27 November 2008

Lord McKenzie of Luton

Parliamentary Under Secretary of State (Lords)

Pensions World magazine conference – ‘Managing Pensions Liabilities’

Thursday, 27 November 2008

[Check against delivery]

Introduction

Good morning Ladies and Gentlemen.

As you know, Mike O’Brien, has now moved on from Pensions to the new challenge of Energy Minister. Since the reshuffle I have taken responsibility for private pensions, working alongside the new Pensions Minister, Rosie Winterton. 

So thank you for the opportunity to offer some thoughts today on our current pensions environment.

I am pleased to say that after a rigorous parliamentary process, the Pensions Bill this week received Royal Assent.

This morning I propose to cover some of the reforms and concerns they may raise in the new Pensions Act, the effects of the current economic climate and what the Government has done to help, and of course, the steps we have taken to strengthen the anti avoidance powers of the Regulator in the Pensions Act given developments on the buy-out scene.

These are certainly interesting times in the world of pensions. 

Both in our current economic climate and in the times to come as we move toward implementing the radical reforms of the new Pensions legislation.

That these radical reforms have come this far is encouraging and due in no small part to the welcome consensus we have seen across all sectors and levels of the pensions industry.  We can now look toward implementing these reforms, and move a step closer to revitalising saving in the UK.

These reforms will mean:

• Between 6 and 9 million people newly participating or simply saving more into a workplace scheme
• Overall annual pension contributions are estimated to increase by up to £10 billion
• And where there is no provision, employers have the option of putting their workers in personal accounts - enabling millions access to the benefits of an occupational scheme for the first time. 

But of course, with reforms of this magnitude, there are concerns around the impact that they will have on existing good quality occupational pension provision.

Concerns this will result in levelling down

There are concerns that these reforms may result in a ‘levelling down’ of pension provision.  But I want to make clear that personal accounts are there to complement, and not replace existing employer provision.

That is why there will be a ban on substantive transfers between existing pensions schemes and personal accounts, as well as the annual limit that we have imposed on contributions to the personal accounts.  Although we have committed to review these contraints in 2017.

But, these changes represent a great opportunity for industry, with around a million workers who were already saving having their employer contributions increased to at least 3%.

And where employers already offer good quality schemes, we want these to continue and want to ensure that we use a simple scheme qualifying test.

This is why we have legislated to facilitate an annual equivalence assesment, so that a scheme may qualify regardless of the definition of earnings used, providing that the cash value of contributions paid into the scheme is equal to or better than the value of 8% of qualifying earnings.

There will be no obligation on employers to use a matching definition of earnings.  And we have made explicit our intention to allow the assessment of contributions over the course of the whole year.  Something that will enable employers to smooth the flow of contributions into workplace pension saving.

As in the run up to the Bill, we will continue to work with groups across the industry, to reassure providers that despite the magnitude of the task ahead, by working together, it is certainly achieveable.

We will open up saving for retirement to millions more people in the UK.

So, I’d suggest that’s a bright looking future.

Current pressures employers are facing and what Govt has done to help

But to be frank, I know we are all aware that the present isn’t looking so bright as it was even this time last year.

Managing the pressures of our current economic climate is as substantial a challenge to that of preparing for the implementation of the Act’s workplace pension reforms in 2012.   

The scale of this challenge was set out in the Chancellor’s Pre Budget Report.

The issue of risk and liabilities has never been brought into such sharp focus than by current market conditions. 

In recent times billions have been wiped off markets and then added back and then removed - in the space of a few weeks.

Coupled with our reforms to increase saving, and our increased longevity…

…we are entering an entirely new territory in pensions.

Which as I said at the beginning, is interesting times.

It is fundamental that during these times, the Government and industry continue to work together to strengthen confidence in pensions.

Over recent weeks we have taken a number of steps in an effort to relieve pensions providers and scheme sponsors of the increased overheads they are facing.

These steps firstly include deregulatory measures in the Pensions Act.

We have reduced the revaluation cap from 5% to 2.5% for future accruals.  These measures have the potential to save employers around £250 million per year in the longer term.

Secondly we want to help occupational pension schemes with restrictive rules take advantage of relaxations in the revaluation requirements.

