Lesley Titcomb – ACA annual members' conference
Friday 3 February 2017
2016 was certainly an interesting and challenging year, for all of us in the pensions industry. We faced difficult financial conditions and political uncertainty, not just at home but in Europe and around the world. And an intense scrutiny from all angles – the Government, the public and the media; all of which saw pensions thrown onto the front pages of the national press. 2017 is likely to be just as interesting. And it’s a good time now, at the start of a new year, to look ahead at how we, and particularly The Pensions Regulator (TPR), might meet, and indeed navigate through, some of the challenges ahead of us.
DB funding and regulation
I’ll begin with defined benefit (DB) funding, since this is at the very heart of what you do. All of you, I’m sure, have been following the public debate about affordability and the future of DB pensions. The debate will continue this year – you’ll be aware that the Department for Work and Pensions (DWP) will be publishing its Green Paper in the coming months.
We’ve been working closely with DWP, as well as other stakeholders and interested parties, such as the Pension Protection Fund (PPF), and have offered our views – I think it’s important to repeat them here now, to you.
We appreciate that some schemes have been struggling, mainly because of the persistent low interest rates and increased longevity and / or because of challenges faced by their sponsor. And yes – many schemes’ deficits will have increased this past year.
However, our analysis shows us that there is not a general problem with affordability across the DB landscape.
Total scheme deficit – on whichever basis you calculate it – yo-yos on a daily basis. But based on the scheme specific figures produced at the time of my last appearance in front of the Work and Pensions Select Committee (WPSC), was approximately £400 billion. That’s a big number but it really doesn’t tell us anything useful about the true state of UK plc’s ability to meet these liabilities.
Our analysis shows consistently that there are only a few hundred schemes that we regard as being in severe distress – that is to say that the sponsors’ ability to fund the deficit is severely constrained. We expect that some of these will recover, or rather the financial position of their sponsors will improve, and some may fall into the PPF eventually. But we need to recognise that these failures are unlikely to happen all at once and the level of risk they pose to the PPF is well within a manageable range.
Conversely, the majority of sponsors are in a good position to manage the risks to their scheme and have the financial resources to cover the liabilities, in some cases in a very short period of time, but mostly over the medium term.
Analysis of data in the Annual Funding Statement (AFS) in 2016 suggested that for the schemes undertaking their valuations in that period, the majority of employers are able to maintain or increase current deficit recovery contributions (DRCs) to deal with their deficits. Some employers pay out dividends that are multiples of the deficit recovery contributions going into their scheme. To put this in perspective, the median ratio of dividends to DRCs in the FTSE350 is around 11:1.
We are currently working on the AFS for 2017. We expect that deficits will have increased for most schemes. But we do not expect a material change – namely, that the risk of a system wide failure is very remote, and that the majority of sponsors can and will afford to meet the full benefit promises that have been made. However, in this year’s AFS you can expect us to take the opportunity to provide clear guidance to trustees and sponsors on the issues we expect them to consider and the steps we expect them to take.
In our view, the scheme specific flexibility available to schemes and their sponsors means that most schemes can manage changes to funding needs and affordability. This means that regulatory framework is working largely as Parliament intended – it allows us to be flexible with employers, tailoring our response to their circumstances.
Having said that, we are actively exploring with the DWP what changes could be made to the existing regime to help those most stressed schemes – and what the consequences of such changes might be. And we are looking at whether our powers need to be strengthened to ensure that we are better able to deal with those unusual cases in which parties are willing to attempt to avoid their liabilities.
And I’m encouraging you too – trustees often rely on you as their expert advisers to help them interpret and understand how to use the flexibilities. So be creative. I want to emphasise that at TPR we are open to innovative ideas. And if you are uncertain whether we would accept a certain idea, ask us.
If all else fails, there are established mechanisms that may be useful in extreme circumstances of distress to which all parties, including the members, must consent. For example, a scheme restructure.
