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Mark Boyle at Punter Southall Annual Conference

Thursday 29 September 2016

It is widely acknowledged that employers and trustees of defined benefit (DB) pension scheme have been operating under challenging conditions in recent years. Falling gilt yields and persistent low interest rates have played their part. And of course what we must not forget is the good news of increased longevity – “younger for longer” as I have rather more positively heard it described.

More recently, we’ve had increased market volatility and the European referendum result with all the additional uncertainty that that’s created. There’s now the prospect of an extended period of very low interest rates and considerable uncertainty ahead. This has – as you will have all seen – resulted in sensational headlines about growing scheme deficits. And all this under the shadow of several high profile, highly sensitive cases, and the intense scrutiny of the media.

So it’s understandable that there is a growing debate around the affordability and sustainability of DB schemes. I listened to the aspects of the debate earlier here today with great interest.

I’d like to talk to you today about how we can all play our part in safeguarding the future of defined benefit pension schemes. It matters what the regulator says, but everyone can play a part.

At TPR we welcome this debate and we are keen to engage in it. The more of the right people that are engaged in it, the more likely we are to find the best solutions. But during this period we also believe that it’s important not to make knee jerk reactions either in response to difficult situations, or to individual cases.

I’d like to take the next 20 minutes or so to share what we at TPR are thinking about the challenges facing DB schemes and their trustees and to outline some of our thoughts in making the future for DB pensions as secure as possible.

Setting the scene – where we are now

The headlines around the growing scheme deficits have led to questions about whether DB schemes are affordable and sustainable.

But headlines about large deficits by themselves do not necessarily mean the system is not working. Pensions are long term vehicles and most schemes will be paying out for another 50 years or more.

All of our research continues to show that the vast majority of employers with DB schemes should be able to repair their deficits and meet their long-term financial obligations to their schemes’ members.

Our 2016 Annual Funding Statement shows that generally, there has been an increase in employer’s profits since their last valuation dates. More than half of FTSE 350 companies paid out 10 times or more to shareholders than to their schemes. As for recovery periods, roughly half of recovery plans of schemes carrying out valuations in 2016 have five years or less remaining to run. The average remains at around nine years.

In our view, the flexibility available to DB pension schemes and their sponsoring employer means that over the longer term most employers will be able to pay members their promised benefits.

However, we recognise that some schemes are operating under strain. There are growing deficits for many schemes, primarily caused by the impact of interest rates and longevity, which serve to increase scheme liabilities by more than the growth in asset values. As I have said, these deficits may be creating alarming headlines, but we don’t believe we should overreact to these.

At TPR we are committed to helping trustees and employers navigate the challenges they’re facing and I’ll outline three specific ways in which we are doing just that.

The first is through our work on 21st century trusteeship, the second is our promotion of integrated risk management (IRM), and the third is by encouraging trustees and employers to fully explore the flexibilities that exist in the current funding framework. I’ll talk about each of these three in a little more detail.

Firstly, 21st century trustee

We are continuing our work on 21st century trusteeship, in our efforts to drive up standards of stewardship across all schemes, not just DB, but also of DC and Public Service pension schemes.

We need to fully understand the challenges that trustees are facing in order to help them to carry out the increasingly complex role that’s expected of them.

So while last year for us was about collecting information by conducting new research into trustees, chairs and board dynamics, this year is about using that intelligence to provoke debate and to provide concrete ideas on how we can drive up standards of trusteeship.

We have our own thoughts on this, but we wanted to hear the industry’s views too, and in July we published a discussion paper, which asked, among other things:

  • Should there be barriers to becoming a professional trustee?
  • What should we do with the schemes that don’t demonstrate acceptable standards?
  • What do we do with schemes that don’t engage with us?

The closing date for responses was earlier this month, and I’m really pleased that we’ve had a wide range of responses, from lay and professional trustees, chairs, pension managers, public service board members, advisers, consultants and industry stakeholder organisations.

Unsurprisingly, there are a variety of opinions expressed, but there are also some emerging themes.

While most respondents supported the idea that the chair of trustees should have demonstrable leadership skills, few respondents thought that minimum qualifications for the chair or membership of a professional body would be helpful.

