NAPF annual trustee conference
David Norgrove, chair, speaking at the NAPF annual trustee conference
December 2010
Introduction
I would like to thank the NAPF for inviting me here today for what will be my last speech as chair of The Pensions Regulator. As some of you will know I step down at the end of the month after six years in the chair.
I’ve found the job endlessly interesting and challenging, mixing as it does finance, business, social policy, politics and of course governance of the Regulator itself. One of my first jobs as chair was to work with Tony Hobman to get the operational side of the regulator up-and-running to deal with scheme funding, risk and avoidance. It meant changes in people, changes in culture and the learning of new skills for staff who moved over from OPRA. We also put in place a large secondment programme with banks, law firms accountants and actuaries so that we could both learn about current practice and teach about our approach.
Thanks usually come at the end of a speech but I want to start by paying a warm tribute to all the staff at the Regulator, to all the Directors, including particularly to two, June Mulroy and Stuart Weatherley who have been there almost from the start, and to Bill Galvin and Tony Hobman, my two CEOs. I have been fortunate to work with such committed and able people.
The shock of the recent economic downturn meant that we all had to learn to run almost as soon as we could walk, and we are now operating an unprecedented caseload.
Things have got increasingly busy. A number of high profile cases have come to a head; cases which have seen us use the strongest of our powers.
These cases, as well as reaching the end of the first full cycle of triennial valuations have taught us important lessons about the way the industry has chosen to interact with us and our DB framework in particular. I’ll talk more about both of these in a moment or two.
The continued decline in open DB provision over the past few years has seen a sharp turn of focus towards DC and the challenges it poses to schemes and to members. This includes us and I will share with you today some of our early thinking about regulating DC in the future.
Finally, it would be wrong to look at the pensions industry today without considering the impact of workplace pensions reform and the role we will play in effecting change and helping many more members save for their retirement.
But before we look too far ahead, let me take a few minutes to look back at the lessons we have learnt from our work over the past 6 years.
DB funding and the shifting pensions landscape
The Pensions Regulator was set up under the Pensions Act 2004, in the wake of a spate of pension scheme collapses that saw around 150,000 people lose some of their pension. It was clear to all that a new regulatory framework, with a greater focus on risks to members was required.
Scheme Specific Funding was introduced, and with it came a new vocabulary, with terms such as ‘recovery plans’, ‘technical provisions’ and ‘employer covenant’.
We’ve seen many of those first schemes again, as they undertake their second round of valuations since the move to Scheme Specific Funding. And what we’ve seen over the last few years is a marked improvement in the standards of work by everyone associated with DB schemes even when set against a backdrop of worsening and uncertain economic conditions.
The economic crisis has meant that pension schemes and sponsoring employers have experienced three of the toughest years in living memory. There is no doubt that without proper funding plans in place the impact of the recession would have been even greater. Without them we could have faced real problems in future years and the PPF would potentially have come under significant pressure.
The downturn was a major test for the new regulatory framework. On the whole, I believe it has proved resilient in protecting members and the PPF, while allowing trustees and sponsors a reasonable amount of flexibility to manage liabilities in line with our view that a desirable outcome for the scheme is usually provided by security from a solvent employer. The use of contingent assets is up 16% in the past year or so, according to the recently published TPR/PPF ‘Purple Book’. Similarly, the unweighted average recovery plan length has increased by one year to 9.4 years, according to the most recent data, and - despite the financial pressure on companies - total employer deficit reduction contributions during 2009-10 were up £2.6bn to £29.1bn.
There have also been major improvements in the key areas of administration and governance. The Trustee Knowledge and Understanding code set benchmarks for trustees and the Trustee toolkit today provides learning support for over 30,000 users. New tools and resources have also sprung up in response to emerging issues and challenges facing trustees, issues like buy-outs and buy-ins and assessing the employer covenant. Again our work on the core issues like data collecting and management have had a material impact on schemes, evidenced by a reduction in wind-up periods.
But there is no room for complacency. Schemes are only marginally better funded then when the scheme specific funding regime was introduced five years ago. Despite everyone’s best efforts, the economic conditions have largely counteracted the gains that schemes had started to make before the downturn. Contributions have had to run to keep up with rising longevity, falling discount rates and shortfalls in expected investment returns.
