Out-Law / Your Daily Need-To-Know

Government seeks evidence on more flexible defined benefit pension scheme valuation

Out-Law News | 25 Jan 2013 | 4:24 pm | 2 min. read

The Government has asked those involved in the regular valuation of defined benefit (DB) pensions schemes for their views on whether more flexibility is needed, given the impact of quantitative easing and historically low gilt yields on scheme deficits.

It is asking whether companies undergoing valuations of their pension scheme assets should be allowed to take a longer-term view of projected returns by 'smoothing' the calculation of their assets and liabilities. It has also proposed that the Pensions Regulator be given a new statutory objective to consider the long-term affordability to sponsoring employers of plans to pay back a scheme deficit.

The call for evidence (29-page / 272KB PDF) follows the Chancellor's Autumn Statement commitment to ensure that pension regulation "does not act as a brake on investment and growth", and calls from the industry for more flexibility in the way that pension scheme liabilities are calculated.

Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, welcomed the Government's action.

"In practice, the level of contributions being paid into DB schemes is in many cases driven more by what a particular employer can afford than by a precise calculation of the scheme deficit," he said. "The proposed new statutory objective for the Pensions Regulator would give this some formal recognition."

"Many commentators consider that deficits in DB pension schemes have been artificially inflated by exceptionally low discount rates. If the economy bounces back employers may discover, when those rates are adjusted, that they have pumped a lot of money into their schemes unnecessarily. That money could have been better used to invest in the employer's business," he said.

Although members of the public are welcome to respond, the Government said that it was particularly interested in responses from trustees, sponsoring employers and actuaries given the technical nature of pension valuations and the potential impact of the changes on companies, pension scheme members and the Pension Protection Fund (PPF). The PPF compensates scheme members if their employers go insolvent and are unable to pay the benefits they promised.

The Pensions Regulator has the power under the Pensions Act to make companies pay more money to underfunded pension schemes in certain circumstances. In funding guidance issued in April, it said that it expected employers to carry on funding schemes in accordance with plans already in place unless there had been a "demonstrable change" in the employer's ability to meet these commitments.

Trade bodies the National Association of Pension Funds (NAPF) and the Confederation of British Industry (CBI) have both called on the regulator to soften this tough approach to scheme funding. Lower yields from government securities, or gilts, driven down as a result of the Bank of England's quantitative easing policy, affect a formula known as the 'discount rate' which is used by a pension scheme actuary to calculate the cost of providing all the benefits currently promised under the scheme during its regular valuations. The current rate creates the appearance of a deficit, which the scheme's sponsoring employer is legally obliged to fill.

The call for evidence proposes amending pensions legislation to allow scheme trustees to allowing scheme trustees to use average asset prices and discount rates over a longer period of time, instead of using market spot rates. Smoothing could be mandatory or voluntary, and use an average over between two and five years.

The proposed new statutory objective for the Pensions Regulator would be the first to focus explicitly on the interests of sponsoring employers. The regulator currently has five statutory objectives which focus on the protection of members, their benefits and the interests of the PPF.