Clause 42 - Pensions Regulator’s objectives

Pensions Bill – in a Public Bill Committee at 3:15 pm on 11th July 2013.

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Question proposed, That the clause stand part of the Bill.

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

We have an hour and a half or so left to scrutinise the rest of the Bill. To be honest, the clause warrants that time.

Sitting suspended for a Division in the House.

On resuming—

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

As the record will show, I was about to observe that the clause could do with at least an hour and a half of debate, and we have just lost 15 minutes. The clause is about a very serious issue. It is the Government’s response to the concerns of British industry about the way in which defined benefit pension schemes are regulated. It is a profound and important issue. Unfortunately, because of the way in which the Opposition have chosen to allocate their time, with speeches running to nearly two hours on some amendments, it seems likely that we will have to whizz through some of this stuff if the Opposition are to reach their new clauses and a whole range of other important stuff. I hope that it will not be suggested that we have not allowed enough time for proper debate. I will try to do justice to the clause in the limited time that has been left to me.

Clause 42 relates to the Pensions Regulator, whose role includes—but not exclusively—overseeing defined benefit pension schemes. Many of them are now closed, but they still have to be properly funded to ensure that employees get their benefits, which, of course, are liabilities that can run many decades ahead, because they benefit not only the people who are in the schemes now, but their surviving spouses and in some cases dependants, so it is a long-term issue.

The regulator has to strike a balance to make sure there is enough money in the pension fund to pay out all the liabilities, but not to place those duties on sponsoring employers so onerously that it is to their detriment and they are not able to continue as sponsoring employers, because the financial pressures are too severe and we therefore—to use a colloquialism—kill the goose that laid the golden egg. In other words, there is a balance to be struck. We all want company pension funds to have enough money in them to pay out pension liabilities as they fall due, but we must strike a balance between that and not placing such heavy duties on sponsoring employers that the pressure being put on them is counter-productive.

The Pensions Regulator, it is important to place on record, already shows a great deal of flexibility in the way that he implements his duties. He currently has statutory objectives, one of which is to protect the Pension Protection Fund. If the regulator is not tough enough—if he allows a scheme to be underfunded for too long and then an insolvency event occurs—that scheme, if it is not sufficiently funded, can end up in the Pension Protection Fund. That is a lot better than when there was not a Pension Protection Fund, but it is still bad news for employees who might not get all the pensions they were expecting, and it is bad news for the remaining employers paying the Pension Protection Fund levy, because every time someone goes into the fund, that means more liabilities for the Pension Protection Fund, and that means the schemes that are still with open or legacy DB have to pay more PPF levy. That could, in extremis, lead to a downward spiral whereby the levies become particularly onerous, other firms cannot meet them and they go into the PPF, and we clearly do not want to be in such a position. So there is already flexibility in the system to try to strike a balance between the pressure on the sponsoring employer to invest and to do their job and to put adequate amounts into their pension fund.

In recent years, growing representations have been made to the Government that that flexibility was not quite right. One of the reasons is that, with discount and gilts rates being at historically low levels, measured pension fund deficits were getting larger. There was a school of thought, which said that that was not a real phenomenon, and that it was not really going on in the pension fund because such liabilities stretch decades into the future. It said that the current interest rates were atypical and, in a few years’ time—however long that might be—interest rates will go up, discounts will go up and that means that the discounted value of future liabilities will go down. Measured deficits will go down and, if British employers were required to shovel money in now just because the numbers were artificially low, we may regret it. It may damage British industry when economic times are hard to pay liabilities that might, to some extent, disappear if we went back to more normal times in respect of interest rates. The argument was made, understandably by employers, that action was needed.

There was an argument that no action was needed because of the considerable flex in the system. I shall explain that briefly. When employers have a deficit in their pension funds at a valuation, it would generally happen that a recovery plan would be agreed between  the trustees of the scheme and the sponsoring employer. It will specify a period over which the deficit has to be filled, and a schedule of deficit recovery payments in addition to regular payments into the scheme.

That process is a negotiation, so there is already flex in the system for how long the recovery period should be and what should be the profile of the repayments. For example, the Pensions Regulator recently allowed an employer a two-year payment holiday, recognising that it was most important that the sponsoring employer had the cash to invest now, as the best way in which to get the pension deficit scheme filled was to make sure that the scheme-sponsoring employer prospered and did well. That is one example of the flexibility in the system.