We clearly can’t have a situation where we move from recovery plan to recovery plan and don’t get any nearer their end. As conditions improve we expect schemes to once again narrow the gap between assets and liabilities as they did in 2006 and 2007.
Closed schemes
That brings me to a more general point.
In 2005 there were widespread predictions of the end of DB. Five years on good DB provision does remain and these predictions have not been entirely borne out.
However, the market is certainly in transition – many schemes are now closed to new members, 58 per cent in 2010 compared to 44 per cent four years ago. And an increasing number are closed to future accrual, 21% in 2010 up from 12 per cent four years ago.
We are in the end game for these schemes and this has a range of implications.
It means that sponsoring employers will have an even greater incentive to de-risk and to shift the scheme off balance sheet if at all possible. I see it as one of the achievements of the regulator in the past six years that we were able to stop in their tracks those businesses that proposed to take schemes off a sponsor’s hands for an amount short of buy out. We have seen enough during this recession that those business models may well have been a disaster for members and the PPF.
But there will be further challenges, requiring alertness on the part of the regulator, trustees and advisers.
If I was asked to make predictions about the longer term, my view is that scheme governance, funding expectations and de-risking will be amongst the key challenges for the increasing number of closed DB schemes.
As schemes close and mature in age profile, over time a smaller proportion will have close ties with the employer. And with fewer current staff involved in a DB scheme, the employer’s interest in the day-to-day running will also lessen. There is also likely to be pressure from shareholders to reduce the sponsor’s exposure to risk.
As a means of tackling these challenges, there will be a need to ensure that the governance model is robust to cope with an ageing membership and the ever widening distance from the scheme sponsor. I my personal view, I believe too that standards of funding will need to continue to rise and that indeed they will do so. Where schemes have not yet achieved funding at 100 per cent of their technical provisions we should ensure that they certainly never fall below the funding required to cover at least PPF benefit levels. We should be less inclined to accept funding of below PPF benefit levels under any circumstances. Where funding goes to in the future, will depend on how much protection government and business agree to give. But we need to bear in mind that these liabilities will be on company balance sheets for decades to come. It may well be in the interests of business to get these legacy liabilities out of their hair and the trustees off their backs, by funding to self sufficiency in the longer term and de-risking to take away the volatility. These are major questions that will be a matter for my successor and no doubt for vigorous debate.
Schemes where liabilities are likely never to be met
Over the past year or so we have highlighted the role of the employer in underwriting the liabilities of the scheme and the impact of this covenant on the funding decisions trustees make.
Where the covenant is strong, it provides trustees with some flexibility in how they meet the scheme’s liabilities. But where it is weak, the opposite is true.
There are a small number of schemes where the liabilities are never likely to be met by the sponsors.
The employer covenant in a handful of cases is so weak that even allowing for this support, these schemes are by any measure insolvent. They can only hope to meet their promises by taking very high levels of investment risk with significant potential to go wrong.
For such schemes we believe the starting point has to be that any deficit should not be allowed to increase. There are two aspects to this.
First is the accrual of benefits. Where an employer is unlikely to ever get close to providing funding for benefits already accrued, it is common sense that they should look seriously at whether future accrual should continue.
Secondly, as set out in our covenant guidance, investment risk should only be taken to the extent that it can be underwritten by the employer.
It's not right for schemes to take excessive investment risks to bridge the funding gap where there is a fragile employer. This is essentially gambling with other people’s money.
If the strategy back-fires, leaving the scheme in a worse position, a minority of younger members will carry the strain and PPF levy payers may have to meet the shortfall.
The Ilford judgement makes it very clear that trustees cannot rely upon the existence of the PPF safety net as part of their strategy for improving the scheme’s funding.
We have already encountered a very small number of schemes in this difficult position and we are exploring the various ways open to us to deal with this situation.
Such schemes raise a new and challenging set of circumstances for us to work through with trustees and with the sponsoring employers and we intend to say more next year.
