Pension Schemes Bill [HL]

Baroness Altmann Excerpts

Monday 21st November 2016 Lords Chamber

[Baroness Altmann (Con)]

My Lords, I, too, support the amendment. I am concerned that there are well-intentioned measures in the Bill designed to ensure that there is capital adequacy in these schemes. One hopes that they will work but how will any regulator know in advance what capital is actually adequate? The circumstances in which wind-up could take away people’s pensions, even if the assets are ring-fenced and protected for the members, are those in which there is no other mechanism for covering the wind-up costs. That is where the members’ pensions would be at risk.

Indeed, we saw this a number of years ago with defined benefit pension schemes, which is precisely why we ended up with the Pension Protection Fund. The Government put in well-meaning legislation that required minimum funding standards for defined benefit schemes which were supposed to ensure that members’ pensions were safe even if the scheme or the employer failed. Unfortunately, the situation with the schemes—due to lack of competent administration in some cases but not all; sometimes due to market movements as well—led to members losing their pensions, and the only real protection that ended up being available was this backstop insurance in the form of the Pension Protection Fund.

Yes, we need capital adequacy. Yes, the Bill is really important. But I would be really grateful if my noble friends the Ministers explained why the Government do not feel this is necessary, or how proper protection for members in extremis can be provided. For example, will NEST guarantee to take over these liabilities? Is there some other plan? I would be grateful for some reassurance from my noble friends.

[The Minister of State, Department for Work and Pensions (Lord Freud) (Con)]

Amendment 18 requires the Secretary of State to,

“make provision for a compensation fund or for the funding to be provided by another source as a last resort”,

in circumstances where the scheme has had a triggering event and has insufficient resources to pay the costs referred to in Clause 8(3)(b)—that is, the costs of complying with duties imposed under the Bill during a trigger event, and the costs of continuing to run the scheme for a period of six months to two years—and a prohibition on increasing charges during the trigger period applies.

The amendment speaks to the heart of what the Bill is about: protecting members. Along with a number of other amendments, it seeks to add further protections and, perhaps, test us a little on the extent of the measures the Government have provided for in the Bill as introduced. I welcome both the focus on member protection and the opportunity to explore the specific measures in the Bill which provide the members with security should the scheme decide to close or start to fail. The amendment would mean that if a scheme experienced a triggering event and had insufficient money to pay for the costs associated with the options the scheme may pursue following a triggering event, other funds must be provided. It also goes further to say that it is the Secretary of State who must provide a compensation fund or for the funding to be provided by another source.

In responding, I will touch on a few areas. I will outline, first, the measures which provide that sufficient funds must be held; secondly, some of the costs and complexities that would be introduced into the system should a compensation fund or other funding be required; and, thirdly, the compatibility with the regime provided for in the Bill.

I turn to the measures which provide that sufficient funds will be held. First, the main provisions in the Bill requiring schemes to hold certain funds are in Clause 8, which provides that for the scheme to be authorised it must satisfy the regulator that it has sufficient resources to meet certain costs. This includes the costs of complying with the requirements under the Bill once the scheme experiences a triggering event and those of running the scheme for a period of between six months to two years, in the event of a triggering event occurring. The Government believe that these measures are sufficient and that this is an appropriate regime for the types of funding in question here. Further, members’ savings are protected via the restrictions on using members’ pots to pay for these costs provided at Clause 33. We therefore consider that the amendment is unnecessary.

However, it would be helpful to explore the counterarguments or challenges as to whether this is adequate risk mitigation—in particular, to explore any suggestions that there is still some risk in relation to: the period before the authorisation regime is up and running; the calculation of those funds to ensure they are sufficient at the point of need; the availability of the funds at the point of need; and the funds diminishing over time. Finally, what happens if the lack of these funds leads to the regulator withdrawing authorisation and creating a triggering event? Let me set out how those risks are addressed within the regime.

In respect of the period before the regime is up and running, paragraph 7 of Schedule 2 provides that the scheme funder is liable for these costs. It places this liability on the scheme funder when a triggering event has occurred in an existing scheme and the liability for those costs does not lie elsewhere. The prohibition in relation to increasing members’ charges applies during this period, so members are protected. If the funder should be in financial difficulty, the matter should be pursued via the normal court channels or insolvency processes. It is not the members’ money which is at risk in these scenarios; it is the running costs of the scheme and payment for activities during the triggering event period.