Another example of the flexibility in the system is the length and end point of recovery plans. If someone had a valuation or a plan agreed in 2010 for a 10-year recovery plan, taking them to 2020, it is not uncommon for the 2013 triennial process to identify another 10-year plan so, rather than say that it is three years into the 10-year plan and we still have to finish dead on 2020, the flexibility in the system allows a new 10-year agreement to run to 2023. Some would say that that is unduly lax: if a 10-year plan is agreed in 2010, it should finish in 2020 and, in 2013, it should be a seven-year plan and, in 2016, it should be a four-year plan. However, it is common for the end point of those recovery plans to roll later into the future. That is a second flexibility in the system. I have mentioned the profile of payments and the length of the recovery plan.

A third flexibility is that the discount rates used can vary. It is not the case that schemes just have to use a gilts rate. Although gilts rates might be low—some would say artificially low, although knowing the future of interest rates is beyond most of us—the assumption that gilts rates are artificially low does not mean that they have to be used in the valuation. When examining a distribution of the discount rates used in scheme valuations, there is quite a considerable variation. There are many other aspects of the flexibility, but the Government had to think about whether a new additional change to the regime was necessary, given the considerable flex that is already and quite rightly being demonstrated by the Pensions Regulator.

The Government consulted on two essential options earlier this year in response to such concerns. One was called the “smoothing of discount rates”. The argument was that we would not just use current gilts rates or some variant rates on current gilts rates, but look at gilts rates or discount rates over several years. If the current situation was atypical, but it was not a few years ago nor will it be a few years hence, and a moving average was used over a number of years, the impact of what might be a temporary current aberrant discount rate would be muffled. It would be diminished. The point of the exercise would have been to give measured deficits lower than the current mechanism is producing potentially, and therefore reduce the pressure on firms to put money in.

We consulted on that proposition, and there was not much support for it. There were those who suggested that it was a bit of a fudge or a fiddle, but people generally recognised that there is already flexibility on discount rates and that the challenge is to use the number that the usual method gives, interpret it sensibly and not fudge the number when it does not produce the  anticipated answer. I have some sympathy with that point of view—funnily enough because it is the Government’s position. The basic idea was that we would not go down that route, not least because perhaps as interest rates rose there would be an asymmetry. When interest rates were falling, everyone said, “Let’s use an average going back into the past so that we can use some higher interest rates,” but as soon as rates started rising, everyone would say, “Why are we using these old historical interest rates from years ago? They are not accurate. We need to increase the discount rates.” To do something asymmetric would have shouted “fiddle” and people would not have trusted the numbers. Having credible measures of pension fund deficits is important. That approach to such pressures was therefore rejected.

The second approach, which forms the basis for clause 42, was to see whether the Pensions Regulator’s remit should be extended to include an explicit growth objective. As clause 42 states, the additional remit added to the exercise of its functions under part 3 of the Pensions Act 2004 is

“to minimise any adverse impact on the sustainable growth of an employer”.

That is not a wholly new concept in pension regulation. I imagine that the Committee is already familiar with the Pensions Regulator’s regulatory code of practice 03, “Funding defined benefits”, which states at paragraph 102:

“When considering the structure of a recovery plan and the contributions required, the trustees should take into account the following matters: the employer’s business plans and the likely effect any potential recovery plan would have on the future viability of the employer”.

The language of the existing guidance closely mirrors the language of clause 42. This is not a step change or a radical departure or about just looking after the firm rather than the pension plan; it is a much more nuanced change. It makes explicit what was in paragraph 102 of the existing guidance. The idea behind it is that in the delicate negotiation between the trustee and the firm, the firm is able to say to the trustees, who of course want the pension scheme gap filled as quickly as possible, “If we go to the regulator with our plan, the regulator is allowed explicitly in statute”—assuming the legislation goes through—“to say that where the employer is coming from is acceptable because it might be a slower recovery plan than you wanted, but it is the best way to ensure that the firm is still here in years to come.” We would all agree that the best way to ensure that pensions are properly funded is to ensure that the sponsoring employer is still around to pay the pensions.

There is a very delicate balancing act. We do not want to allow firms not to put money into pension schemes when they could do so without an adverse impact on the employer. There has been some suggestion that many firms are at the moment relatively cash rich, so it was quite a balanced judgment. We do not want to overdo things, because more pension funds would be underfunded for longer and insolvency events would just happen—we can try to guess when, but they do just happen—and that would mean that when firms become insolvent and go into the PPF, they go in with bigger deficits. That means more people with more shortfalls on their pensions, because they went into the PPF, but more particularly, the levy payers, which are the remaining firms with DB pension liabilities, would then face increased costs and would rightly object.

I hope that I have emphasised what a delicate balancing act all of this is. When we concluded—the Chancellor announced it in the Budget—that we were not going ahead with the smoothing proposal, but that we were going to change the regulator’s remit and add this additional remit, we were striking the right balance.