So we will therefore introduce a statutory override to enable overly restrictive scheme rules to be amended where trustees agree.

This override will apply both to the revaluation changes and also to the similar change we made to the indexation cap in the 2004 Act.

Thirdly, we made administrative easements for employers on the issue of qualifying earnings.  This was a particularly good example of a broad spectrum of pensions industry experts working together to reach a consensus.

Through these amendments, we will enable employers who are confident their workers are on course to receive the new minimum level of pension saving, to certify their arrangements meet the new quality standard, without the need for continuing individual reconciliation.

We will provide flexibility for employers and their schemes, while ensuring that all members of employer sponsored schemes regularly receive pension contributions, at least in line with the new minimum level of pension saving which they should get if in a personal account.

This reinforces our commitment to supporting existing high quality occupational pension provision.

Fourthly, in agreement with their management, we have frozen the current rates for the administration levies that fund the running costs of the Regulator and the PPF, along with the Pensions Ombudsman and the Pensions Advisory Service.

Finally, we have begun a four week informal consultation on the employer debt provisions as set out in the 1995 Pensions Act.  We are seeking views on whether the rules should be modified so as not to hinder corporate restructuring unnecessarily – so long as the employer covenant was strong before the restructuring and remains so afterwards.

This is a difficult area, and it may not be easy to find a way to address the issues without creating loopholes. But if we can, we will hold a full consultation in February, and introduce any changes in October 2009.

I will stress that this is not about weakening protection for anyone, but about listening to concerns, and consulting on the options but all the while with the clear principle that we are not undermining the employer covenant and we are still protecting employees.

These moves show responsible and flexible action in the face of the economic downturn.

Defined contribution and defined benefit schemes

These are undoubtedly difficult times.

Markets have seen sharp falls in value with consequent impacts on defined contribution and defined benefit schemes.

However, while stock markets fluctuate over the short term we must remember that pensions are about the long-term.

For many members of defined contribution schemes “lifestyling” arrangements, which automatically reduce exposure to riskier assets such as shares as members approach retirement, will have offered some protection against short term fluctuations.

And those retiring in 20-30 years have decades for their pension pots to grow.

You may remember that recently there were calls to change our rules on the age of annuitisation, and we have resisted these. 

Actuarial evidence suggests that age 75 remains a suitable age for securing an income for life, via annuitisation or another route such as an alternatively secured pension.

In any case, only 1 in 20 people annuitise after the age of 70. 

For defined benefit schemes, as we know, these are declining in number, with many which continue closed to new members. 

We do recognise the trend.

But a high quality defined benefit scheme is still a good product.

Deficits are expected to increase.  And that is why the Pensions Regulator’s recent statement - that their guidance on recovery plans is still applicable in current conditions - will I hope have provided trustees with some level of reassurance.

Recovery plans typically seek to make deficits good within around 7 years, but given current financial pressures - emerging strains on company cash flows and affordability - this may result in some schemes having to undertake longer plans.

Which is why the Regulator has issued this statement, and will continue to work closely with scheme providers to ensure that recovery plans are innovative, affordable and effective.
Maintaining confidence at this time is vital.

Both for the challenges we face now in the economic downturn, and for the challenge in implementing the reforms in the Pensions Act in 2012.

Our protection system

And we shouldn’t lose sight of the current protection system we have in place, that we have built up.

The Pension Protection Fund protects over 12 million members in over 7,000 eligible defined benefit occupational pension schemes.

It is designed to work both in a benign market environment and in a downturn.  As I am sure you will know the PPF and the DWP are monitoring the situation carefully, but to date we have not seen any significant increase in claims on the PPF.

There are no liquidity problems for the PPF, and compensation continues to be paid. The PPF currently has around £2billion in assets but is only paying £3.5 million a month in compensation. 

The Pensions Regulator has adopted a proactive approach and provides increased protection by focussing its resources on the greatest risk.

And the Financial Assistance Scheme is now paying assistance to over 9000 members, affording them security in retirement.

The PPF, the Regulator and the FAS, provide a solid framework for protection and support for pension schemes.

Brighton Rock

I and my Ministerial colleagues welcome the fact that a number of organisations are thinking creatively about the most effective way to manage pensions liabilities. 

