The Government’s Green Paper on defined benefit (DB) regulation contains numerous interesting measures which it hopes will stimulate debate across the industry – however, by-and-large the suggestions support the Government’s view that the current system is not broken.
"The Government has put a number of options on the table, from gentle encouragement to 'nuclear deterrents'."
With around £1.5 trillion in assets invested and 11 million current and future pensioners expecting to rely on DB entitlements, any changes to existing regulations will have far-reaching consequences across the UK economy. The Green Paper published by the Department for Work and Pensions (DWP) has therefore been much anticipated.
However, the main conclusion of the Green Paper, titled ‘Security and Sustainability in Defined Benefit Pension Schemes’, is that there is no significant structural problem within current regulations.
The Government has put a number of options on the table, from gentle encouragement to 'nuclear deterrents'. Although the Government is seeking to consult on several contentious issues, given the tone of the Green Paper it is difficult to foresee fundamental changes emerging.
The paper sets out in detail six consultation questions for stakeholders across the industry. These cover:
- the appropriateness of current valuation measures
- helping members understand their scheme’s funding position
- understanding current investment choices
- the case for different funding arrangements for different employers (in particular, stressed sponsors)
- enhancing member protection through additional powers for the Pensions Regulator (TPR) and/or trustees
- consolidation of smaller schemes
Perhaps the two more eye-catching suggestions relate to scheme indexation and scheme consolidation.
Pension increases – a stressful experience?
The Government has poured cold water on the prospect of pension increases being reduced or removed as a rule. However, they have noted a case for the reduction or suspension of increases where an employer is ‘stressed’ and a scheme underfunded – though noting the obvious ‘moral hazards’ to be negotiated. The consultation also asks for feedback regarding a statutory override to allow a move to a different index (e.g. from RPI to CPI) – a similar proposal was rejected in 2010, despite support from many schemes whose rule drafters had never envisaged the difficult position trustees might now find themselves in.
Consolidation - all for one and one for all?
The consolidation of smaller DB schemes is an option worth exploring, according to the Government. Noting that only 4% of schemes have over 10,000 members, they present arguments for and against this proposal – their view is that there is a strong case for supporting voluntary rather than compulsory consolidation. However, the Government notes the complexities involved here including set-up costs, lack of flexibility, cross-subsidy across unrelated employers, differing benefit structures and eligibility for the Pension Protection Fund (PPF).
Affordability for employers
The greatest risk to members is the collapse of a sponsoring employer, Government acknowledges.
However, the Green Paper proposes that there is no general affordability problem for DB employers. Relying on research from TPR and a number of other sources including Barnett Waddingham, they have assessed several metrics for the ‘affordability’ of deficit reduction contributions. Their view is that there is no general case for relaxing funding requirements or benefit levels and thereby transferring risk to members.
The real impact of pension schemes on UK business
Referencing our annual report, this blog highlights FTSE350 companies’ DB pension commitment, and puts some context around deficits.Read more
The Government’s assessment is that just 5% of DB members are in schemes where the prospect of additional support appears uncertain at this time – their expectation is that, in line with modelling from the PPF, the vast majority of schemes will reach a comfortable funding position assuming employers maintain current levels of deficit contributions.
I would agree that the current level of contributions required to fund DB schemes can in theory be paid by most employers without risking insolvency. However, for a significant number it is having a big impact on their future investment plans and the amount employers are doing to support current employees in saving for their retirement. Tackling this issue is extremely difficult and politically sensitive.
From the Government’s position, we can understand why radical changes appear to be off the agenda for all but the most exceptional cases.
A further blog will consider the issues up for discussion with regard to corporate activity.