23 October 2008

Lord McKenzie of Luton

Parliamentary Under Secretary of State (Lords)

Fitch Ratings Insurance Roadshow

Thursday, 23 October 2008

[Check against delivery]

Good afternoon Ladies and Gentlemen.  I hope you have all enjoyed the day so far.  I shall perhaps explain that following the reshuffle and a division of Minister’s portfolios, I have recently taken responsibility for the UK private pensions landscape to support our new Minister for Pensions and the Ageing Society, Rosie Winterton.  So I am particularly pleased to be able to attend this event and to speak to an audience of senior insurance management professionals.  Examining risk in pensions and how they can be managed, has never seemed more relevant than in our current economic climate.

These are difficult times in the global economy.

In recent weeks we have experienced a series of unprecedented events in world financial markets.  A couple of years ago, I doubt there were many that would have envisaged a single week where we would see the collapse of Lehman Brothers, Morgan Stanley bought by Bank of America, Lloyds TSB agree to merge with HBOS and a ban on distortionary short selling practices.  This is a financial crisis that is affecting every country in the world.  In a highly leveraged, interconnected and complex global financial system, shocks like these are profoundly felt and quickly transmitted across countries. 

The Government is taking action to deal with these challenges.  The immediate priority is financial stability and we have acted to protect both the banking industry and consumers.  We have brought forward specific and comprehensive measures to ensure the stability of the financial system and to protect ordinary savers, depositors, businesses and borrowers.  These measures include:

• Providing sufficient liquidity in the short term by extending the Special Liquidity Scheme
• Making available up to £50billion of new capital to UK banks and building societies to strengthen their resources through the Bank recapitalisation scheme
• Ensuring that the banking system has the funds necessary to maintain lending in the medium term, achieved through the credit guarantee scheme, guaranteeing up to £250billion of unsecured debt issuance.

It is particularly at times like these that we recognise that people are considering what this holds for the future.  And as a DWP Minister, I recognise that people are naturally concerned about their pensions.  A look at last weekend’s headlines confirms this.  Headlines proclaim, ‘Pensions have billions in toxic assets’, ‘Pension plans are stronger- or are they?’, and ‘Worried investors spread assets.’ 

These are unsettling times.  It seems like a day doesn’t go by where we don’t hear of volatile movements on the FTSE.  But we need to think about the long term.  This is a fact that is often overlooked in the many column inches written about this issue.  As Christopher Hitchens, Chairman of the National Association of Pension Funds put it in a recent FT article, ‘Headlines that stock market falls have wiped out people’s pension savings are frankly misleading and unhelpful.’

We recognise that pension providers and scheme sponsors may be coming under strain.  But the fundamentals of the pension system remain strong.  Pensions are about long term investment.  Those retiring in 20-30 years have decades to watch their pension pots recoup.  And many of those coming up to retirement will have their pension invested in lifestyled funds with their pots having been moved into safer, lower risk investments, reducing the impact of recent heavy equity market falls. 

But perhaps first to Defined Benefit pension schemes.

The falling stock markets will have increased the deficits of these schemes.  But volatility in scheme funding is not unusual - a similar situation arose in 2003 when the stock market fell by over a third but recovered subsequently.  The key point is the long term horizons of pensions.  While scheme assets fluctuate with asset prices, their liabilities are spread very far into the future.  Employers will not have to immediately replenish the increased deficits.  The Pensions Regulator operates flexible, scheme-specific funding arrangements that allow employers to recover deficits over a long period, typically around 7 years.  Even where sponsoring employers do become insolvent, the protection system put in place in 2005 provides strong safeguards for members.  This system is three fold:

• Our regulator is more powerful and proactive, providing greater protection for members. This also reduces the risk of problems arising in the first place.
• There is the Pension Protection Fund to ensure there is a safety net for those whose Defined Benefit pension scheme fails.  This currently protects 11 million members.
• And the Financial Assistance Scheme was created to deliver justice to those who suffered losses to their occupational Defined Benefit schemes before the Pension Protection Fund existed.  From June 2008, it began paying 90% assistance like the PPF.

This protection system provides a strong and clear framework to ensure that people can continue to have confidence to save for their future.

Just this week, we have tabled an amendment to the Pensions Bill to ensure new business models involving the buy-out of pension schemes, do not undermine the security of members benefits.  Our main concern, was the emergence of new business models in the buyout market.  Models that can reduce the security provided by the pension scheme’s sponsor employer.  But I want to reassure you that these amendments do not impact on typical insured buyouts – that is, the normal purchase of bulk annuities.  And the powers are targeted, so that they do not have a disproportionate impact on legitimate corporate activity.

I do not contend that the protection system is flawless.  We are facing some major challenges with the increased insolvencies of employers and the liquidation of defined benefit schemes.

Let me make it clear that in the event of liquidation, there is no risk to scheme members of pensions not being paid.  Even when sponsor companies with underfunded schemes become insolvent, the Pension Protection Fund would normally step in to protect member benefits. 

We are looking further at how to reduce the financial pressures on companies sponsoring pension schemes.  Last year’s Deregulatory Review of Pensions, and our recent consultation on risk sharing, gave several options and indeed I would welcome your views on these.  Some of the options we are pursuing include various ideas around easing the burden imposed on employers undertaking routine corporate restructuring.

