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The Actuary The magazine of the Institute & Faculty of Actuaries

Out with the MFR in with the MFR?

IN THE SAME SOPHISTICATED way that he treats his fingernails,
the chancellor of the exchequer announced
in the March budget that the government intends
to trim the MFR from our lives forever.
Even as Gordon ‘ACT’ Brown was prudently sitting
down, a joint report was being issued on the Web by
the Department of Social Security and the
Treasury, setting out the government’s
own proposals for the security of occupational
pensions. They have agreed
to adopt a long-term funding standard
specific to each pension
scheme, together with a regime
of greater disclosure, as recommended
by Paul Myners. But
the government has gone further,
proposing additional
measures to protect occupational
scheme members.
As usual, the devil will be
in the detail, but it is not
difficult to find enough
demons lurking between
the pages of the
report to wind up
any pensions
It is true that many
of the proposals will
go out for consultation
first and some
will require primary
legislation. This will take time and
it is likely that, as with Goode, many of the proposals
will be watered down. Until then, MFR remains fully
in force. Replacing MFR will be a lengthy process and
it is possible that the existing regime will still be in
place for the next formal valuation of many pension
schemes. So you can’t set light to GN27 just yet.
The actuary’s duty of care
Although the removal of the current MFR compliance
regime has been welcomed by most, the alternatives
proposed are likely to leave scheme actuaries playing
piggy in the middle, particularly because of the statutory
duty of care to members.
It is not clear what additional safeguards would be
provided by this new duty of care. This is an area
where the actuarial profession needs to tread carefully.
Can these safeguards be achieved? More importantly,
we need to be very clear as to what new responsibilities
we are taking on. Otherwise, we may say yes and
end up with mission impossible.
By taking into account the strength of the employers,
actuaries could find themselves in a difficult position,
perhaps recommending that financially weak
employers contribute at higher rates than stronger
employers. Of course, actuaries are versatile, but we
are not necessarily in the best position to judge the
financial strength of a company. And if we translate
that weakness into a reduction of 1% from the discount
rate, who is to say (and I bet the company will)
that it shouldn’t be 0.5%? Call in the lawyers, please.
It is not hard to see that these proposals could give rise
to potential conflicts between the trustees and the
employer and, of course, the scheme actuary.
Investment strategy
With MFR going, trustees will need to review the
investment strategy of pension schemes because, once
the proposals are introduced, the strategy will be
Perhaps this is the time to move out of gilts, as the
government would like? Into equities? That would be
a brave decision at the time of writing! How about a
move from equities or gilts into corporate bonds?
What if the government makes any pension scheme
deficiency a preferential debt in the event of
employer insolvency? Well, we could see a downward rating of company debt with a knock-on effect on
bond prices.
The actuary’s duty of care to members will result in
asking for higher contributions because the company
has a lower credit rating, and you can imagine the
rest. In fact, banks and shareholders are going to start
sitting up and taking more notice of what’s going on
if the preferential debt law comes in. If they do, they
are likely to demand that less risk be carried within
the pension scheme, and gilts yields could start falling
once again.
Winding up
The government is clear that solvent employers cannot
simply walk away from their pension scheme
obligations. Consequently, it seems likely that the
level of solvency cover on a risk-free basis is likely to
assume even greater importance in a post-MFR era. In
practice, the so-called ‘long-term’ funding statement
may be nothing more than a statement about funding
for buy-out.
The liabilities on winding up seem likely to be
beefed up under the proposals, well beyond MFR. At
first sight, the government’s proposals would suggest
that it makes sense for a company considering winding
up to do so quickly, before the new stronger
requirements on solvency come into force. And this
seems to make sense. However, the issues are quite
complex and much clarification is needed regarding
the proposals. For example, trustees could exercise the
power to defer the wind-up and continue as a closed
scheme until the new provisions are in force. For
schemes already in the process of wind-up, trustees
may need to consider the proposed changes before
determining the applicable time for a debt calculation.
So the company needs to think very carefully
before pulling the trigger.
There is a great deal of uncertainty in the government’s
report about winding up, especially since the
new proposals seem to suggest that the company can
choose how to meet the debt and may even be able to
force the scheme to continue as a closed scheme.
Was this just bad wording, or was the government
serious? The trouble is that the actuarial profession is
rather too clever, sometimes. We will probably set up
a working party and then hold seminars to cogitate
and deliberate on this new transfer of power to the
company and how it interacts with trustee powers on
winding up. Before we do that, may I suggest we first
ask the minister, ‘Did you really mean that?’ [Sounds
like a 201 communications paper question.”
Sadly, pension schemes will still have to deal with the
problems of MFR compliance for a considerable time
before the government’s alternative proposals take
effect. How long? According to the government, the
intention is to ‘develop proposals for legislation when
parliamentary time becomes available.’ Well, with an
election coming and then the euro referendum, it is
not hard to imagine another three years before we see
any change.
After all, the big driver seems to be to get schemes to
invest less in gilts rather than to tackle the thorny
issue of the security of occupational pensions. Why
else would the announcement be buried so well that
the report hardly made the news? If the Myners voluntary
code is successfully adopted by the industry,
the government can indulge in a round of back-slapping
and leave the MFR to rot slowly. It is up to the
actuarial profession and other bodies to ensure that
the uncertainties associated with the current MFR are
removed as quickly as possible.
The king is dead, long live the king?
So, despite the initial euphoria over the government’s
proposals to scrap the MFR, I believe that many
clients may soon realise that the minimum funding
requirement has been replaced with the maximum
funding requirement. Out with the MFR, in with the
MFR? However, the proposed duty of care means that
the actuarial profession will be placed in the firing
line if things go wrong! Time to start biting our
The government proposals at a glance
Long-term funding statement
Trustees will have to draw up a scheme-specific funding statement, on
the basis that the employer will continue in existence, which sets out:
°ª funding objectives;
°ª investment policy; and
°ª assumptions used to project assets and liabilities.
It will also include a contribution schedule agreed by the trustees and
Schemes that are not adequately funded compared to the funding
statement will have to produce a recovery plan, which must be filed
with the occupational pensions regulatory authority (Opra), and made
available to members.
Role of the scheme actuary
Legislation will set out a duty of care on the scheme actuary directly to
scheme members. The actuary will be obliged to take into account the
strength of the employer when making recommendations about the
funding statement. He/she will also have additional duties to report to
Winding up
The government will legislate to make it clear that companies must
meet the accrued entitlement of scheme members in full if a scheme is
wound up while the employer remains in existence. The company will
have the choice of whether to meet the liabilities immediately
(presumably by buying out benefits) or to set in place arrangements to
meet them as they fall due.
The government will also consider how the statutory priorities on
winding up should be altered and whether the legislation covering the
amount and priority of the debt due to the scheme when an employer
becomes insolvent should be changed.