Home > News > 2001 > March 2001 > The UK Government's proposal to replace the MFR
The UK Government's proposal to replace the MFR
Danny Wilding considers the implications of UK Chancellor Gordon Brown's budget speech.
The 2001 Budget and UK pension schemes
In his Budget speech Gordon Brown announced that the Government will abolish the Minimum Funding Requirement and has accepted the recommendations of the Myners Report on institutional investment. Both of these will have a significant impact on occupational pension schemes.
The Government's proposals to replace MFR
In his Budget speech on Wednesday 7 March, Gordon Brown announced that the Government is to scrap the controversial Minimum Funding Requirement (MFR) and replace it with a long term funding standard, underpinned by a regime of transparency and disclosure.
Barnett Waddingham very much welcomes these proposals. Indeed, our own response to the MFR consultation document issued by the DSS put forward the idea of replacing the MFR with a "Statement of Funding Principles" and the proposed long term funding standard seems to be much the same sort of thing.
There are a lot of questions still to be answered but we have set out below our initial comments on some of the key areas of the Government's proposals.
New long-term funding standard
The new funding standard will have to be published by schemes (a good thing in our view) and should set out a schedule of contributions designed so that the scheme can meet its on-going liabilities in full in the long term. If the scheme drifts away from its agreed funding standard then it is proposed that corrections will have to be made over a 3-year period. This is a relatively short period, but that might be acceptable bearing in mind that a scheme has flexibility over its own funding standard. Also the Occupational Pensions Regulatory Authority (OPRA) should be given the power to review the time limits for individual schemes.
Tougher conditions on voluntary wind-up
The proposals will prevent employers from walking away from the scheme leaving it insufficiently funded to pay the accrued pension liabilities. Perhaps we have read more into the wording than was intended but it would seem that the proposal is to measure the "debt on the employer" (when a scheme winds up voluntarily) by reference to the cost of buying annuities (immediate annuities for retired members and deferred annuities for non-retired members). This would put the employer's ultimate liability in the hands of the insurance industry, regardless of the competitiveness or economic sense of investing in these (currently very expensive) insurance policies. This is likely to encourage many employers to run-off schemes as closed paid-up schemes rather than pay the buy-out costs of winding-up.
The Government is also going to give consideration to improving members' protection on the insolvency of an employer, by perhaps making the debt relating to the pension scheme a priority debt.
New transfer value basis
The MFR currently defines the minimum transfer value and so the Government has asked the Institute of Actuaries to consider a new transfer value basis to apply following the scrapping of the MFR. It remains to be seen whether this becomes a compulsory minimum transfer value or whether we revert to the pre-MFR regime when actuaries were free to choose a scheme's transfer value basis.
Scheme Actuary's statutory duty of care
The Scheme Actuary, when advising on the funding plan, will be required to acknowledge a statutory duty of care that he will have to the pension scheme members. At present an actuary has a duty of care to the trustees (as his client) but only a more general "public interest" duty to the scheme members. Different classes of member might have different interests (for example, pensioners and active members) and there could therefore be conflicts for the actuary to consider under the proposals.
Implementation
The proposals imply that they will be made so soon that there is no need for the MFR to be amended in the short term. We note that primary legislation will be required and that introduction of the proposals will be "when parliamentary time permits". This could still be a relatively long wait, and it is disappointing not to have a timetable. Nevertheless, there is a statement to the effect that the mooted temporary changes to the MFR will not be made.
There appears to be a message that the Government has recognised the potential damage to occupational pension schemes arising from the MFR and will now allow that to be dropped, even if there is an hiatus of a year or two whilst the proposed legislation is being prepared.
Summary
MFR abolition is good news for the members, sponsors and trustees alike of on-going pension schemes that progress is being made at last to get rid of the MFR. However, for schemes that do not run their full course, for whatever reason, the potential tightening of the winding-up regulations may appear onerous. In particular, closed or discontinued schemes should take further advice and consider the implications carefully.
Other Budget pension scheme changes
The Earnings Cap
For fiscal year 2001/2002 the Earnings Cap will be £95,400 (£91,800 in 2000/2001). This increase is as expected.
Tax on Surplus Refunds
In an unexplained change, the tax levied on a refund of surplus from a pension scheme to the company falls from 40% to 35%. This takes effect from the date the Finance Bill receives Royal Assent. The rate of tax charged on cash payments to dependents under personal pension drawdown is also 35%. Is there a reason for bringing these two rates in line?