As Mike O’Brien said, we welcome innovation - but we do need to ensure that we understand and manage the risks of new approaches appropriately.  For example, Brighton Rock have suggested that they could offer an alternative, insurance-based approach to the PPF. 

As Mike made clear earlier this year, we do not consider that it would be appropriate to open the PPF up to competition at this point. 

The PPF is a young institution, and particularly under current economic circumstances, we consider it is vital that we neither undermine the stability of the PPF, or of savers' confidence in the PPF. 

However, we do continue to keep this issue under review, and should the Government's position change, I am pleased to be able to confirm that the 2004 Act provides sufficiently wide regulation-making powers for us to be able to effect such a change in regulations, without the need for primary legislation.

And confidence will be the key to working toward a stable UK pensions environment.

The Buy-Out Market

Before I conclude, I’d like to talk for a few moments on the focus of today’s conference - the pensions buy out market.

The buy-out market is affected by the current market volatility. I understand trustees and their advisers may be deferring the decision to transfer all or a portion of a pension scheme to an insurer until markets are more settled.

Nonetheless, recent MetLife research found that more than half of trustees are still keen to buy out their pension scheme liabilities – with over half of trustees saying they were looking towards a buyout.  And transactions in the first half of 2008 have exceeded the record business volumes for the whole of 2007.

As the pensions landscape evolves so should the pensions industry’s response to it.

However, there is concern that some models -particularly non-insured buy outs - may remove from the pension schemes the security provided by an employer – without putting adequate capital in place to replace that security.

Which is why we strengthened the anti avoidance powers of the Regulator.

This was no doubt, a difficult area to resolve.

We originally introduced amendments containing broad powers to strengthen the Regulator’s anti-avoidance powers.  However, these did generate significant concerns and over the summer, the DWP, the Regulator, and stakeholders have worked diligently to develop what is now in the legislation.

We have worked with the CBI, British Venture Capital Association, and the Association of Pension Lawyers among others, to respond to concerns that the detailed proposals should be on the face of the Pensions Bill, and that the powers should not have an undue impact on legitimate corporate business.

As a result we put the substantive proposals on to the face of the legislation together with important safeguards to ensure that the measures are targeted and do not have a disproportionate impact on routine corporate activity.

Further to this, the Regulator has published draft content for a Code of Practice.  This sets out the circumstances in which it expects to use the material detriment test.  This is intended to provide the regulated community with a greater degree of certainty.  The Regulator expects to consult formally on this draft now the legislation has received Royal Assent.

This shows significant progress in developing this legislation.

These powers will enable the Pensions Regulator to be able to deal with new risks that could be detrimental to scheme members’ benefits and the PPF.

But the safeguards are now in place to ensure that these powers are proportionate and appropriately targeted.

The CBI, BVCA and NAPF have all welcomed the clarification provided by this work.

And I’d like to thank them for the valuable role that they and others played.

Their welcome response, and the close scrutiny and depth of this work enable me to reassure the regulated community about the intended operation of the material detriment test and code of practice as well as clarifying the extent of retrospection and the regulation-making powers.

A proportionate and fair response.

And importantly, one that will not impact on the vast majority of employers or their pension schemes.  

Conclusion

I hope you will accept what I have set out as a flexible and considered response to all the challenges pensions are facing.

If I can be so bold as to say, the current pensions environment is more interesting than ever.

I want to assure you that the Government is committed to helping you manage pensions liabilities.

Through our flexible responses to current economic conditions, through our protection system, through careful preparation to the implementation of the Pension Act’s reforms.

Through listening to your views.

I believe we do share common goals. 

Strengthening confidence in pensions, providing people with the tools they need to save for retirement.

Employers, the pensions industry and government need to promote the virtues of pensions savings. The proposals we have developed over the past few years have put us in a better place to deal with the impact of this crisis on the pensions market.

Of course the fluctuations in financial markets will affect the value of people’s assets in the short term.

But our priority must still be focused on the long term. Together we can ensure that the pensions market, and the people that rely upon it, are secure for years to come.

I do hope that in a relatively small gathering like this we can have a detailed informal discussion, so I look forward to your comments and questions. 

Thank you.