If agreement can’t be reached on a restructuring, then the situation may warrant a Regulated Apportionment Agreement (RAA). We will only entertain an RAA if a strict set of criteria are met, and if the alternative would be inevitable insolvency for the employer. An RAA has to be approved by us, and the PPF must also not object to it. Cases involving RAAs are often complex and are likely to attract a greater level of public attention due to implications for business, jobs and pensions.
It has been suggested that the RAA process should be made easier. I would be interested to here any thoughts you may have on how. However, our line in the sand is that it isn’t acceptable for an employer to engineer financial distress to bring themselves within scope of a RAA application. Or to try to unload their liabilities onto the PPF, for example through dubious use of a pre-pack administration. Under circumstances such as these we may well take a view that their actions are avoidance, and we can – and will – invoke our anti avoidance powers.
As you can imagine, we will take a dim view of any advisers who advise employers to avoid their responsibilities in this way. And I would like to be very clear that we will take action against advisers if necessary – not I am sure that anyone in this august company would do such a thing! We are currently pursuing the criminal prosecution of an adviser, not an actuary I hasten to add, who refused to respond to a section 72 information request. This is the first time we have taken such action. We have also made referrals to the appropriate professional body where we feel an adviser has sailed too close to the wind.
We know that trustees and you as advisers appreciate clarity. In 2017 you can expect us to be much clearer about what we expect in the area of funding, starting with this year’s AFS in which we will adopt a more directional approach. Our language will be clearer. Our expectations will be clearer. And with individual schemes we’ll be clearer on the point at which we will pivot from to enforcement and the formal use of our powers.
And while I am here, speaking to you face to face, I’d like to ask you to do your bit too.
Our research shows that some trustees don’t even access our guidance when it’s published, instead they rely entirely on advisers like you to interpret it for them. So, let me ask, do you make an effort to understand our guidance fully and interpret and communicate it in the most effective way? Or do you perhaps have a house view on what we mean, that you’ve maintained for a number of years? I am continually struck by how many trustees or sponsors tell me that their advisers have told them that “TPR won’t like that”. Really? And when did you last ask us?
That leads me on to the subject of consolidation in general, and particularly for the smaller schemes. This is not a straightforward problem to solve.
Let’s start with defined contribution (DC). Our concerns are rising about the fragmentation of DC provision and the persistence of a tail of sub-scale schemes. In our opinion, these pose an unacceptable risk to consumer protection. The consolidation trend we have observed and welcomed in previous years has slowed. There are now 34,500 DC schemes, a fall of only 2% on last year. Most of these, 32,000 schemes, are ‘micro schemes’ with between 2 and 11 members, and of these around 23,000 are ‘relevant small schemes’ (commonly called ‘SSAS’). Relevant small schemes are subject to minimal legislative duties, compared to those applicable to larger schemes. Of most concern to us is that of the 750 DC schemes being used for the purposes of AE, 360 fall into this ‘micro scheme’ category.
We strongly believe that it is unacceptable to have two classes of DC pension saver – those that benefit from the premium of scale and good governance and administration, and those that do not. Our approach to resolving this issue will be threefold. We will launch the implementation phase of our 21st Century Trustee initiative shortly, with a clear objective to raise standards of trusteeship and take regulatory action against those trustees who persist in failing to meet the required level of competence.
Secondly, through the introduction and implementation of the new authorisation and supervision regime for master trusts, we will seek to create a secure, scalable and value for money cornerstone of the multi-employer DC savings market, which we see as the natural destination for unsustainable small schemes. And, thirdly, we will engage with industry and Government over what steps need to be taken to protect consumers trapped in the sub-scale and unsustainable tail of DC schemes; and what barriers stand in the way of efficient consolidation, such as the removal of the requirement for an actuarial certificate.