The report by Paul Myners on institutional investment, commissioned by the Chancellor of the Exchequer, was published on 6 March 2001.
The report is extensive with detailed comments on all aspects of pension fund investment, including trustee decision making and knowledge, appointment of investment advisers, operations of fund management, measurement of fund management and accounting for brokerage commissions. He also proposed the abolition of the Minimum Funding Requirement (MFR).
Myners complimented the efforts of occupational pension scheme trustees to date in fulfilling their duties and the high quality of advice from investment advisers. However, he thought the current system had potential shortcomings, which could lead to inefficient investment decision making. He therefore proposed a voluntary code of conduct for trustees. He suggested that this needed to be backed up by legislation only if in, say, two years' time sufficient compliance could not be demonstrated.
He also suggested trustees must be able to demonstrate explicitly that they have complied with the principles, and must inform members of how they have complied. Thus, there would be a significant increase in required disclosure. The proposals are far-reaching, and are summarised below:
- In relation to investment decisions trustees should have sufficient expertise to be able to evaluate critically any advice they take.
- Trustees should ensure they have sufficient in-house staff to support them in their responsibilities.
- Trustees should generally be paid, unless there are specific reasons to the contrary.
- As good practice trustee boards should have an investment sub-committee to provide appropriate focus on investment issues.
- Trustees should assess whether they have the right set of skills, both individually and collectively.
- Trustees should draw up a forward-looking business plan.
- Trustees should set out an overall investment objective for the pension fund, bearing in mind the liabilities of the scheme and their attitude to risk.
- Trustees should set their investment managers objectives which do not relate to the performance of other pension funds (i.e. Myners rejects investment benchmarks based on industry-wide measures such as the CAPS or WM median).
- Strategic asset allocation decisions should receive a high level of attention.
- Investment decision-makers should consider a full range of all major investment classes (including, for example, unquoted and private equity).
- Trustees should consider the relative benefits of active and passive investment management for each asset class.
- Trustees should agree with their investment managers an explicit written mandate, which should include clear timescales for performance measurement and evaluation. (Myners also suggests that the mandate should not be terminated before its expiry other than for specific clear breaches.)
- The Statement of Investment Principles should be strengthened significantly in many respects. In particular, trustees should consider further issues in respect of setting consistent performance benchmarks, asset allocation, active divergence from market indices and risk controls.
- Trustees should make formal assessments of their own procedures and decisions.
- Trustees should require their fund managers to show active intervention (including exercising voting rights) in the companies in which they invest. This should be included in investment management agreements.
- Contracts for actuarial services and investment advice should be open to competition. The fund should be prepared to pay sufficient fees for each service to attract a broad range of potential providers.
Government response
Gordon Brown included the following in his budget speech on 7 March 2001:
"To promote long-term investment and to protect investors, I have accepted the recommendations of the Myners Report. We will abolish the Minimum Funding Requirement; through tax and regulatory reform make it easier for life insurance and pension funds to invest in venture capital; and we will ensure both a strengthened role for pension fund trustees and clearer duty on fund managers to promote beneficiaries' interests. I support the challenge to the industry Mr Myners has laid down and his proposal that we should be prepared to legislate as necessary to achieve the improvements he prescribes."
Separately, indications have been given that a Government pensions review will be made within two years, with legislation as necessary. This review is expected to be consistent with the proposals in the Myners Report.
Conclusion
The starting point of the report was the question of efficient allocation of capital within institutional investment, and in particular sourcing of funds for private equity investment. This appears to have been widened to a root-and-branch reform of the whole investment process for pension schemes. However, the theme of private equity investment remains within the report, which suggests that pension scheme trustees should consider this asset class. We believe that private equity will remain a marginal, rather than mainstream, asset class for pension scheme investment.
The timetable for change is not clear. It appears that the Government may back the proposals in the Myners Report in their entirety. Some of these proposals are far-reaching and would suggest a significant increase in disclosure and a more detailed investment decision-making process. It would suggest a high level of expertise expected of trustees, and perhaps more trustee training.
Therefore, although we support the proposals in principle, we believe certain aspects of the proposals may not be practical in the short term (or at all for some smaller schemes).
Danny Wilding, March 2001.