Just to be clear, we issued a call for evidence that originally asked people to consider the long-term affordability of deficit-recovery plans to sponsoring employers—the original language we consulted on—but we have refined it for the Bill. When we consult, we also listen and amend our proposals, and employers who responded to our consultation generally wanted a new objective that went wider than just affordability of deficit recovery plans in order to draw out the flexibilities in existing funding legislation. They felt that would help to support the long-term health of sponsoring employers and, in turn, promote growth and protect members’ benefits. We recognise that the importance of sponsoring employers in this manner is in line with our wider objective to support private sector-led economic growth.

I hope it was helpful to canter through the rather long and detailed process of trying to come up with the right balance. Because every recovery plan is the result of negotiations between trustees and employers, all of whom will have different relationships and different bargaining strengths, we have to be very careful.

One final question that the Committee might be wondering about, is that this is obviously not yet the law of the land, so what are we doing to make sure that the regulator is not pushing firms too hard as we speak? I assure the Committee that the regulator produces an annual document setting out his approach to DB regulation. Over the last couple of years those documents—particularly this year’s document, which has recently been produced—are much stronger on the importance of making sure that trustees think about the position of a sponsoring employer. I spoke to an employer earlier today who said not only how helpful the new legislation would be, but also the new guidance that came out earlier in the year from the Pensions Regulator.

Finally, clearly just passing a law is, as ever, only the start of a story. We need to monitor the effect of the change. For example, we will need to disseminate to trustees and others the new statutory duty that we are placing on the regulator. We need trustees to know that the regulator is looking for recovery plans that respect the sustainable growth of an employer. We can have discussions in these Committee Rooms, but Britain’s many thousands of trustees will not know about them unless we tell them and they will only change their behaviour if we tell them. The regulator is talking about having roadshows going around the country and making sure that pension schemes are aware of the changes. We will be monitoring to see that the new statutory framework actually changes things. We are not just putting clause 42 in the Bill for the goodness of our health; we really want the recovery plans and the relationship between trustees and employees to be incrementally changed. It is meant to tilt the balance to make sure that proper weight is given to the sustainable growth of an employer.

I hope that the measure will give the right foundation for the regulation of occupational pension schemes. At a time when we are all keen to promote growth, I hope that we get the right balance between protecting members’  benefits, protecting the Pension Protection Fund and ensuring that sponsoring employers are around in the medium to long term to pay the pension benefits that we would all like to see them pay. On the strength of that, I commend clause 42 to the Committee.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions) 3:45 pm, 11th July 2013

I thank the Minister for that explanation. He got into his stride as he went on, but I was a little puzzled by his opening. It seemed to be along the lines of complaining once again about the intense scrutiny to which the Minister’s pot follows member proposal was exposed under clause 29, and he certainly seemed to be cautioning against the sort of future press release that he always seems to be anticipating, on the basis that somebody must always be out to get him.

The Minister is right: the issue is complex, but the difference between this clause and, say, clause 29 is that we do not think that the Government are in the wrong place. In speaking to the clause, the Minister set out some of the complexities in the balance that he had to strike, and I am of the view that the balance has been reasonably well struck. The whole country would applaud the Government if they extended their growth objectives to the economy as a whole, and not just to the Pensions Regulator; that would be to the benefit of us all. The Minister has done an excellent job of setting out the different things that had to be balanced, and on that basis I have no intention of dividing the Committee.

Photo of Steve Webb Steve Webb The Minister of State, Department for Work and Pensions

I will not detain the Committee. I sense that the hon. Gentleman’s second point may have been partisan, but he raises a serious issue. The Government are indeed extending the growth duty to a whole range of regulators apart from the Pensions Regulator. Although we are doing it in this Bill just for our regulator, the Government as a whole are bringing the growth objective to a whole range of what I think are called non-economic regulators. In future, Government regulators will have to have far more regard to growth, which is not what the hon. Gentleman meant, but it is actually a relevant response.

In the hon. Gentleman’s opening comment, I think he may have mistaken length for scrutiny. It is quite possible to scrutinise us rigorously but his new clauses cover issues like NEST, independent trustees and scaled accumulation, and we have one on the PPF. One of my concerns is that they will all receive inadequate scrutiny because earlier today he mistook length for proper scrutiny.

Photo of Gregg McClymont Gregg McClymont Shadow Minister (Work and Pensions) 4:00 pm, 11th July 2013

The Minister is rather keen to determine the proceedings of the Committee. I suggest that he let the Opposition do their job of scrutinising the legislation and he stick to his side of the table, so to speak. The desire to frame our proceedings in a way that is most beneficial to the Minister and the Government is understandable but it is not in the spirit of scrutinising legislation, which is our job.

I say again that I have no intention of dividing the Committee on the clause.

Question put and agreed to.

Clause 42 accordingly ordered to stand part of the Bill.