Where there are schemes that don’t reach expected levels of governance, most respondents thought a targeted approach by us towards those particular schemes would be better than placing additional burdens across all schemes.

On the question of how trustees can demonstrate their competence, there is little support for mandatory qualifications. Most respondents felt that it is the knowledge and skills of the board as a whole that should be considered, with the support of advisers and other service providers, rather than the knowledge or skill of a single individual within the collective.

We’ll be taking all these responses into account as we develop our strategy over the coming months. But this is not about imposing new standards of governance. It’s about assessing the effectiveness of our communications to understand what works and what doesn’t. And it’s about considering what solutions might be required, particularly if some trustees are not improving despite additional targeted support.

Trustees play a crucial role in safeguarding pensions. That’s why we are focussed on driving up standards of trusteeship. Our aim is to make them a knowledgeable, powerful first line of defence for pension scheme members.

Secondly, Integrated Risk Management (IRM)

Integrated Risk Management, or IRM, is a tool designed to help schemes identify, understand, balance and manage the risks associated with funding, investment and their employer covenant in the round.

Trustees have told us this is an area they would like more practical guidance, and so last year we issued a comprehensive guidance for schemes on IRM, which sets out how both trustees and employers should be thinking about risks materialising; and how they could manage the impact of those risks.

We plan to follow this up shortly with a “quick guide” to IRM, which is aimed at trustees of smaller DB schemes.

This new guide takes the principles set out in our IRM guidance and explains how trustees can apply IRM in a very practical way to their own scheme, along with the key issues to consider.

We urge all trustees to look at our IRM guidance - it’s particularly important that trustees talk to their sponsoring employer. We want them to develop a common understanding of the relationships between the risks associated with funding, with investment and with the employer covenant.

This should, in turn, result in a better working relationship between trustees and employers, better decision-making, and a more evidence-based focus on the more important risks. Schemes should consequently be in a better position to cope with unforeseen changes in their circumstances.

A good understanding of the risks will also provide a basis for exploring the flexibilities that currently exist in the system.

Thirdly, flexibilities in the DB framework

Most of you will be aware that in July 2014 TPR was given a new statutory objective –specific to scheme funding – which is to minimise any adverse impact on the sustainable growth of an employer.

We need to balance our objective to protect members’ benefits and to protect the PPF with this additional objective; and to do so in a way that does not adversely impact on the growth of the employer. Of course this balance is not always easy to achieve, because at times those objectives can be in tension.

But the current DB funding framework is designed to strengthen the pension scheme; and it also has the appropriate flexibility to give employers the breathing space they need to grow their business.

It is specifically designed to be flexible; to allow us to seek that balance as much as possible, between protecting members of schemes – and the PPF – and not undermining the sponsoring employers’ ability to grow their business by placing unreasonable burdens on them. It is in the scheme’s best interests that the employer survives and, ideally, flourishes. It remains our view that the best security for a DB scheme is a sustainable and ongoing employer.

Here is a real example of a DB scheme and its sponsoring employer working together to use the current flexibility built into the framework. The trustees of a scheme accepted a two year deferral of scheme contributions from 2014 to 2016 so that a significant capital project could be completed.

The trustees sought independent advice and were advised that the capital project was likely to result in a significant increase in revenue and cash generation. Equally important, they were advised that not being able to make the investment in the business was likely to weaken the employer over the longer term as their core market was evolving. As part of these negotiations, they were able to secure a guarantee for the full liabilities of the scheme from the wider employer group which helped to mitigate any downside risk for the trustees.

This is but one example of the flexibility that the system is designed to permit.

So that’s where we are at the moment. Trustees and employers are operating in challenging circumstances and we accept that there are some schemes under severe strain. But we believe there is not a systemic affordability problem with defined benefit schemes in general. The vast majority of schemes should be able to pay out their promised benefits. And the PPF is there as an effective safety net for members when an employer becomes insolvent. The system is working largely as Parliament intended.

However, it is right that this framework is reviewed periodically, particularly as the conditions in which schemes are operating are changing. At TPR, together with DWP (our sponsor department), we have been looking at whether there are any improvements that could be made to the system.