We also know that other schemes may well rescue the failing scheme, as has happened before, to protect the reputation of the industry. This is a different dynamic from what would be the case in non-money purchase schemes, where the debt is about money needed to pay member benefits and where funding obligations to pay for the promised benefits would attach if another entity took over the scheme. The master trust industry can support the movement of members—some trusts are willing to do so—or take over failing master trusts, so government intervention is less warranted where an industry solution may be possible. This might be an appropriate point to deal with the question from the noble Baroness, Lady Drake, about the identification of receiving schemes. They will be on a list kept by the Pensions Regulator, and some industry players may wish to step in and identify themselves.

On whether the funds available to the scheme will be sufficient, regulations will set out matters that the regulator must take into account when deciding whether it is satisfied that those funds are sufficient. We anticipate that these will include matters that will support the establishing of the assets needed to cover these specific costs, such as the business plan, the size of schemes, the costs of contracts and the value of assets, the nature and level of assumptions made in that business plan, the security of the scheme funder and the state of the scheme administration. Also covered will be the range of potential assumptions that may be used in arriving at the figure required.

Regulations may also specify the information that the regulator must take into account and requirements relating to the financing of the scheme or funder, such as requirements relating to assets, capital or liquidity. We anticipate that these will include matters such as how the funds are to be held to ensure that they may be accessed for specific purposes only, so that they are safe in the event of the funder becoming insolvent. In this way the Bill provides that to be authorised, a scheme must hold sufficient funds for those costs and that these funds must be held appropriately.

The supervision part of the regime focuses on ensuring that the funds remain sufficient and are not eroded over time, and that the Pensions Regulator can act swiftly should a drop occur in the funds held. There are measures in the Bill that work together to provide that this requirement to hold funds to cover the costs of the triggering period is an ongoing requirement, and one that the regulator will be able to supervise. Clause 19 states that if the regulator stops being satisfied that an authorised scheme meets the authorisation criteria, it may decide to withdraw the scheme’s authorisation.

Further, alongside the information-gathering powers that the regulator has under the Pensions Act 2004, Clause 14 requires the scheme and funder to submit annual accounts, while Clause 15 gives the regulator the power to require schemes to submit a “supervisory return” and Clause 16 places a requirement on certain persons to report “significant events”. We anticipate that these significant events will include matters in relation to the funds held under Clause 8. Through these means, the Pensions Regulator will have a stream of data in relation to which it can make further inquiries to ensure that it remains satisfied that the criteria continue to be met, and it can take action if that ceases to be so.

If the regulator becomes concerned that the assets are no longer sufficient to satisfy it that the criteria are met, it may issue a warning notice to withdraw authorisation, which is a triggering event, and will have access to the pause power and direction-making powers under the triggering-events part of the Bill. In this way, the Pensions Regulator can act quickly and decisively as soon as any risk arises, to diminish risk and prevent the situation deteriorating any further. On the question from the noble Baroness, Lady Drake, about which liabilities the receiving scheme will have for debt in the existing scheme, the Bill imposes no liabilities on the receiving scheme for debt in the existing scheme.

This approach caters for a number of different structures under which the master trust schemes have been set up. It ensures that the regulator can make a scheme-specific assessment of the funds that must be held to cover the requirements. It helps ensure that the risk of the scheme not holding these funds, or of the funds being eroded, is minimised.

In addition to the consideration that this risk is already dealt with via the Bill’s provisions, I will turn to a second matter: the costs and complexity that this amendment could introduce into the regime. As soon as compensation is added to the regime—based on the concept that where the funds are insufficient, someone else will step in—an element of moral hazard creeps in, as the noble Baroness, Lady Drake, acknowledged. Master trusts are businesses set up to provide a service to a number of employers. Many are set up to make a profit; some are not-for-profit, but all are selling or marketing their services to employers and must take responsibility for providing protection to their members. I would also be concerned about the added cost of delivering a compensation fund. Noble Lords have left it for regulations to establish whether this fund or requirement would be a government-funded compensation scheme or a levy-funded compensation scheme, or on whom any additional sourcing requirement would be placed. So this would be a broad regulation-making power.

In terms of what type of compensation may be envisaged, if it was levy-based there would be additional administrative costs to consider, as well as additional costs to the schemes that would presumably need to contribute to it as well as holding funds for their own scheme for a very low risk, as my noble friend Lord Flight pointed out. These would be funds that the scheme could not use for its own risk mitigation. The type of risk we are looking at here does not warrant the introduction of a compensation scheme. Members’ pots or promised benefits are not at risk. Clause 33 provides protection when a trigger event occurs, as it prevents charges being increased or new ones being introduced. It is about the risk of the scheme being unable to meet costs related to paying for activities under the trigger events such as wind-up, bulk transfers, finding a new funder or suchlike. The cost and complexity of a new compensation fund is not warranted.

