23 April 2008

Rt Hon Mike O'Brien MP

Minister of State for Pensions Reform

NAPF Seminar on Buyouts

Wednesday, 23 April  2008

[Check against delivery]

Buyouts and Keeping the Pensions Promise – O’Brien

It is my pleasure to be here.

This is a historic week for pensions.

Yesterday, the Pensions Bill was passed by MPs and now moves on to the Lords.

This Bill represents the most radical reform to the private pensions landscape in a Century.

It will see 9m people saving more and £10bn more being saved in UK pensions by 2015 – this is a great opportunity for the pensions industry and will help millions have a better retirement.

The two cornerstones of these reforms are:

• building renewed confidence in pensions and
• getting more people to save for their retirement.

So I welcome the chance today to set out the Government’s view of pension buy-outs and more widely our vision for continued confidence in UK pensions.

Can I also say I appreciate the support of NAPF and, indeed, of many of you in this room today in helping shape these reforms over the past year … and in resolving important issues. 

Perhaps none more complex than those relating to buy-outs and other ways of de-risking pension schemes.

In recent months, I’ve met with many experts, from Goldmans following their successful Rank deal, to Paternoster, Brighton Rock, Pensions Corporation, the CBI, ABI and others.

A clear consensus has emerged.

Insured buy-outs are often very sensible and effective mechanisms for securing the pensions promise.

An insured buy-out can give members comfort that their benefits are backed by the safeguards provided by regulation.

While providing employers with certainty that they have met their commitments in full.

And we have seen a growth in other ways of de-risking the pensions promise.

Such models represent an innovative response to our ageing society and they are a welcome addition to the rich tapestry of the pensions market.

But it is important that while we foster these innovative products we are alive to emerging risks and ensure that they are appropriately managed. 

We must be careful not to inadvertently sacrifice hard won trust in pensions for the sake of a new market solution.

Pension = a promise

As Pensions Minister, my aim has been to build a pensions system that encourages everyone to save for a better retirement.

This means getting more consumers to recognise that saving in a pension is, for the vast majority, the best way to provide for their future.

But it is equally crucial that we build and maintain a high level of trust in the pensions market.

Pensions are long term instruments, so if we are to encourage more people to put their money away for long periods, they need to be confident that their pension is reasonably safe.

It is incumbent on us all to work to provide trust in the system.

A pension should equal a promise. 

Not just a commodity to be bought and sold regardless of the consequences.

It is a promise that should be fulfilled.

Because to lose your pension is to suffer an injustice.

It is undoubtedly the case that, over the last ten years, we have been coping with the legacy of a crisis of faith in private pensions.

The Maxwell affair, the collapse of schemes and the corrosive effects of mis-selling scandals had worn down people’s faith in pensions.

A loss of trust can undermine the very idea of saving.

What is the point of saving for a private sector pension if it is all lost because of a corporate scandal?

Over the last decade, we have sought to rebuild faith in UK pensions.

PPF, tPR

A key step has been to provide a safety net for those who save.

That’s why we created the Pension Protection Fund.

It ensures that 90% of Final Salary scheme benefits are safeguarded in-case something goes wrong.

It currently protects nearly 11 million members.

But it is not enough just to react when things go wrong.  We need to identify emerging risks and reduce them before they take hold.

So the Pensions Regulator was created to provide greater protection for members and reduce risks to the PPF.

A risk-based regulator, replacing an old-style, ‘tick-box’ organisation.

And the way it has gone about this task has won plaudits from many in the City – for example, companies that seek clearance for corporate transactions from the Regulator give consistently good, strong feedback on the proportionate approach the Regulator takes.

FAS

When I became the Pensions Minister last June, the issue at the top of my in-tray was the scandal of those who lost their pensions and the Financial Assistance Scheme.

I recognised the ongoing damage being caused by this problem.

Not only was there a great wrong done to 140,000 people.

But the hard won confidence in pensions we were building, was at stake.

Confidence and trust take time to build and they can be all too easily lost.

So confidence was renewed last December when we were able announce a final and just settlement for these people.

Our challenge now is to sustain this level of trust, to continue to protect the pensions promise.

That is what I am trying to do.

New models

The financial markets move fast. 

As longevity predictions have be revised ever upwards, so new innovative new products have emerged to deal with these changes.

