24 Feb 2017

The Government has published a Green Paper on the key challenges facing defined benefit (DB) pension schemes.

Increasing pension fund deficits in recent years together with several high profile cases during 2016 have led commentators and the Work and Pensions Select Committee to question whether there is a fundamental problem with the funding and regulation of DB schemes.

The Green Paper explains the conclusions the Government has drawn from the evidence presented and invites readers to a conversation about possible ways to improve the security and sustainability of DB pension provision.

The Government’s main conclusion is that there “is not a significant structural problem with the regulatory and legislative framework”. In its view, the available evidence does not seem to support the suggestion that DB pensions are generally ‘unaffordable’ for employers and there is little evidence that scheme funding deficits are driving companies to insolvency. It identifies the single biggest risk to scheme members as the collapse of the sponsoring employer.

However, the Government accepts that pension scheme deficits are having a significant impact on some employers and for these employers the level of deficit repair contributions may become unsustainable. Last year it undertook an informal consultation on the state of DB pension provision and many of the options put forward by respondents relate to what can be done to assist “stressed” schemes and employers.

The Green Paper looks at the following four areas.

Funding and investment

To counter the perception of DB schemes being in crisis (a perception that the Government states is not supported by the evidence), the Green Paper suggests that the Government and the pensions industry should try to improve understanding of scheme valuations and scheme deficits, in order to provide a better sense of the risks to members.

The Green Paper asks whether there is rationale and scope to encourage or facilitate some schemes to make different investment decisions, and to mitigate any barriers to greater use of alternative asset classes. Examples include giving the Pensions Regulator (the Regulator) a more central role influencing or determining the level of risk a scheme should be taking; mandating or encouraging alternative valuation measures; improving the skills of trustees through training or requiring the appointment of professional trustees.

The Government will be carrying out further research on the nature and quality of trustee decision making, and the factors that influence investment strategies and choices of asset classes in smaller and larger schemes.

Employer contributions and affordability

The Government does not believe that there is a general ‘affordability’ problem for the majority of employers running a DB scheme and so states that measures to reduce burdens on employers across the board are not needed. However, it is open to arguments for rationalising indexation so as to achieve a level playing field for all DB schemes, for example, by introducing a statutory over-ride to allow schemes to switch from RPI to CPI where the scheme rules will not permit the change to be made.

The Green Paper suggests that a targeted approach is needed to address schemes with affordability issues. For some employers this may mean encouraging or requiring deficits to be closed more quickly while for stressed schemes and sponsors there may be a case for greater use of existing flexibilities or new easements. Changes put forward for stressed schemes and employers include:

  • Allowing struggling businesses to separate from their pension scheme more easily
  • Cutting or renegotiating benefits
  • Giving the Regulator a workable power to separate the scheme from the sponsor or wind up schemes in certain circumstances
  • The Regulator providing more intensive support to employers and schemes to review options including the potential for restructuring to rescue business value (even while keeping the pension scheme attached), and possible mandatory appointment of professional trustees.

The Green Paper notes that all these options have drawbacks and could raise ‘moral hazard’ issues.

Member protection

The Government believes that the funding framework and the wider system for protecting DB pension members’ benefits is working broadly as intended. However, following recent high profile pensions cases, it has looked at how the Regulator’s powers and the role of trustees could be strengthened to provide additional safeguards.

The options put forward during the informal consultation include:

  • Allowing the Regulator to take a more proactive role in scheme funding and to be more explicit about the level of risk it is appropriate for a scheme to take
  • In a corporate restructuring, giving the Regulator powers to act proactively to prevent certain corporate activities. The Government is not in favour of a blanket requirement on parties to obtain clearance from the Regulator but believes there may be a case for the Regulator having a clearance regime in specified circumstances. Such a regime would have to be very limited to avoid potentially significant disadvantages to business and a high threshold would need to be set for the circumstances where seeking clearance would be required
  • Introducing a duty, applicable to all parties responsible for a scheme, to co-operate with the Regulator, and providing the Regulator with a power to interview relevant parties (supported by a sanction for non-compliance).

The Green Paper stresses that, in taking forward any changes to existing powers, the Government would need to be certain that any new powers are proportionate.

Consolidation of schemes

The Green Paper sets out the arguments for and against consolidating smaller DB schemes into one or more “Superfund” vehicles in order to reduce costs, and improve investment options and governance. The Government is in favour of greater consolidation on a voluntary (rather than compulsory) basis.

The Government has decided that it will not provide such a “Superfund” but asks whether it should introduce structures or incentives to encourage the pensions industry to provide new consolidation vehicles.

Our comment

Whilst the Green Paper sets out numerous options for change in the four areas under consideration, the Government stresses that it does not necessarily support the options presented. The intention is to encourage an informed debate to start building a consensus on what, if anything, should be done to further support DB schemes.

DB scheme employers and trustees who wish to use their experience to influence the debate have until 14 May 2017 to respond to the consultation.