These themes are also, as you will be aware, being debated by other parties, notably the PLSA (Pensions and Lifetime Savings Association, formally NAPF) and the WPSC, and we are engaged actively with both of them. You can expect to hear more from us on these themes over coming weeks.

I’d like to spend the remainder of this talk share some areas we feel that the current framework could potentially be improved.

Outlook for the future

The current framework was created by the Pensions Act in 2004. And clearly the pensions landscape has changed considerably since then as already discussed. Economic conditions have made it more expensive for employers to meet their pension promises.

Despite considerable challenges for some businesses, as I have said, we believe that most employers will be able to meet those promises. However we have identified four areas within the current legislative and funding framework that could improve the way we regulate and improve our ability to protect members’ outcomes:

  • information gathering
  • valuations
  • scheme funding
  • corporate actions

I’ll briefly go through each of these four areas now:

Firstly, information gathering

Information flow from schemes to TPR is critical to our work. It’s vital that we have up to date and relevant information so that we can target our interventions and act quickly. To help us do that – to act quickly, before things go wrong, we think that some improvements to our information gathering powers could be considered.

Specifically, by allowing us more flexibility in how we collect information, and by placing more of an onus on other parties to cooperate with us and to provide us with more information.

Secondly, valuations

Valuations are a vital part of the scheme funding process. They set the groundwork for understanding the position of the scheme and making decisions on risk and funding strategies. You’ll know that schemes currently carry out their formal valuations every three years.

We think some flexibility on the valuation period might be beneficial – allowing us to require more regular valuations where necessary but also potentially allowing a longer period between valuations from well run, well funded schemes.

We also think there is a case for a reduction in the period of time a scheme has to complete its valuation – which is currently 15 months. Improvements in technology and a better understanding of the valuation process means that schemes could almost certainly complete their valuations more quickly.

Thirdly, scheme funding

Use of our powers currently depends upon a subjective interpretation of key terms included in legislation, such as “prudence” and “appropriateness”, the precise meaning of which is not made explicit. It can sometimes be difficult for us to get the scheme to engage with us appropriately. There may be ways to improve the position – for example by more clearly specifying desired outcomes for schemes and acceptable parameters for scheme funding.

Another idea could be to shift the burden of proof onto schemes to demonstrate, to our satisfaction, that their proposals are both “prudent” and “appropriate”.

Lastly, corporate actions

The current framework does not require corporate sponsors to seek clearance from us ahead of major corporate events. Our powers have been designed to work retrospectively to seek redress after an event.

We think it may be appropriate to consider making it mandatory, in certain circumstances, for employers to approach TPR for clearance before a major corporate action can go ahead. We fully appreciate however that there is the potential for this to be a significant burden on employers and it would therefore need to be highly targeted and proportionate.

It would also need to be very clear in what circumstances clearance would be required – but this could include for example where the employer covenant would be materially weakened through corporate activity such as significant dividend payments, change of control, share buy-backs and loans. Of course, if the scheme is well funded, then TPR approval may be unnecessary.

So these are four areas that we have identified where we think that improvements could be made to the current framework. Of course it is for Parliament to make any decisions on this, but we have been talking with DWP and have outlined these suggestions to the Work and Pensions Select Committee, in response to their call for written evidence. We will be participating in the enquiry on DB funding over the coming weeks and we look forward to hearing broader views from other parties across the industry.

Before I finish I’d like to note also that we are not just looking outward for ways to improve, we are also looking inward. These are challenging times for everyone in our industry and at TPR we need to rise to the challenge too.

In particular, we are looking to become more accessible and more visible to our regulated community. We are looking at becoming clearer in our views – clearer about what we want and when we need it by; and clearer about when we are switching from educating and enabling modes and into enforcement mode.

So, to conclude:

We are absolutely committed to being a strong, visible regulator. We believe that the system is still working effectively, in the way that it was designed by Parliament. But now is also a good time to consider ways to strengthen it further in order to better protect those who are saving into their pensions.

The Pensions Regulator is alive to the significant questions now being asked about DB funding. We intend to play an influential part in the debate on affordability and any potential improvements to the framework which safeguards DB pensions.