The Pensions Institute argues RAA processes should be streamlined and trustees should be able to reduce benefits in a bid to help those struggling with deficits, James Phillips reports.
As we wait for the government to set out its plans for the future of defined benefit (DB), many in the industry have put forward their own views on how to tackle the perceived problem.
The Pensions Institute, part of the Cass Business School, has outlined how it believes regulation should be amended to provide The Pensions Regulator (TPR) with the power to change benefits, alter indexation and compel stakeholders to attend interviews with the watchdog.
This would enable a move away from a situation where a scheme enters the Pension Protection Fund (PPF) and those yet to retire bear the brunt of any reduction in benefits.
The report, Greatest Good 2, says this could be enabled via providing a more streamlined regulated apportionment arrangement (RAA) process for schemes in stress - those, it says, "where a scheme is significantly underfunded relative to the value of the sponsor's business, and the trustees cannot rely on the financial support they need from the sponsor because the covenant is at risk".
The Pensions Institute calculates there are 1,000 schemes that meet this definition, with 600 of those unlikely to ever pay full pensions.
The paper suggests an "early warning system" should be set up by the regulator to give it advance notice when a scheme is in stress.
This would draw on data such as the ratio of the annual cost of PPF drift to average profit before tax over five years and a calculation of a section 179 shortfall as a multiple of profit before tax or net assets.
It would also look at Experian credit scores as a measure of stress as well as those schemes having both s179 funding below 75% and material PPF drift.
Pensions Institute fellow Matt Roy says this would make it easier for TPR to intervene and help schemes at a much earlier stage without too much effort.
"TPR should collect additional funding data to create an early warning system for schemes in stress," he argues. "Why not create a mechanical screening measure that uses a series of predefined metrics to automatically flag up schemes that appear in danger for review?"
Then, the paper suggests, TPR should be able to direct schemes, defined as stressed under this system, to alter benefits or indexation. It could also call in stakeholders for interview to truly understand the scheme at hand.
Roy says when in those cases where the best outcome - all members receiving full benefits - is not possible, the regulator should aim for a so-called "second-best", PPF-plus compromise.
He explains: "TPR has some great powers but it finds it difficult to use them to deliver second-best outcomes, because it's not government policy to do so.
"Giving TPR powers to alter indexation, alter benefits, and to interview stakeholders would help to deliver second-best outcomes."
He points to Ireland, where the regulator's equivalent - the Irish Pension Authority - has the authority to direct trustees to amend benefits.
It can do this where schemes have failed to submit an annual funding statement or submitted one which does not meet the required funding standard.
Yet, BrightonRock head of research Con Keating is not convinced by this idea, stating this would see TPR undermining trustees' authority too much and argues such a framework would be akin to Russia in the 1920s.
"We are going to turn the regulator into the thought police," he states. "It will be a crime to think of going bust without having your scheme fully-funded and a little bit more.
"For the ones where it does intervene and it is subsequently proven that it was wrong, what is it going to do? What is it going to do to compensate shareholders and all the other interested parties?"
Nevertheless, the paper concedes that members would need to be properly informed of the benefits of doing this - and calls on the government to "better educate the public about how the strength of the sponsor covenant can affect their pension and that they may not always receive the full value of the benefits they have been promised".
The Pensions Institute says the RAA process should also be streamlined, extending the timeframe to enable companies that will almost certainly face insolvency because of their pension deficit to cut the cord with the scheme.
The use of RAAs is somewhat rare, with just a handful granted approval, and not all of those yet carried through. This is mainly due to the stringent criteria that need to be met before they can go ahead.
One key concern is the company in question must face going bust within the next year, even if ongoing deficit contributions over a longer time period are considered by a covenant adviser to almost certainly lead to insolvency.
The report says the government's mind-set needs to be changed from aiming only for full benefits to aiming for the "greatest good for the greatest number", a utilitarian view. As such it says the 12-month test should be weakened, and the regulator and PPF should reveal when they would look favourably at RAAs.
It also says trustees should be allowed to alter indexation when agreed with the sponsor.
Cass Business School professor and Pensions Institute director David Blake says this would enable members in stressed schemes to get a better deal than in the event of insolvency.
"We believe that allowing streamlined access to RAAs would make it easier to get an intermediate position and achieve second-best outcomes," he says. "Trustees should have access to streamlined RAAs if they conclude that, based on actuarial and covenant advice, full benefits are unlikely to be paid, insolvency is likely, and the result is better than insolvency. We can get some PPF-plus deal."
But he says such an approach would require a wide cultural shift from the government; scheme managers and trustees as well as the general public - who would all need to be convinced that such a second-best outcome would give a better outcome overall.
The paper also rails against the "cliff-edge" for PPF compensation - blasting the inequity which means younger generations are more likely to fall foul to the cap.
"Given the maturity of many closed schemes, the majority of members might be within five or 10 years of retirement, depending on when the scheme closed," the report states. "They might also face unemployment post-insolvency, which means that their presumed ability to make good any pension shortfall through future earned income is illusory."
Blake says: "We should change the cliff-edge compensation rules for retired and non-retired members to a phased approach based on age and length of service."
This, the report adds, "would introduce greater equity between member cohorts and allay concerns about the gaming of the compensation rules by directors with high pensions in failing businesses".
Yet Keating says a much simpler solution would be to just change the PPF so it pays out full benefits regardless of membership type, and disputes the need to accept "second-best" outcomes.
He argues: "The Pensions Institute is suggesting fourth-rate solutions. There is a ‘first-best' solution to the problems they are talking about and that would be for the PPF to pay full benefits. Then, all the problems they are worrying about go away.
"To be in the land of the second-best, the first-best has to be non-feasible. Well it's not non-feasible; it's done in other countries."
The response is yet another comprehensive document providing a number of potential solutions to what some perceive as a crisis in DB. Yet, some of its suggestions - notably TPR being able to mandate trustees to alter benefits or indexation - will prove controversial.
With this month's general election result not giving a conclusive majority, however, such reform and, indeed, an extensive government response may be some time away.
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