To this end, we’re working very closely with about a dozen big pension providers, looking at how we can deal with the legacy book of orphan, often very small, occupational pension schemes that have lost their sponsors and trustees. To see how we can wind those up and distribute the money to the members or move them somewhere else to get better value for money in the long run, such as an authorised master trust. That would resolve thousands of small DC schemes, and probably some DB schemes as well, over a period of time. We are hoping that this initiative will help to substantially reduce the tail of small schemes over the next few years.
Turning to DB schemes, it is true of these too that many of the smaller ones, some of which are also in the most distressed category, lack scale and suffer from poor governance and administration. Finding a consolidation solution is not so straight forward though. It was clear from the evidence given to the WPSC that many people agree with us, that a consolidation solution may be beneficial – a vehicle that sits between free standing schemes and the PPF is a common theme – but it is clear that there is no consensus on how this could operate.
We are grateful to those of an innovative and entrepreneurial disposition who have come forward with their ideas, and I encourage them all to respond with their ideas to the Green Paper later this year. But it remains to be seen if any of these can be made to work in practice. In our experience, and we have been shown several ideas, all would require a legislative change and it will therefore be a matter for Government to determine whether the desirability of consolidation is sufficiently great to warrant a change in the law.
Let me now touch on scheme governance. It is clear from our 21st Century Trustee research, and our engagement with schemes, that the quality of governance and administration is still not consistent. We are grateful to all the participants and respondents who took part in our research. While some themes emerged, there was no consensus on what should be done. Like most regulators faced with such an impasse, we have therefore decided what we think is the best way forward and I want to tell you how that is likely to play out this year; although I stress our final plans are unlikely to be made public until after March this year.
It was very clear from the research and from the stakeholder responses that an effective chair of trustees and a good professional trustee on a trustee board has a marked positive impact on the effectiveness of the Board. As a first step then you will not be surprised to learn that we want to understand in more detail the characteristics of the most effective chair and seek ways to support suitable potential chairs to attain the necessary level of skills and experience. It is interesting to note that the characteristic of a good chair of trustees is not very different from those of a chair of the board of a company, and we will seek to exploit that overlap where possible.
We have made clear that we are not willing to accept two classes of pension scheme member, those who benefit from the premium of good governance and those who do not. We will drive up standards and tackle non-compliance through targeted education and enforcement.
Work is underway to set out a three to five year ‘road map’ on different phases of education, enforcement, engagement and evaluation activities.
In particular we propose to undertake an employer focused campaign. Our intention is to raise awareness of the need for them to support their lay trustees, for example in granting time off work to prepare for and attend trustee meetings, and to pay for adequate training. Other proposals include us setting out clearly the standards we expect of chairs and professional trustees, given the evidence of the crucial role they play on effective trustee boards; to provide a clear definition of a ‘professional trustee’; and to undertake a ‘back to basics’ campaign for lay trustees focusing on the fundamentals of good governance.
I’d like to take a moment to highlight our focus on record-keeping – that is the integrity of the data that schemes hold and its security, particularly its security from cyber attack.
Our recent survey on record-keeping, published in November last year, showed that trustees are not placing enough importance on record-keeping, which is a prerequisite for a number of things. Not least, the basics of ‘paying the right benefits to the right member at the right time’; being able to carry out an effective Guaranteed Minimum Pension (GMP) reconciliation, being able to calculate an effective cash equivalent transfer value (CETV) and being able to participate in the Pensions Dashboard project, to name but a few.
It is clear that the improvement in data integrity has stalled, there being no progress in last year’s survey over the one we carried out two years before. Once again, it seems that trustees are not responding to our calls for improvement, so we will be obliged to turn up the heat. Rather than merely surveying data integrity scores as we have done hitherto, we are going to require trustees to include their data scores in the scheme return – and you will have noticed that we are making a point of fining trustees who fail to make their returns on time. We will also from now on be taking a particular interest in those schemes which report persistently poor data scores in their returns and dealing with them directly.
Like a scheme return or a chair’s statement, data integrity in an absolutely basic ‘hygiene’ factor for a pension scheme, and failure in this sort of area can be symptomatic of far more serious failings. So, please advise your clients to take their record-keeping more seriously in future, or to expect a call from Brighton!
