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Comments from ACCA
January 2006

ACCA (the Association of Chartered Certified Accountants) is pleased to comment on the consultation document of the above title. These comments have been put together with the help of senior members of ACCA with wide experience of dealing with defined benefit (DB) schemes from a range of different perspectives.

At the outset we agree that a document of this kind is likely to prove useful to the extent that it will identify, for the benefit of al concerned, the detailed approach to regulation that the Regulator will adopt. It will be helpful for trustees and employers in particular to be aware of the position of the Regulator as regards matters that will or may lead to regulatory intervention. Chapter 1 of the document in particular contains some excellent background material and data which employers and trustees alike will no doubt find useful.

Our focus in this letter is on broad principles of regulatory activity, but we do go on to address some of the specific questions posed in the document.

The approach to regulation of defined benefit schemes

We recognise that much of the material in the document is necessarily presented on the basis that legal provisions as regards scheme funding levels and the Regulator’s duties are already in place, and therefore represent an indisputable starting point for regulatory policy.

We are concerned, however, at the accumulation of regulatory oversight and control which seems now to be being exerted over DB schemes, and at what appears to be something of a dis-alignment between regulatory policy and other related issues.

We would have liked to have seen in the consultation document some greater appreciation of the fact that the problems currently facing DB schemes are invariably outside the power of employers and trustees to control or influence. This is most obviously so in the case of changes in longevity, but is also true with respect to fluctuations in interest rates and changes in Government policy, for example the ending of tax relief on dividends. More recently, the industry has been presented with a new crisis in the form of the slump in the long-term bond market. It is unreasonable, in our view, for the approach taken to the regulation of pension schemes to ignore these environmental factors and to assume that deficits are necessarily caused by some sort of failure on the part of employers and/or trustees.

In respect of the sort of matters outlined above, trustees and employers have faced very substantial financial problems. This remains the case. But there are real signs that trustees, employers and employees alike are making huge efforts to make good the deficits which have arisen as the result of these various contributory factors and are contributing substantial amounts of money to keep their schemes going – the rising contribution levels acknowledged in section 1.4 were continued still further in 2005. We consider that, as a guiding principle of its regulatory approach, the Regulator needs to be looking to provide further encouragement to schemes to help them reduce their deficits, as opposed to merely setting rigid funding parameters with the implication that regulatory action will follow should schemes breach them. Its approach to the funding of DB benefits needs to be informed by an understanding of why the trend away from DB schemes has been taking place: we do not see it as being inconsistent with its statutory role for the Regulator to aspire to support those schemes which want to remain DB schemes (or DB hybrid schemes as many now are) to be able to do so.

The recovery plan

The document says that one of the main regulatory actions it envisages will be to ensure that a scheme in deficit puts in place an acceptable recovery plan. It also says that the recovery plan should aim to make good the shortfall in ten years.

We do not dispute the sense of the recovery plan idea, which is consistent with the essence of the Regulator’s role. But to suggest that a plan, to be acceptable, should aim to cut the deficit concerned in as little as ten years is in our view quite unrealistic as a regulatory goal. It actually becomes absurd and unworkable if one accepts that, as has been suggested, some schemes, in order to meet the ten year target, will need more money than is likely to be produced from their entire cash flow over that period. The ten year target must be substantially raised, to at least twenty years.

In keeping with this upwards revision of the recovery target, we would also like the Regulator to acknowledge that just because a sponsoring employer does not fund its scheme liabilities to prescribed levels will not necessarily always mean that the long-term interests of the fund are being adversely affected. Companies can in some cases achieve a higher capital return for the fund in the long term by retaining funds in the business and re-investing them. This point has recently been made by the House of Commons Treasury Select Committee, which seized on the slowdown in business investment growth in the twelve months to September 2005 and related this statistic to the pressure which pension schemes are now under to allocate increased resources to their pension funds.

Ultimately, of course, the promises made by a DB scheme will only be as reliable as the ability of the sponsoring employer to keep them. The rules on the funding of pension schemes must not be determined in isolation from this central fact. And if funding rules, and the supervision of them, create a climate which is so strict as to threaten the capacity of individual businesses to operate, then the flight away from DB schemes will be assured.

The employer’s covenant

The document makes repeated reference to the strength of the employer’s covenant. We welcome the acknowledgement by the Regulator of the significance of this aspect for the true funding level of a scheme. But in the context of the document, it would have been more useful to have had some account of how this useful concept is to be evaluated.

Our responses to some of the specific questions posed in the document are set out below.

Q1 Do you agree that the key risks caused by scheme funding are as set out?

We would not dispute the five key risks set out in question 1 for the purposes of determining the sphere of action of the Regulator. But, as outlined earlier, we believe that the Regulator needs also to bear in mind, when considering regulatory intervention, the risks which bear on schemes themselves and which have potentially substantial influence on their financial health. These additional risks will include Government interference in the taxation of pension schemes, and – where senior executives consider that they would be better off with alternative pension provision – the risk that such interference will weaken the employer’s covenant.

Q2 Do you agree that the principles set out are those on which the Regulator should base its approach to scheme funding?

The last of the seven listed principles suggests that the Regulator should be a disinterested referee of the performance of schemes in relation to their funding responsibilities. We believe that, especially in current circumstances, where many schemes are struggling with the consequences of forces outside their control, the Regulator could aspire to being something more active than a disinterested referee. We suggest that two additional principles should be added to those set out in the document. The first should be to assist schemes to recover their funding, where practicable to do so. The second would be to work towards the restoration of a financially healthy DB sector in the UK. As we outlined above, we believe that the regulation of funding levels must not be considered in purist isolation from considerations of the solvency of employers and of the effects which excessive regulatory demands might have on the continuing commitment of employers to DB schemes.

Q7 Do you agree that the impact of the regulator’s proposals is likely to balance its duty of protecting members and the PPF with a need to take a proportionate approach for employers.

As also outlined above, we are concerned that in some respects the balance seems to be tilting too far in the direction of imposing compliance responsibilities on employers and trustees. We would point, for example, to the associated current proposals of the Pensions Protection Fund with regard to the credit of contingent assets, complete with requirements for them to obtain legal opinion in each and every case. This will inevitably increase costs. We also endorse the view stated in Annex B of the document that the incentive to invest in equities would be weakened if plans put in place to reduce FRS 17 shortfalls ignored the contribution of superior equity returns. The Regulator should in our view consider whether it can re-think its proposals with a view to reducing bureaucratic consequences and reducing disincentives to the running of pension schemes.

Q8 Do you agree that we have proposed reasonable factors to consider how to intervene?

We would not disagree with the suggested trigger factors in principle, but we believe that the Regulator should consider carefully the language and tone used in the document in order to avoid a further substantial rush by employers away from DB schemes.

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