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The Actuary The magazine of the Institute & Faculty of Actuaries

The new pensions watchdog how sharp are its teeth?

When the Pensions Regulator
took over from the previous
regulatory authority (Opra)
in April 2005, it had a new
and wider brief, clearly defined objectives, and
a new set of powers in addition to inheriting
Opra’s existing powers. There was a perception
that Opra was a bureaucratic and reactive regulator
and that what was needed was a more
proactive approach. Now that the regulator has
been in place for over a year, it seems a good
time to take stock of how it is doing so far.
Regulator’s activities
The regulator has certainly been busy. In the
period since it was established, it has issued and
consulted on 11 codes of practice setting out
the behaviour expected of schemes and
employers in a number of areas as required by
the Pensions Act 2004. Consultation is now
closed on all the codes and seven of them have
been brought into force. In addition, the regulator
has issued guidance
notes to expand on its
requirements and
to explain its
approach to
exercising its
Guidance has
been issued on
clearance applications,
reporting of
breaches, notifiable
events, funding
(including the use of
contingent assets and
withdrawal arrangements
for multi-employer
schemes), and the approach to the
regulation of cross-border schemes. In its regulatory
and information gathering role, the regulator
has issued 9,000 scheme returns and is
now processing the information received in
response to most of these requests.
But has all this work made significant progress
towards achieving the regulator’s objectives?
The Pensions Regulator’s objectives are:
°ª to protect benefits for members of workbased
°ª to promote good administration of workbased
schemes; and
°ª to reduce the risk of claims on the Pension
Protection Fund (PPF).
In seeking to achieve its objectives, the regulator
seeks to adopt a risk-based approach,
focusing its resources on the schemes which it
estimates are most likely to give rise to
problems. It also adopts a co-operative
approach, working with schemes, employers,
and other interested parties to resolve issues
rather than seeking to impose solutions. The
regulator acknowledges that there are certain
potential pitfalls with its risk-based approach
(see its medium-term strategy paper issued in
April 2006). For example, there is the danger of
classifying a scheme as low-risk, regulating it
with a light hand and identifying significant
risks only when it is too late for intervention
to make any difference. However, since
resources are limited, it does appear that some
form of risk-based approach is probably the
most sensible.
Limits on powers
There is reason to be concerned that the regulator’s
powers are more limited than may have
first appeared and that its approach to using
those powers might potentially hinder its effectiveness
in some areas. When the proposals for
the new rules on contribution notices and
financial support directions were initially
planned, there was considerable concern that
this would hinder corporate transactions and
reorganisations and act as a brake on UK merger
and acquisition activity. In practice this does
not appear to have been the case.
In a number of cases, it seems that the regulator
has not been able to exercise its powers.
While the powers seem wide, a contribution
notice can only be issued where there is an act
which is motivated by a wish to avoid or minimise
recovery of a debt, and where it is reasonable
for an order to be made. A financial
support direction can only be made where certain
financial conditions are met in relation to
the employers, and again subject to reasonableness.
In many situations, there may be good
arguments why a contribution notice or financial
support direction should not be made, for
example, where there is no evidence of an
improper purpose. The regulator is not responsible
for these limitations, which are inherent
in the legislation, but the regulator’s approach
may lead to these powers being taken less seriously
in future.
Limits on clearance
The legislation included a proposal for a clearance
procedure and the regulator introduced
this in April 2005. Under the optional clearance
process, companies considering corporate transactions
where there is an underfunded defined
benefit scheme can apply to the regulator for a
clearance statement. This gives assurance that
the transaction does not contravene antiavoidance
legislation and that the regulator will
not use its anti-avoidance powers in relation to
the transaction once it is completed. Also since
2 September 2005, employers who withdraw
from underfunded multi-employer schemes
must seek approval from the Pensions Regulator
if the full debt is not to be paid.