A third matter is that I am not convinced that the amendment is compatible with the wider regime provided for in the Bill. There would be some significant challenge in ensuring that this provision did not lead to unintended effects: if, for example, the other source of funding was to place a requirement on a specific person to provide the costs as a last resort. The regime has been specifically crafted to ensure that all types and structures of master trusts can comply with the requirement. This has been specifically designed to ensure sufficient flexibility in enabling schemes to comply with the obligation.

--- Later in debate ---

I hope I have answered my noble friend’s questions. The Government’s view is that the measures during the period before existing schemes are authorised are appropriate and that the schemes, once authorised, will hold the funds. Clause 33 provides that members’ pots are protected by the restrictions imposed on increasing charges. The issue is simply not the same as for defined benefit schemes. The risks and the costs are different.

[Baroness Altmann]

Will my noble friend write to me with some clarification on how costs would be covered? If a scheme fails and records are in disarray, how would the costs of wind-up be covered? I accept that they cannot come out of the members’ pots. If the company running the scheme or the employer has failed, where will the money come from to make sure that members’ current pension funds are transferred over and the costs of administering the transfer, executing the bulk transfer and clarifying the records are met? Currently it would seem that the members’ pots will be in limbo. The money cannot come out of their pots, but there is no one else to pay.

[Lord Freud]

The money cannot come out of their pots, but the Pensions Regulator will be looking to transfer those pots to another master trust. The protection that this amendment and my noble friend are suggesting is almost conditioned by what we watch in the defined benefit market. This is a different situation, where there are protected pots. There may be costs in a catastrophic situation, but they will not fall on members, and it is not the job of government to protect non-members from getting into a mess.

--- Later in debate ---

[Lord Flight]

The issue is an administrative one, in that you have people’s pension fund money, and the manager has got into trouble and, let us say, gone into liquidation. What administration would make sure that a new manager takes over and continues to investment-manage those pots of money? There have been suggestions that the Pensions Regulator himself should be empowered, or maybe required, to act as a broker with regard to such arrangements, but that problem has not yet been solved. That, surely, is the practical issue, not people losing money out of their pension pots.

[Baroness Altmann]

The issue that we are dealing with is indeed an administrative issue, but saying members’ pots are protected does not protect members’ pots. In a scheme which has failed and is winding up, and whose administration is in disarray, it will take some time and money to decide and assess how much each member’s pot is actually worth, for example in the cases of a big master trust whose systems fail or of a smaller master trust whose systems simply were never up to scratch. We have 80 or so master trusts out there at the moment and have had no protection regime at all, no capital adequacy rules and no proper assessment of the quality of the trusts. We have so many members’ pension funds growing for them, and there is the possibility that more than one of these schemes will fail and need to wind up. There will be costs associated with assessing what the value of those members’ pots actually is. I do not hear anything at the moment that explains how the costs of administering and sorting out the records of that scheme, so that we know what each member’s pot is worth, are going to be funded. If the Pensions Regulator finds a way to pick up the cost, if NEST has to pick up the cost or if there is some insurance regime for industry-wide assessment of those costs, that is fine, but I just feel that we are assuming that this will be a wind-up of a scheme whose records are fine and it will be shipped off to another scheme, which will want to earn money for those members. That is not the case that is necessarily going to arise.

--- Later in debate ---

[Lord Flight]

My Lords, I believe this clause has aroused most concern in the industry, particularly the insurance industry. A number of organisations, particularly life offices, undertake a range of business activities in addition to simply sponsoring a master trust. The clause suggests that the scheme funder or sponsor must set itself up as a separate legal entity and undertake no other activity beyond sponsoring the master trust. Given that the whole purpose of the Bill is to ensure that funds are available to see through the orderly exit of the scheme’s sponsor, the provisions of Clause 10 as it stands are surely counterintuitive. One wants the sponsor to be as strong financially as possible, but the clause as it stands could well invoke the very thing that the Government are trying to avoid.

More specifically, as the noble Lord has pointed out, the insurance industry typically will have master trusts side by side with group personal pension schemes. As matters now stand, they are regulated by the FCA and PRA, and there would be a considerable duplication of regulation under the arrangements as proposed. I am sure the Government have focused on this, but I certainly feel that Amendments 19 and 20 are appropriate to address the problem that stands.