But it’s not just about data integrity, it’s also about data security. Pension schemes hold huge amounts of personal, employment and financial data on individual members and are likely to be attractive targets to cyber criminals. Some pension providers, particularly those subject to PRA and FCA supervision, will probably already have a security strategy in place.
But the majority of trust based schemes use third party administrators that are subject to no regulation whatsoever, and these may well need to look at tightening up their existing arrangements. Ultimately it is the trustees who are responsible for the security of their scheme data and we expect them to be very demanding customers when it comes to quizzing their administrators on the steps they have taken to secure the scheme’s data.
In both of these areas, data integrity and security, Trustees should be holding their administrators to account, and if their administrator cannot demonstrate adherence with accepted industry best practice, such as the standards set by PASA, we will expect them to change their administrator. Leaving members at risk of being paid the wrong benefits, or of having their personal information stolen by cyber criminals is not acceptable.
I’ll touch now on scheme valuations. We think a more risk-based and segmented approach to the timing of valuations and / or updates could make this process more effective. In June last year we wrote to the WPSC recommending legislative changes to, among other things, the timings in the triennial valuation process, and we continue to work closely with DWP in this and other areas.
We appreciate that schemes do need to take time on their valuations, and in particular trustees and the sponsoring employer need time to discuss and agree their valuations. But improvements in technology means that the timescale to produce a valuation should be shortened in many cases.
In fact we have suggested moving from a 15 month to a 12 month deadline and the WPSC has suggested nine months.
As I have said, we look forward to the DWP’s Green Paper on DB regulation, which will set out the Government’s preliminary proposals for further discussion and which we hope may ultimately develop some of the suggestions we and others have expressed.
I’d like to speak now about something that we call TPR Future. When your Chairman asked me to speak here today I asked him whether there were any particular topics he wanted me to cover. He said it would be useful to know how TPR ‘overcomes its resourcing limitations’. The simple answer is we don’t overcome them, and we continually have to make difficult decisions about where we direct our limited resources.
We also have to be able to explain to our regulated community what we do and what we don’t do, how we do it and how we make the choices we have to make – for example, how we pick which cases to pursue.
We also believe that we need to look at thechallenges ahead, for example the continuing shift in provision from DB to DC, the UK’s exit from the European Union, and the implementation of a new Pension Schemes Bill and many others. In addition to that, our role and responsibilities have increased significantly over the last decade.
So we are conducting a piece of work, within TPR, to consider how we deliver regulation, in regulating across DB, DC, public service schemes and in our automatic enrolment responsibilities, for the next five to 10 years.
This programme will cover all aspects of our regulatory remit, and will look at our operational practices, how we get our messages across, how we use our powers, the other regulatory tools available to us and the resources capabilities that we will need.
We’ll be asking key questions, such as: do we have the right balance between educating, enabling and enforcing? Do we identify the right risks to which we allocate our resources? Given that DC and public sector scheme regulation require a different approach to DB, how are we going to deliver that? Which regulatory tools are most effective in which circumstances?
We are also challenging the type of regulator we want and need to be. Can we be quicker and more responsive? Can we be clearer about what we expect of trustees and sponsors, not just in our guidance but also in how we communicate with individual schemes on particular issues, such as their valuation and recovery plan?
We are involving our stakeholders in this work, indeed your Chairman has already contributed on behalf of the ACA as a key stakeholder. We expect to do a number of things differently as a result of this work and we will be saying more about our proposals over the next few months.
I’m very aware that we are coming to the close of the conference and I’m anxious not to take up your travelling time. So I will wrap up swiftly. We do still have challenging times ahead – both the economic and political environments remain uncertain. So it’s important for all of us that we at TPR remain focussed on our goals, to which I know you here today are also committed: to continue to build confidence in savings and to strive for the highest possible standards in the pensions industry.