The Association of British Insurers (ABI) today called for the government to appoint a special panel of “wise men” to set the appropriate discount rate for assessing pension funds, and revise it when necessary.

The ABI proposal responds to the government’s consultation on the Minimum Funding Requirement (MFR) for pension schemes, which was introduced to improve security after Maxwell. The ABI argues that the MFR has distorted financial markets by encouraging pension schemes to invest in gilt-edged stock, while offering only limited security. It believes the MFR should be replaced with a new, more flexible scheme.

The ABI accepts that a standard measure is required to gauge the adequacy of the assets available to meet pension obligations and to help with the calculation of transfer values. But it thinks a balance needs to be struck between three key objectives: the need to offer security to scheme members; to avoid the imposition of unreasonable costs on sponsoring companies; and to allow trustees flexibility of investment choice.

The ABI proposes that the Chancellor of the Exchequer and the Secretary of State for Social Security should appoint a panel of experts including investment practitioners, pension specialists and actuaries. The panel would meet periodically to consider and agree a discount rate for future pension fund liabilities. This would enable the present value of these liabilities to be calculated. Comparison with the actual value of the funds invested would then show whether an individual fund had sufficient assets to back its future liabilities.

Mary Francis, Director General of the ABI, said:

“We believe our wise men proposal offers the most balanced approach. It would allow a common standard to be devised reflecting expert judgment about the prospects for a range of investments and their implications for pension funding. Pension funds would have a greater choice between bonds, equities and other asset classes including venture capital, offering the prospect of higher returns, while fairly safeguarding the security of scheme members”.

The panel proposal draws on the precedent established by the Monetary Policy Committee of the Bank of England to decide on interest rates, although in contrast with the MPC its members would not need to be full time. The panel would be responsible for deciding the discount rate, which would be altered periodically to reflect changing market circumstances. Pension funds would not be faced with a rigid formula that would drive them to limit their choice of investment asset.

In its response to the Government consultation, the ABI also rejects a number of other suggestions for replacing the MFR. It strongly opposes the idea of additional prudential regulation, which would be costly and intrusive. This could have the undesirable effect of making the regulator, rather than the trustees, determine the choice of asset allocation. Prudential regulation would also be impracticable without the backing of a funding standard similar to the MFR.

The ABI also rejects the idea of a “central discontinuance fund”

or a compulsory or mutual insurance scheme. There would be significant moral hazard problems connected with all such proposals. In addition, it is difficult to imagine the government acting as the necessary guarantor for a central discontinuance fund, and the industry sees no argument for providing cover under a compulsory insurance scheme.

Notes

1. The ABI proposal is contained in its response to the consultation launched in September last year by the Treasury and the Department of Social Security concerning pension funding. The consultation centres around the Minimum Funding Requirement, which was introduced in 1997 and is intended to provide protection for scheme members by setting a benchmark for the acceptable level of a scheme’s assets. Critics of the existing formula have argued that it distorts financial markets by encouraging funds to invest too heavily in gilts.
   
   The ABI submission is being delivered to the government today. A copy, which includes an executive summary, is attached.
   
   
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