As is already the case, we will not hesitate to use our powers in situations where a weak covenant has been ‘manufactured’ in a bid to offload the scheme.
There are two other matters I want to discuss before I turn to DC. They are enhanced transfer values and the use of our powers.
Enhanced transfer values
This time last year I raised concerns with regard to enhanced transfer values (ETVs), and - following consultation on our revised guidance back in July - we will be publishing the final guidance later this week.
It is fair to say there has been a lively debate in the industry. Whilst I know I will struggle to convince some of you today, I feel it’s important to make a few points about this vital issue.
Firstly in my personal opinion it’s ironic that some in the industry have said that Government and TPR should do more to maintain DB provision while baulking at any suggestion that members should think twice about transferring out of a DB scheme.
We are not saying that transfers will always be inappropriate. We are though still asking trustees to begin from the presumption that these exercises are not in most members’ best interests, and that is based on our belief that in the overwhelming majority of situations this will indeed be the case. However we do recognise that there will be individual and specific circumstances in which a transfer may be in the member’s best interests.
We point to these in our final guidance, to be published later this week. They are where a members’ life expectancy is limited; where no dependants will be supported long term by the DB pension; where the member is a sophisticated investor and is specifically looking to balance the risks in a portfolio of retirement benefits; or where the level of benefit is significantly higher than the PPF cap and as such would be cut if the schemes entered the PPF. And even in these cases, trustees need to be satisfied that allowing the member in question to transfer is in the interests of the remaining members of the scheme.
The number of members falling into this category will likely be a small proportion of all those offered a transfer.
Our concern is that members – who are essentially in the same position as consumers in these transactions – may not get the protection they need to make the best decision. We would be failing in our objective to protect members if we turned a blind eye.
And why do we believe members need protection? Well, we have seen some concerning behaviour, for example where the member is offered advice paid for by the employer but on the condition that members take that advice. We have also seen examples where excessive pressure is placed on members to make a decision, with daily phone calls, emails and even home visits.
It is also a simple fact that it’s very difficult for members to gauge whether giving up a DB pension promise – in exchange for a cash transfer into a DC scheme – will be in their best interests over the long term.
Offers that involve cash incentives are likely to result in less objective decision-making, and members may struggle to evaluate the strength of the offer in the context of the benefits they are giving up and the risks that are being transferred to them. They need to be able to make an informed choice, and take such decisions with their eyes open.
Trustees can help to safeguard members by ensuring that any such exercises are well-run, with members' interests at the forefront. Our approach is consistent with the FSA's approach to contract-based pensions and we published a joint statement with them in July. Whether carrying out transfer exercise is the right choice or not, is not for us to judge. However, if a sponsor does decide to carry out a transfer exercise we will expect it to be fair and that members will be made aware of the risk they are taking on.
Given the gravity of the decision, the difficult financial equation, and potential for detriment if they get the decision wrong, we believe our stance is reasonable and proportionate.
Use of the regulator’s powers
In 2010 the regulator continues to use its powers in the most effective way we know how – as a deterrent. By expending a significant amount of effort on education and enablement, we can minimise the need to enforce at a later stage.
We do not use our powers if we can avoid it. But over the past five years there have been many occasions where it has been necessary. Since 2005 we have requested, and been granted by the Determinations Panel, the power to remove 14 individual trustees from schemes and to appoint 25 trustees to schemes. In the past two years alone we have used the power to request information from employers, advisers or schemes on 88 occasions. And on five separate occasions we have been granted to power to raid properties and to retain any documents which may help with our investigations. So we don’t sit on our hands.
Sometimes we reach the brink of exercising our heavier powers. Just a couple of months ago we were poised to use the power to set technical provisions and impose a recovery plan for the first time, in respect of the EMI pension scheme. This had been a long case and we welcomed the fact that the trustees and employer were eventually able to come to an agreement which was reasonable for all the parties involved.
This was a high-profile case that received media attention. Most of the time we are in the situation of having helped to deliver a positive outcome without being able to tell anyone about it. Legislation – designed to protect employer’ commercial confidentiality and encourage people to share information with us - rightly places restrictions on what we can and cannot say publicly about our interventions, with most case-specific information falling into the latter category.