Clearly, this is to be welcomed, and in many cases this helps pension promises remain secure.

We must be prepared to adapt to our ageing society, and these new products will help us to do so.

But in some new models emerging in the buy-out market the security of an employer could be taken away – without putting adequate capital in place to replace that security.

This could create an asymmetry of risk:  a business model where the provider benefits if all goes well – but scheme members or the PPF could pick up the bill if things go badly.

It would not be fair to members, or to all those schemes which pay the PPF levy, if we allowed new business models to develop in which a provider assembled significant financial risk without being required to put in place adequate structures to manage the risk.

We should avoid a perverse situation that enables profits to be privatised but losses to fall on members or the PPF.

Traditionally in occupational pensions, if trustees are confident in the employer, they can decide on a funding and investment strategy that reflects the employer’s ability to underpin the risks undertaken.

The employer will benefit from lower contributions if the risk pays off, but will pay more if the investments under-perform.

And under the regulatory regime of insurance companies, they must back their investment, longevity and other risks with capital.

So the capital or the employer must stand behind the pension promise, and that provides an important security.

For those regulated by the FSA, the capital requirements are clear.

Any new approaches to pension scheme risk management should have a similar level of security – there should be capital, or other supporting structures underpinning the risks.

And where providers are based offshore, outside the UK regulatory regime, that causes concern. If that happens, then we need assurance that appropriate controls are in place.

I say to trustees, look carefully at the security of member benefits, and involve the Regulator early if you have any concerns.

Because I am concerned that the intrinsic risks of these new business models present a real downside.

Suppose investments fail to perform as expected.

If the link between the scheme and the employer has been severed, without adequate capital being put in place to back the risks of the scheme, then there is no backstop to ensure that benefits will be paid as promised.

In a worst case scenario, the provider could be driven into insolvency and the scheme could enter the PPF with a funding deficit.

That would mean scheme members would receive PPF compensation that was lower than the pensions they had expected.

It would mean the PPF would need to cope with new costs.

And it would mean that PPF levy payers - that is, continuing pension schemes - would have to pay higher bills.

We cannot avoid every risk; but that does not mean that we should take reckless risks with member’s benefits, or with the finances of the PPF. 

I want to ensure the Regulator has the right powers to protect people’s pensions, to ensure confidence in pensions is strengthened.

That is why last week I proposed giving the Pensions Regulator stronger powers to reduce the risk to members’ benefits by scheme changes or corporate transactions.

The proposals would apply to an employer or their associates, including major investors in the employer who might seek to profit from the scheme.  

This allows us to continue with a regulatory regime that does not place disproportionate burdens on employers who wish to provide final salary schemes, but focuses regulation on situations which pose risks to pension scheme members.

The indications are that we have a broad consensus from the industry, consumer groups and all political parties for action.

None of us want to burden employers or pension providers with unnecessary regulation – but we share a belief in the critical importance of making sure that pension promises are kept.

How we are responding to new risks

The proposals I announced last week will ensure that the Regulator's anti-avoidance powers remain effective and take account of new developments in the market place.

These powers – the powers to issue Contribution Notices and Financial Support Directions – were a key part of the measures introduced by the Pensions Act 2004. 

They prompted thoughtful debate back in 2004 – and it was widely recognised that measures were needed to avoid the ‘moral hazard’ that unscrupulous employers might seek to offload pensions liabilities onto the new PPF.

But there was also concern that we were giving these powers to a Regulator that was something of an unknown quantity. 

Some were concerned that the Regulator might act hastily and cause undue damage to employers by careless use of its powers.

I believe that the way the Regulator has conducted itself since then has significantly reassured stakeholders on this point.

It has shown maturity in its approach and I expect this to continue.

The details

My discussions with industry experts have made clear to me the importance of getting the detail right; to be proportionate; to encourage, to welcome and celebrate innovation.

So let me confirm today that I am committed to doing exactly that

• any increase in powers will be targeted
• we are consulting over the coming weeks so that we get the detail right
• we welcome your advice
• and we are committed to and understand the importance of innovation.

Of course, you may be thinking “that’s all well and good, but the devil’s in the detail”. 

So I would urge you to look critically at the consultation document I will be publishing shortly.

I want to hear your considered views so that we get the details right.