And already:

• The Pensions Regulator has indicated they will issue simplified guidance to trustees on how to act in current conditions, to ensure that the recovery plans have regard to with reasonable affordability
• And the Pension Protection Fund Board has decided that its protection levy will only be increased in line with inflation in the coming year, just as the Board said in 2007 it hoped that it would.

We will publish the Government’s full response on risk sharing in pensions, later in the Autumn.

And turning now to Defined Contribution schemes. There are an estimated 9.8 million Defined Contribution pension arrangements in the UK currently receiving contributions. Defined Contribution pensions tend to be heavily (around 80%) invested in equities.  Information from the insurance industry tells us that around two-thirds of these schemes offer a lifestyle fund whereby assets are shifted to less volatile assets as a member comes close to retirement. This will have helped shelter many people close to retirement from the recent turmoil.

However, this has not prevented a focus on whether any change should be made to the age by which annuitisation must take place.  Although I sometimes think this debate- which we have it on a recurring basis in the House of Lords- overlooks the fact that many with Defined Contribution pensions pots have a practical deadline by which they need to generate an income, which falls long before they reach age 75.

Indeed it would be good to know a lot more about how prevalent lifestyling is among those coming close to retirement, and how much protection it is offering to them. Insurers presumably have this information in their systems – and it would be helpful to public confidence if more of this information could come into the public domain.

As I have said, the Pension Protection Fund was created to ensure people don’t lose their pensions in the future. 

It’s designed to work in a benign environment and in a downturn.  Its long term risk model helps them to work out how much risk they face over the next decade and mitigate that risk as much as possible.  Understanding the risks the PPF may face in the future will enable them to build long term sustainability, set a stable risk-based levy, and ensure that people get the compensation they are entitled to. 

It is important that the 11 million or so scheme members protected by the PPF, the people receiving compensation now, and the people receiving compensation in the future, have confidence in the PPF’s financial security and long term sustainability. 

Obviously, one way that pension trustees can reduce the uncertainties involved in scheme funding is to enter into an annuity contract with an insurer.  Where these annuities are in members’ names, scheme members are moved from the protection of the PPF to the protection offered by the Financial Services Compensation Scheme.  Such deals would not usually therefore increase risk to scheme members or to PPF provided the levy income lost is matched by a reduction in the PPF’s exposure to risk.  Trustees do, of course, need to be sure that they are applying the assets of the pension scheme fairly between the different classes of members.  You will be aware that during 2008 there has been significant growth in the market for bulk annuities, although one consequence of current volatility in the equity markets may be trustee nervousness about cementing the terms of a buyout.

There is clearly a great deal of creative thinking underway about methods of derisking defined benefit schemes.  I am supportive of secure market led solutions to manage the risk of pension provision.  But I do consider that it would be wrong at this time to open up the market to those who would effectively be providing an alternative to the PPF.  If in the future we do open up the market to these types of products, we would need to ensure that we are confident that these providers enter the market with the ability to provide long term security for those taking out such policies.  Confidence in those institutions is equally important for those members remaining under the wing of the PPF.

Despite the present turmoil, and the challenges that the ratings agencies, the financial services industry and the Government face, we need to keep things in perspective.  We know that the financial services industry is an important part of our economy in itself and an increasing component of our wider economy.  We should recognise that even the sometimes complex financial instruments play a role in helping trade and commerce to flow.  But we must focus on working together to rebuild market confidence, to enhance transparency in complex financial instruments and to provide a solid and responsible governance framework.

In our present economic circumstances, when our penny is pinched, it is appealing not to pay into our pension and to keep that cash for today.  And more people are tending to do.  Some may wish to stay in work longer to improve their retirement income and the challenging economic environment will not make this easier.  But for those who want to stay on in work, we are committed to reviewing the default retirement age in 2011.  And if it is shown that the default retirement age, currently 65, is not necessary, we will abolish it.  This is a move we have already taken internally, across Government departments.

By providing auto enrolment into a pension scheme and matching contributions from employers for every pound saved, we are providing strong incentives to save.

The Pensions Bill, which is now in its final stages, will cement the remaining part of the Pension Commission’s radical blueprint for reform to revitalise pensions saving.

Reforms which will mean:

• Between 6 and 9 million people newly participating or saving more into workplace pensions
• Overall annual workplace pension contributions in this country are estimated to increase by up to around £10billion by 2015, the majority of which will be new saving
• And where there is no current pension provision, people will be able to save in personal accounts. Enabling millions access to a pension scheme for the first time.  Especially those who work for small employers.

Coupled with our reforms to state pensions, this is a socially inclusive approach, which should provide incentives for everyone to save. 

We are not near the end of the journey.  Instead it marks a new beginning as we turn towards making the Pension Commission’s vision a reality.  A reality in which pension saving is the default, not the exception; a reality where employees receive matching contributions on their savings from employers, doubling their lifetime savings capacity.

A reality where all employees can get access to workplace pension savings.

These objectives are not just desirable.  They are a fundamental part of living in a society where everyone has the opportunity to enjoy security in retirement.

Thank you for inviting me today.  I look forward to taking your questions.