When we do release details of our interventions, as we have this year, it demonstrates that the regulator is not just all bark. It can bite. But we would prefer not to have to use our heavier powers at all. The regulator’s Determinations Panel provides a crucial, impartial, check on the way in which we exercise these powers.
Some recent cases are also testing the scope of our powers. I should emphasise that we don’t see this as a negative exercise. It is important for us to have clarity around their reach.
DC and The Pensions Regulator’s plans
I now turn to DC, which has gained increasing attention over the past few years. And this will only increase as membership grows and as we approach auto-enrolment from 2012.
We have a duty to protect the benefits of all members and we must therefore ensure that DC scheme members are offered the appropriate protection and support they need to make good choices about their savings. They also have the right, just like their DB counterparts, to be in a well run, high quality, good value scheme.
While there are many excellent DC schemes, members face risks including the consequences of poor administration, high charges, inadequate contributions, inappropriate investment choices and insufficient or sub standard communication.
Members in each different type of scheme face risks to varying degrees. For example members in small trust-based schemes may be certain that the trustees should be acting in their interest. However the risk of insufficient resource and knowledge within the board means they may be at higher risk of poor administration than those in for example a large GPP where the provider has greater resource to expend on each member.
We don’t make a judgement on which type of provision is best, but we do recognise that the different segments may call for somewhat different regulatory approaches.
Knowing what approach is best comes down at least in part to knowing who is accountable for the decisions that lead to members receiving adequate retirement income.
- How much can we rely on the member to make good choices?
- What can and should the employer do to ensure that provision is appropriate for their staff? and
- What is the role of the provider and the trustee?
In trust-based DC schemes the accountability is clear. There is less clarity in DC contract-based schemes. We have been liaising with our colleagues at DWP, the FSA and Treasury, as well as with major players within the pensions industry, to explore what a safe, secure and sustainable DC market might look like.
In the new year, we plan to consult with the industry on our thoughts in this area, with the aim of publishing a revised DC regulatory framework in late 2011.
The future
Looking ahead, The Pensions Regulator will play a key role in delivering some of the most significant and far reaching changes in generations to the pension system.
In another six years time, all existing employers will have reached their auto-enrolment duty date and up to 8 million people will have been auto-enrolled into a qualifying pension scheme, helping to reduce the number of people – currently over 7 million – who are not saving enough for their retirement.
Following the completion of the ‘Making Auto-enrolment work’ review back in October, our work is now flat out - developing the process for registration and maximising employer compliance while minimising unnecessary regulatory burdens. We are mindful of the impact on all employers, but particularly small and micro-employers, which are less likely to be engaged in pensions already. To help employers to get ready we will communicate directly with all employers at least 12 months before their duty date and then again three months before.
This communication is so important because it will take time for employers to get ready for auto-enrolment, to update payroll and HR systems, and to communicate the changes with their employees. This time is crucial for employers, many of whom up until now may have had little or no interaction with pensions, to become familiar with their new duties.
We will do everything we can to educate and enable employers to fulfil their duties. During 2011 we will be publishing guidance for employers and trustees, and their advisers, explaining the new duties in as much detail as is possible. There will also be interactive tools designed specifically for small and micro-employers. These will ask a number of questions of the employer and in response deliver the relevant information for that employer’s situation.
We want to see maximum compliance and we will do everything we can to help employers fulfil their duties. As in all our work so far we do not want to hand out penalties where this can be avoided. No penalty will be issued without due warning and the opportunity for the employer to rectify the situation. We cannot of course leave deliberate non-compliance unchecked and we will have powers to deal with this behaviour.
Our strategy for enforcement will be published for consultation in 2011 and we will look for feedback from across the industry and from employers.
Conclusion
It has been a fascinating six years. When I took the job friends thought I was mad. Some thought it would be boring. The more informed thought it was not doable and that my doom was inevitable. We were bound to fail. I do not believe that we have failed. I began by thanking the staff at the Regulator for their part in that. I now want to thank the NAPF and above all you the trustees for the part you play. Without you we would certainly fail.
Thank you.