First published in Professional Pensions, 14 February 2018
Any day now, although perhaps I should say any season, the DWP’s white paper will emerge, covering a raft of pension policies. This was originally conceived to put forward solutions and law changes to ease the defined benefit funding “crisis”. Its mission now seems to have morphed somewhat into something more minty than white.
The collapse of Carillion and the emerging back story led Theresa May to propose new powers for the Regulator: perhaps to veto dividend payments, or impose punitive fines or bonus clawbacks on wayward directors.
These are all serious suggestions that may have merit, so it’s probably right that they should be minty rather than white. They demand proper consideration and debate if we are to avoid a Dangerous Dogs Act moment - a rushed and ill-thought-out piece of legislation, introduced because of an urgent political imperative.
I’m a trustee to a number of DB schemes of various sizes and positions, so would I want any of these things? There are two problems.
Firstly, funding deficits are only an informed estimate of the amount of money needed to pay the benefits as they fall due. An actuary’s best-estimate valuation gives you a 50:50 chance of having enough money, while a buy-out valuation gives you a 100 percent chance. Somewhere between sits the technical provisions valuation, which can move radically with experience and/or if you change your assumptions. The point being that the target is not definitive but, in fact, both dynamic and subjective.
The second is that the company’s covenant behaves in exactly the same way - it too is rarely definitive.
Currently we let the trustees make sense of this. They must objectively assess the covenant (with or without external help), calculate the funding level (with help) and identify a solution that marries these together – before convincing their sponsor to agree to it.
There are three flaws in this. It assumes trustees are up to the job of objective assessment, technically competent and able to robustly negotiate. It also assumes the sponsor is open and honest with the data they disclose and that the situation remains stable once negotiated. While the first two can happen, sometimes they don’t - and the last never does. So what’s the solution?
The answer to the stability flaw is, largely, to accept it. We live in a capitalist economy where things have to fail sometimes and are not entirely protected simply by prudence.
The answer to poor trustees is to get better trustees, although I accept there are supply issues and benefits in non-expert trustees. Alternatively, we could beef up the powers of the Regulator – but that’s not a sustainable solution when they have neither the time nor the budget to negotiate every DB valuation. And why should they if we have trustees?
So perhaps the solution lies in addressing the sponsor issue - most sponsors are open and honest, but sometimes to varying degrees. So we could create a clear and enforceable legal obligation for sponsors to disclose all relevant information to trustees in real time, balanced with market sensitivity to avoid a crisis in capitalism, with fines if they should fail to do so. Add in an annual funding renegotiation that is triggered by the trustees if they felt it necessary and we may reduce the impact of the three flaws. Though the first would remain to an extent, trustees would have to be particularly incompetent to let sleeping dogs lie if the signs of disaster were made obvious.
We live in an uncertain world with no perfect solutions. We have to accept the system will fail in some circumstances (that’s why we have the PPF). The ideas I’ve set out here, while not fully formed, marry pragmatism with a carrot and stick. It could be an answer.