The Pensions Regulator

Keeping the link: the regulator's view on abandonmentArticles

Keeping the link: the regulator's view on abandonment

In the light of the growing secondary market in pension liabilities, the Pensions Regulator is planning to issue guidance for trustees to help them recognise arrangements that may effectively result in abandonment of the scheme. In preparation, the regulator has issued a discussion paper and is currently seeking feedback from trustees and other stakeholders on the contents of the proposed guidance.

There is a developing secondary market in pension liabilities where employers are seeking to reduce or remove their exposure to the risks associated with DB schemes. The term ‘secondary market’ includes a range of products that reduce risk associated with investment, interest rates and inflation, and various forms of guarantee including insurance buyout.

The regulator’s position

The Pensions Regulator is keen to see innovative thinking being applied to the way that pension schemes manage their funds so as to reduce risks to members and to the sponsoring employer. However, we are starting to see evidence of proposed transactions where the primary intent is for the employer effectively to abandon the pension scheme. These transactions seek to break the link between the scheme and an employer of substance without the employer meeting the full cost of securing the pension benefits with an insurance company.

Such transactions are of concern to us because they potentially put members’ benefits at risk and could lead to claims on the Pension Protection Fund (thereby increasing costs on levy-paying schemes generally). Losing the link to an employer means that there is no party that can restore a scheme’s funding position if assets prove insufficient to meet liabilities. To add to this concern, providers entering the market may wish to carry out a number of such transactions, potentially creating the systemic risk of a number of schemes failing simultaneously.

We do not consider that abandonment of a scheme by its sponsoring employer is usually likely to be in the best interests of scheme members unless the full section 75 debt is paid. Our position remains that, in most circumstances, the best means of delivering members’ benefits is for the scheme to have the continued support of a viable employer.

Proposed guidance

Trustees must apply an extremely high level of scrutiny to any transactions that replace the current employer with a nominal employer, and their starting presumption should be that such an arrangement is unlikely to be in the best interests of members. We believe that trustees should be able to secure better standards of administration and investment practice without breaking the link to the employer. Promises of improvements in these services are often made in proposed abandonment transactions, but are not the primary factors to consider when such a proposal is made.

Trustees should consider taking professional advice on any proposal of this nature. They should consider, among other things, the covenant and position of all parties involved in the intended transaction; the potential gain to all parties in the transaction; the proposed structure of any trustee board after the transaction; and the amount of new money that is to be made available to the scheme, if any. Trustees should recognise that the strength of the employer’s covenant is a critical factor in setting the scheme’s technical provisions – its target funding level – and should consider the implications of the employer’s removal for the level of the technical provisions and, therefore, their plans for elimination of their scheme’s deficit.

Employers and trustees should also bear in mind that the Pensions Regulator has a statutory duty to protect members’ benefits and reduce risks to the Pension Protection Fund, and has been granted anti-avoidance powers. We will critically assess any cases of possible abandonment in the light of our duties and the powers available to us.

The regulator is planning to produce guidance for trustees explaining how to recognise arrangements that may result in abandonment, and setting out the factors they should take into account when such an arrangement is proposed. The guidance will stress the value of continuing employer support and the advisability of consulting the regulator at an early stage in these circumstances.

Our discussion paper

The regulator has recently issued a draft of the guidance described above. This is included in a discussion paper which sets out the background of DB risks, and methods of transferring and managing these risks, against which the secondary market in pension liabilities is developing. The discussion paper also looks more closely at the risks associated with arrangements that result in abandonment, our expectations of trustees in these cases and our intentions regarding the regulation of this area.

We are very keen to receive feedback from trustees and other stakeholders on this discussion paper and the draft guidance it contains; the period for submission of responses continues until 9 February 2007. As well as comments on the guidance, we are interested in gathering a range of views and information on products or methods that have been introduced to manage risk, the take-up of these products and the risks posed by abandonment.

To view the discussion paper and find details of providing feedback, visit http://www.thepensionsregulator.gov.uk/

John Ashcroft is head of strategy at the Pensions Regulator

Published: PMI News, January 2007