we would caution against adopting a fixed regulatory view as to what an appropriate asset allocation strategy should be. Trustees are required to make such decisions with respect to their own schemes, after taking advice from suitable professional advisers. Different schemes may legitimately have different strategies because of the nature of their membership – a ‘young’ scheme will be able to afford to adopt a higher risk element than a more mature scheme. This is perfectly proper and we would not welcome any involvement on the part of the regulator which would effectively exert pressure on schemes to follow one strategy rather than another. Neither, in our view, would schemes find it constructive for the Fund to exert pressure to move out of equities into more conservative alternatives. If asset allocation is to be added to the risk-based equation therefore, we suggest it should be carried out flexibly and proportionately, and we do not think there is a pressing need for it to be rushed in.

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