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Stand behind the pension promise

When Gordon Brown announced the abolition of the minimum funding requirement in the Budget, a collective sigh of relief went up from those involved with defined benefit pension schemes.

However, that same afternoon, the Government published a short consultation paper putting forward its proposals for replacing MFR. The political need for putting something in place of MFR is clear. Whatever may be said against MFR – and there is a lot that can – it does provide some lower limit to the security of the member&#39s accrued rights in a defined-benefit pension scheme.

If the Government simply removed MFR with only Paul Myners&#39 transparency statement instead, member security would undoubtedly have been weakened. That would have left the Government politically vulnerable in an election year and offered up a hostage to fortune for many years to come.

The consultation paper has two key proposals that the employer should “stand behind the defined-benefit promise” and that the scheme actuary should give consideration to the strength of the employer when assessing the scheme-specific funding criteria.

Standing behind the defined-benefit promise means making sure that the member gets the promised level of accrued defined benefits, at least where the employer remains solvent.

The Government recognises that dealing with the underfunded defined-benefit scheme of an insolvent employer is more difficult and the second key aim is to avoid such a situation arising in the first place. Presumably, the intention is that the more concern the scheme actuary has about the possibility of the employer going bust in future, the closer to the cost of annuity buyout will the actuary try to target the scheme funding level.

The problem, of course, is that, in current circumstances, annuity buyout rates are much more expensive than 100 per cent of MFR and the very act of demanding a cash injection from the employer may make it more likely that the employer does go bust.

A defined-benefit scheme of a solvent employer could hope to limit the cost to the employer by ceasing accrual and investing in equities on a closed fund basis.

If the equities perform as well as hoped (and the employer does not go bust in the meantime), that is fine. If not, the employer may be dig ging an even deeper hole for everyone.

Personally, I think the Government is correct in principle – an employer who is not prepared to “stand behind the defined benefit promise” has no business to be offering a defined-benefit pension scheme in the first place.

Also, there is some uncertainty about whether an employer can legally walk away from the pension promise anyway. Often, the scheme documentation will go further than the existing pension legislation requires. How practical it is to pursue the employer for the difference between 100 per cent of MFR and the cost of annuity buyout is another matter.

There are some pretty clear conclusions for IFAs in all this. The Government is committed to abolishing MFR but its alternative proposals for safeguarding member security could be altered as a result of the consultation process which is now taking place. But IFAs cannot afford to be complacent about the potential impact of these proposals on their defined-benefit clients.

Just imagine the client&#39s reaction if a rival IFA is first to tell them the Government is proposing to raise their commitment to the existing scheme from 100 per cent of MFR to, say, 130 per cent of MFR.

It will be important to understand the existing scheme&#39s documentation with regard to whether the employer is already committed to annuity buyout costs in the event of the scheme winding up. Legal advice may be necessary on this point.

It will be particularly important for the IFA to be clear about whether the client is the employer or the scheme trustees.

It is perfectly possible that the two entities will have conflicting agendas, even though a majority of the trustees could be directors and senior managers of the employer. When wearing their trustee hats, they must put the interests of the beneficiaries first.

The two major loose ends which the Government ack-nowledges in its consultation paper are what to do when the employer is bust and the scheme cannot afford full buyout and what to do about individual transfer values from defined-benefit schemes when MFR ceases to underpin them.

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