Brian Holden is a former trustee of Co-operative Insurance Society ‘s pension fund

An increasing number of UK pension schemes have had to be wound-up because the sponsoring company has gone into liquidation. But in many cases that does not have an adverse impact on the pension scheme as it is often a lot healthier than the sponsoring company.

However, in the case of underfunding, the UK is making use of its very own pension benefit protection scheme.

The Pension Protection Fund, the PPF, was established by the Pensions Act 2004 and became operational on 6 April 2005. It pays compensation to members of defined benefit schemes where the sponsoring company becomes insolvent and the pension scheme does not have enough assets to cover a PPF level of compensation.

The PPF is financed by a levy charged to pension schemes, which is related to their PPF liabilities, and a risk-based levy, which is based on the degree of underfunding of those liabilities and sponsor default.

To date, over 7,000 members of 10 pension schemes have been transferred to the PPF. These members are either receiving compensation payments because they have retired, or will do so at a future date. These payments are mainly funded by the assets inherited from schemes that have transferred to the PPF, which are sometimes enhanced by assets recovered from the insolvent employer, and partly by investment income and partly by the annual levy raised from pension schemes.

The reaction of the pension industry to the PPF has been mixed and it is regarded as a necessary evil. While the principle of the PPF has been accepted and supported, the prospect of increased costs to schemes and employers is not acceptable to schemes that are unlikely to require it. For these and other reasons, the PPF is currently consulting on the method of levy calculation for the next three years as well as the likely levy details for 2010 - 11 and beyond.

I also think we need to give the people who run pension schemes - trustees, the majority of who are unpaid, or pension boards - protection, in other words the same level of insurance cover that directors of companies have.

In the UK, pension schemes trustees take out their own pension scheme protection in the form of a trustee liability insurance. While a number of pension schemes already have this insurance cover they tend to be the larger ones that can more easily afford the cost of the protection.

But I believe that what is good for the trustees of a large pension scheme is just as good for the trustees of the small ones as they have the same range of responsibilities. But many pension schemes and their sponsoring employers - who usually bear the ultimate cost - are unhappy about providing insurance protection because they see the cost of the protection as too high. However, over the life of an average pensioner the levy is fairly negligible.

 

Dick Kamp, pension affairs manager at the pension fund of Dutch retailer Laurus, which has AUM of €430m

The participants of pension plans need protection. But a benefit protection scheme is only one of the instruments at the disposal of a supervisor. Ultimately every country will choose a solution that fits best within its own context.

In the Netherlands, we have another partly more self-regulatory approach regarding the protection of participants and for the last couple of years there have been tremendous developments in this area.

Basically, the protection of participants is two-fold: it is about both the financial position and governance of the pension fund.

The first real step towards protecting scheme members came in September 2002 when our supervisor set out strict and mandatory requirements for the financial positions of pension funds. If a pension fund did not have the financial position required at that time - and a lot of them did not - it needed to have a recovery plan which would lay out how to return to the required level within an eight-year timeframe.

These requirements have now been refined through the financial assessment framework, the FTK, which is part of our new pension law that came into force on 1 January 2007. It increased the recovery timeframe to 15 years. The FTK, which uses market valuation of liabilities, gives pension funds more control over their coverage ratio, which is an important figure to them.

Before 2002, a pension fund needed a coverage ratio of 105%, in other words an extra 5% of reserves, and the liabilities were valued at a fixed interest rate. Pension funds had no market valuation of their liabilities and prospective mortality rates were not taken into account. So from that respect the level of protection was much less.

The FTK introduced a market value environment for liabilities. The current regulations require a pension fund to have a higher solvency ratio, depending on the level of risk in the investments, which is like paying a levy for protection to yourself. And on top of that, rigorous governance requirements have been placed on a pension fund.

It is the combination of these that creates sufficient protection for our members.

Basically a Dutch pension fund cannot go bankrupt. If its financial situation is severely hit, the benefits of the participants will decrease to the level the financial position allows at that time. But the benefits will only decrease if it's not able to develop a recovery plan that suffices within the 15-year timeframe. And I don't know of any pension fund where this has actually happened.Both the 2002 regulation and the development of the FTK had been widely discussed before they came into force. The FTK had a mixed reception in the industry. We were one of the first six pension funds to enter into the FTK in 2005. I welcomed it because pension funds are now able to match their assets and their liabilities, as they can choose actual assets that follow market interest rates. With that, they can be more in control of taking the level of risk that is acceptable to them.

Because we believe in rigorous governance processes moral hazard is not an issue in the
Netherlands.

In addition, the associations of company, industry-wide and occupational pension funds have responded to a demand for increased professionalism in pension fund governance and among trustees by developing a self-regulatory plan to further increase professionalism of board members. From 2008 the annual accounts of pension funds will have to include a report on the development of their board members' professional skills.

 

Peter Damgaard Jensen, CEO at PKA, which manages eight Danish pension funds that have a total AUM of DKK120bn (€16.1bn)

We do not have pension benefit protection schemes in Denmark and it is not an issue in the pension debate. I don't think such schemes are necessary in a Danish context because there is great responsibility in the pension industry and because funds have to be fully funded, in other words have a funding level of more than 100%.

And that requirement has historically been met by the Danish funds.

Pension protection schemes are only needed when pension funds have funding problems. The closest we came to this was during the equity crisis in 2001-2002, when funding levels in the Danish pension industry were generally low. But even those with the worst funding levels were still fully funded. The mean value of our funding level across the eight different pension funds that we manage is around 125-130% at the moment.

It was also very clear from when the Danish pension funds were first established that they had to rely on their own funding and facilities and that there would not be anyone else to save them in case of underfunding.

A great deal of responsibility lies with the different pension funds and the regulator has put pressure on us to be as professional as possible, which I think is good for the industry as a whole. The industry itself has been very aware that it would be the pension fund members that would end up paying for funding problems and has been very responsible. That is one of the reasons why Denmark has no history of pension fund bankruptcies.

In 2002 the Danish financial authority introduced a strict and mandatory regime for pension schemes that included stress tests and mark-to-market values. This created greater awareness of the need to have the right funding levels and being aware of the risk profile in the different funds.

Instruments such as stress tests and mark-to-market values had not been developed before the end of the last century. I think Denmark was actually one of the first countries to introduce them.

Before 2002, we more or less used a voluntary code. But even that meant you still had to be fully funded.

If a pension fund were not fully funded, it would probably be taken under administration by the Danish financial authority — but this has never happened in the history of Danish pension schemes.

Interviews conducted by Nina Röhrbein

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