But there are three points I would like to clarify today, as they have been the subject of some media speculation.

Firstly, in relation to the issue of Contribution Notices, I am going to consult on the desirability of re-writing the law to make it clearer. 

At the moment, the law says that the Regulator could issue a Contribution Notice following an act, or a deliberate failure to act.

Common sense tells us that in some cases an action could be split up into a number of smaller activities:

For example, if I want £200 from the bank, I could take it out in one go, or go to the cash machine on 10 occasions and take £20 out. 

The overall effect of the action would be to take £200 from my account – but each individual transaction was only worth £20.

I want to make it completely obvious that if a pension scheme was in a similar position, the Regulator would be able to look at the whole picture – in my example, the £200 – and would not have to argue that £20 was a sufficient trigger for action.

This is not new. 

It is simply restating existing provisions for clarity – the Government considers that the legislation should already be read in this way, but in the spirit of simplification wish to ensure that this is obvious to everyone.

Secondly, I propose to make changes to the “good faith test”.

This is a test which only applies in some of the circumstances in which it would be possible for the Regulator to issue a Contribution Notice.

It doesn't apply if the Regulator is issuing a Contribution Notice because someone is seeking to avoid a debt to a pension scheme.

And it doesn't apply if the Regulator is issuing a Financial Support Direction.

The absence of the test in these areas has not caused problems.

But where it does apply, I believe it has unhelpful side effects.

For example, it places an onerous burden on the Regulator to find documentary evidence of ‘bad faith’ – which informed parties are unlikely to record.

And it has the potential to encourage perverse behaviours – for example, someone may avoid looking at the likely consequences of an action in case they saw arguments that should deter them from that action.

So changing the good faith test will prevent unscrupulous parties from exploiting the current system - but this change is unlikely to affect more than a handful of cases.

And thirdly, in relation to Financial Support Directions – these will still only be issued to persons ‘connected or associated’ with the sponsoring employer of the pension scheme.

We are looking at the test that could trigger the issue of a Financial Support Direction.

So that we can remove a side-effect of the current legislation that could motivate parties to move assets around groups to frustrate pensions legislation rather than for legitimate business reasons.

But we recognise that these are complex areas, and that is why we are consulting – and I believe that consultation can often provide better solutions to the issues Government identifies.

Avoiding uncertainty – clearance by the Regulator

Some of you may be thinking that the consultation sounds good – but what about the uncertainty it could bring to conducting normal business.

“How can I go about my business if I don’t know what the law is going to say?”

Well, your lawyers will no doubt be able to advise you if a transaction affects the security of your pension scheme.

But you do not need to rely solely on their advice – remember that the Pensions Regulator offers a clearance process, where it will issue a binding statement that it would not be reasonable to use its ‘anti-avoidance’ powers in relation to a transaction that it has cleared, providing all the relevant facts are disclosed to the Regulator.

Let me make three important points:

Firstly and most importantly, the overwhelming majority of pension schemes should not be affected by these changes.  We do not expect a significant increase in the number of cases which should come for clearance;

Secondly, if you get clearance for a transaction now, the Regulator will be bound not to use its powers in relation to the transaction – not just existing powers, but also the revised powers we propose to provide;

Thirdly, the Regulator does not anticipate extending the time it takes to grant clearance as a result of these changes – so normal transactions will not be frustrated.

I suspect that informed commentators share our priorities, and understand that we are not going to rush headlong into onerous regulation.

For example, I noted that Andrew Hill, writing in the FT last week commented that:

“Suggestions that the watchdog, which by all accounts has used its powers judiciously, will now have a sudden rush of blood to the head are unwarranted and ill-judged.”

Conclusion

The whole topic of de-risking pension schemes, including various approaches to buyout is important and fast moving.

I welcome the timely focus that NAPF is bringing with this event today – and I am sure it will move the debate forward.

I welcome innovation and the fresh approach to pensions this can bring.

New ideas can help us to adapt to changes we face as our society ages.

But I also recognise we need to ensure regulation keeps pace with a changing market.

My forthcoming consultation document will set out how we will ensure key risks are managed effectively.

I look forward to a constructive consultation to get the details right.

Our shared responsibility should be to ensure pension promises are kept, with confidence in UK pensions secured for the long-term.