[Baroness Altmann]

My Lords, I echo the comments made by my noble friend Lord Flight. Why do the draftsmen of the Bill think that having a separate legal entity is definitely a good thing? What are the risks that this approach tries to close down? Perhaps if we could understand those risks better, we might be able to address the issue in a slightly different way. Is the aim somehow to ring-fence the DC covenant of the scheme funder and prevent them from having other financial obligations that might take away from the support for this master trust, or to minimise the burden on checking accounts? Obviously, it is easier to review the accounts of a stand-alone entity than of a much broader group. Hopefully, if we could better understand what the rationale is, it might be possible to address some of the very important concerns that have been expressed by some of our major insurance companies.

[Lord Young of Cookham]

I am grateful to the noble Lord, Lord McKenzie, for his amendment. I gently point out that there is a spelling mistake in it, but there are other reasons for resisting it.

Amendments 19 and 20, tabled by the noble Lord and the noble Baroness, Lady Drake, deal with Clause 10, which sets out the requirements that a scheme funder must meet in order for a master trust to be authorised. I hope to explain to noble Lords, particularly my noble friend, the thinking behind insisting that there is a separate legal entity behind each scheme. A scheme funder by definition is key to the master trust’s financial sustainability. By “scheme funder” we mean a person who is liable to provide funds in relation to the scheme when the administration charges paid by and in respect of members are not sufficient to cover the scheme’s costs, or someone who is entitled to receive profits when the scheme’s charges exceed its costs.

Amendment 19 would remove the requirement for the scheme funder to be a separate legal entity that carries on business activities only directly related to the master trust, and would replace it with a requirement for the scheme funder to be approved by the Pensions Regulator. I listened with interest to the points that noble Lords made in respect of that amendment. Amendment 20 would similarly remove the requirement for a master trust’s scheme funder to be a separate legal entity that carries on only the master trust business. The effect of both amendments would be to allow the same legal entity that acts as scheme funder to engage in business activities not directly related to the master trust, making it more difficult for the Pensions Regulator to identify matters relevant to the master trust and therefore to assess the financial sustainability of the scheme.

To enable the regulator to assess the financial position of the scheme with certainty when deciding whether the master trust should be authorised or remain authorised, the scheme funder must be set up as a separate legal entity. This is defined in the Bill as meaning, in effect, a legal person whose only business activities are in relation to the master trust. Requiring scheme funders to be separate legal entities will make their financial position, and the financial arrangements between them and the master trust, more transparent to the regulator and provide greater clarity regarding the assets, liabilities, costs and income in relation to the master trust business. This will greatly assist the regulator in carrying out its assessment of schemes’ financial sustainability.

There will be greater transparency regarding any additional funding streams coming into the scheme funder entity, and the level of commitment of those funds for the purposes of running the master trust, should the scheme funder be in receipt of income generated from other lines of business carried on by connected entities. The amendments would remove that transparency by making it possible for the scheme funder to carry on business activities not related to the master trust under the same corporate entity. It would therefore be difficult for the regulator to identify the financial sustainability or otherwise of the master trust.

One of the other authorisation criteria of which the regulator needs to be satisfied is that the people involved in the master trust scheme are fit and proper. Clause 7 specifies people that the regulator must assess for this purpose, including the scheme funder. It is not clear to what extent Amendment 19, requiring the scheme funder to be approved by the regulator, would differ from the assessment that the regulator is already required to carry out under Clause 7. Requiring the regulator to approve the scheme funder in general terms, rather than setting out requirements in the primary legislation requiring the scheme funder to be set up as a separate legal entity, would not only potentially make the financial sustainability of the scheme less clear to the regulator but would also give master trusts and scheme funders less certainty about the conditions that must be met for authorisation.

To turn back to the requirement for the scheme funder to be set up as a separate legal entity, I am aware that a number of concerns have been raised about the impact that this will have on existing businesses, such as the removal of protection and cross-subsidy through diversified lines of business supporting the master trust, restrictions on the use of shared services and the disruption of existing business. I shall come to each of these in turn, but I reassure the House that this authorisation criterion is not designed to prevent funds from flowing from one business to another, nor is it our intention to disrupt existing arrangements unnecessarily. The overarching aim of the requirements is transparency in the cash flows to and from the master trust business, and the assets and liabilities related to it, so that the regulator can readily ascertain the financial position of the scheme funder and the financial arrangements between the funder and the scheme. I think that paragraph answers the question asked by my noble friend Lady Altmann.

The requirements in Clause 10 do not prevent the master trust benefiting from the support of other businesses. Support can be offered from the scheme funder’s wider group explicitly through the provision of a legally enforceable guarantee or other formal arrangement from another group company of sufficient financial strength. Where the scheme funder currently conducts other businesses, a degree of cross-subsidy may already take place, and there is no intention to prevent this.