Will the WPC’s punitive fines really act as a ‘nuclear deterrent’?

Ahead of a Government Green Paper, the Work and Pensions Committee (WPC) has published its recommendations to address perceived flaws in the regulation of defined benefit (DB) schemes. In the first in our series examining the WPC’s recommendations in more detail, we discuss the proposals to impose punitive fines on culpable employers.

What is the nuclear option?

This is the WPC’s recommendation that The Pensions Regulator (TPR) should be allowed to impose punitive fines which could treble the amount payable by scheme sponsors who are believed to have neglected their pension obligations. The intention would be that such extreme fines would not normally expect to be issued, but instead would act as a 'nuclear deterrent' to irresponsible employers – such sponsors would be incentivised to engage proactively with TPR in dealing with stressed schemes.

TPR’s current anti-avoidance powers

Although there have been some recent successes, TPR’s anti-avoidance powers tend to be used sparingly. In evidence submitted to WPC, it was noted that as few as three Contribution Notices and four Financial Support Directions have been issued by TPR since 2005. It was also noted that these proceedings can take several years to reach a conclusion, which is not likely to be in the best interests of stakeholders.

Furthermore, as there is no added punishment for incurring anti-avoidance measures, there is a feeling that some employers may be happy to risk these being imposed. In the worst case scenario, an employer might expect an unfavorable action to result in having to make good on what was due to have been paid to the scheme in the first instance.

"From a corporate perspective, there is a concern that the introduction of this power would make corporate transactions involving DB schemes even more difficult."

Trebling the fine

As such, the Committee have recommended that the Government opens the way for fines payable to be increased to up to three times the current level. The measure would serve to remind sponsors of the downside risks of failing to meeting their pension obligations.

If the punitive fines are set at a high enough level, it should act against moral hazard where an employer chooses to underfund their pension scheme because they believe that a) the scheme will end up in the PPF in the event of insolvency, and b) the worst they can expect to be fined is the amount of the original shortfall.

An added advantage is that employers will be much less keen to trigger anti-avoidance proceedings and may look to apply for clearance from TPR for corporate transactions.

From a corporate perspective, there is a concern that the introduction of this power would make corporate transactions involving DB schemes even more difficult.  We will return to the issue of clearance in a future blog.

Comment - In theory, with such a deterrent in place, scheme sponsors should be keener to fund schemes to an appropriate level to avoid the wrath of TPR. However, given the limited historic use of TPR’s powers, the challenge will be to convince stakeholders that the threat of such a penalty being issued is genuine.  This may well mean that behaviours will only change materially once we have witnessed the fallout of this particular deterrent being applied for the first time.