To date, the regulator has received over 330
applications for clearance (including approval
of withdrawal arrangements) of which only
three have been turned down. Not all those
applications will have resulted in positive clearance
decisions being made. The regulator
prefers to encourage the withdrawal of applications
that are likely to be unsuccessful, so
avoiding the need for a decision that clearance
is not forthcoming. A number of high-profile
transactions have been cleared, illustrating the
adoption of fairly sophisticated financial
arrangements. The regulator’s reluctance to
make negative decisions, together with the fact
that a number of potentially contentious structures
have been approved and that limited
information about unsuccessful applications is
available, may lead to these powers having less
impact in shaping behaviour than originally
In relation to information about applications,
the regulator is constrained by its obligation of
confidentiality, and unsuccessful applications
are by their very nature unlikely to be publicised
by the applicants. This may give rise to a
misleading impression that clearance is more
likely to be granted than refused, since more
publicity is given to successful applications
than to those turned down or withdrawn. The
regulator has indicated in the past that it
intends to produce case studies showing examples
of decisions that have been made or applications
where pressure has been put on the
applicant to withdraw. So far, it has found it a
challenging task to do so in a way that both
provides sufficient detail to be meaningful and
does not breach the confidentiality obligations.
Parties to transactions are becoming more
reluctant to apply for clearance. This may
partly be because resources within the Pensions
Regulator are increasingly stretched. Although
initially some rapid decisions were made, it is
now often a matter of weeks rather than days
before a decision can be obtained, and in certain
circumstances the employer will not have
the luxury of being able to make an application
before the event. The regulator’s approach to
staffing includes significant reliance on personnel
seconded from organisations within the
pensions industry and the aim of rotating staff
between different functions. The lack of continuity
of personnel in relation to a particular
case can add to delays, and create an inconsistency,
or a perception of inconsistency, which
may further dissuade certain parties from seeking
This reluctance to make applications for
clearance may also be due to the perception
that the trustees and regulator will effectively
hold employers to ransom, requiring a substantial
funding commitment into the scheme
as the price of clearance, whether or not the
amount of the contribution is justified by the
increased risk to the scheme of the transaction
in question.
On a more positive note, even where employers
have decided to proceed with corporate
transactions without seeking clearance, having
evaluated the risk as fairly low, the existence of
the regulator and its powers has meant that the
pension scheme and its funding is taken more
seriously by those involved in corporate transactions.
More publicly available information
about cases where clearance has not been
granted could help to clarify the parameters on
acceptable transactions.
Scheme funding
The regulator’s influence may be felt more lastingly
in areas that initially received less attention
than the anti-avoidance powers. The
regulator recently, in a statement issued in May
2006, finalised its approach to the regulation of
the funding of pension schemes. By setting
clear parameters as to what is and is not acceptable
in terms of scheme funding, the regulator
can influence the behaviour of schemes and
employers in a way that should lead to considerable
additional funding being put into pension
schemes over the next five to ten years. If
this does prove to be the case, then this would
go a long way to achieving two of the regulator’s
objectives: the protection of benefits of
members and reducing the risk of claims against
the PPF. This is because well-funded schemes are
less likely to give rise to large losses for members
and the PPF.
In this context, the regulator’s approach
appears to have softened since the initial consultation
document. Initially, the regulator suggested
that it would investigate any scheme
whose technical provisions (ie liabilities measured
on its scheme-specific funding basis) were
less than 70% or more than 80% of its buy-out
cost. Following consultation, the references to
buy-out costs were removed in order to reduce
the role of the insolvency valuation in the trigger
process. The suggested range is now
between the section 179 value of PPF liabilities
and the FRS17 measure of liabilities. The regulator
stresses in its guidance that the triggers
are not to be treated as targets but are tools for
the regulator to manage its workload. Since the
scheme actuary will often be in control of the
valuation process, the actuarial profession in
particular needs to guard against treating the
triggers as targets. Failure to do so could lead to
the adoption of objectives that are not suitable
for the scheme or the employer’s circumstances
in order to avoid falling inside the trigger
range. It could also lead to accepting or proposing
an approach that does not trigger
review by the regulator, but may be insufficiently
prudent for the circumstances of the
The first valuations under the new regime are
only now being conducted, and it will be interesting
to see the extent to which the regulator
actively intervenes in this area to ensure that
scheme funding is treated correctly. In practice,
its cooperative approach and confidentiality
concerns could again lead to limited publicity
being given to its interventions.
After a very busy first year, while the new Pensions
Regulator has made important progress in
a number of areas, it is nevertheless disappointing
that it is not being seen to be more
effective. If the restrictions on its powers, and
its apparent reluctance to demonstrate that it is
prepared to take tough decisions where necessary,
undermine its authority, that would be a
great shame.