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Pensions Update

DWP’s Security and Sustainability in private sector Defined Benefit Pension Schemes at February 2017

This provides a unique snapshot into the current position of DB schemes and what the future might hold and the DWP is genuinely interested in hearing from all stakeholders – not just from those who shout the loudest or have the biggest pockets. Its conclusions are at variance in many respects from the conclusions from the House of Commons Select Committee on pensions chaired by Frank Fields which reported only on 21 December 2016 following its inquiry on the collapse of BHS and what it highlighted as regards wider flaws in DB schemes and their regulation.

How important are DB schemes?

Some key facts:

  • They manage around £1.5 trillion assets– around ¾ of the UK’s annual GDP- investment in UK government bonds, corporate bonds and equities.
  • The average pension is £7,000 per annum.
  • There are around 6,000 DB schemes with around 11 million members.

However DWP recognises that it has limited evidence about these schemes, even after an informal consultation with various stakeholders in 2016, and so it is consulting to try to build a consensus for their future. Interestingly what evidence they refer to:

  • does not appear to support the view that these pensions are generally ‘unaffordable’ for employers. While DB pensions are more expensive than they were when they were originally set up, many employers could clear their pension deficit if required.
  • does not show that scheme funding deficits are necessarily driving companies to insolvency, and it seems clear that the majority of employers should be able to continue to fund their schemes and manage the risk their schemes are running.
  • shows however there are some employers who are finding that their pension scheme deficit is having a significant impact and where the level of deficit repair contributions may become unsustainable. The single biggest risk to the members of these schemes is the collapse of the sponsoring employer.
  • on the whole, the regulatory regime is satisfactory and that the funding regime sets a fair balance between the interests of the members and those of the sponsoring employers. However experiences differ from scheme to scheme, that some schemes and employers are struggling, and that some changes may be beneficial but there was no consensus on whether or how to adjust the current balance between protecting members and supporting employers.

The consultation breaks down into four broad areas,: Funding and Investment; Employer Contributions and Affordability; Member Protection; and Consolidation of Schemes.

Funding and Investment

There is a belief that the current valuation and funding arrangements influence schemes to make overly cautious and short term investment decisions but the funding regime is not designed to eliminate all risk to members’ benefits. Rather it seeks to strike a reasonable balance between the demands on the employer and the security of member benefits, recognising that a strong, sustainable sponsoring employer is the best protection for a DB scheme.

  • The DWP think more might be done by both government and those in the pensions industry to help people and commentators better understand scheme valuations and ‘scheme deficits’, to provide a better sense of the risks to members.
  • It is not clear that in general discount rates being used are overly pessimistic, and that there is not strong evidence to demonstrate a systemic issue with the current flexibilities available so this goes against the comments that schemes are not using the available flexibilities when deciding what assumptions to use about future investment growth, and that this is leading to scheme deficits being overstated.
  • Is there scope to encourage or facilitate some schemes to make more optimal investment decisions, and to mitigate any barriers to the greater use of alternative asset classes?
  • No firm decisions can be reached on the quality of scheme trustees’ investment decision making, as there is insufficient evidence so the DWP intends to commission further research to investigate the factors that influence investment strategies and the choice of asset classes.

Select Committee view

A nimbler regulator intervening earlier to nip potential problems in the bud. TPR should never again take two years to intervene in a negotiation concluding with a 23 year deficit recovery plan. The timetable for valuations should be flexible—shorter or longer—to reflect the riskiness of schemes; the statutory timescale for the submission of valuations and recovery plans should be reduced to nine months, though TPR should intervene sooner where it has concerns; and recovery plans of more than ten years should be exceptional.

Our view

Trying to get members and commentators to better understand scheme valuations seems an uphill struggle given the various ways in which schemes can be valued and investment decisions are difficult even for the most professional of trustees.

Employer Contributions and Affordability

  • The DWP are not persuaded there is a general ‘affordability’ problem for the majority of employers so we do not agree that across the board action is needed to transfer more risk to members, or indeed to reduce members’ benefits to relieve financial pressure on employers.
  • But the DWP recognise there are some companies who are paying very substantial deficit repair contributions which may not be sustainable in the long term. The DWP have looked at what might be done for these ‘stressed’ schemes and their sponsoring employers, and the difficulties in doing so. Although the types of options for these schemes include allowing a struggling business to more easily separate from their pension scheme, renegotiating benefits, providing more intensive support from the Pensions Regulator and enhancing the powers of the Regulator so that it could separate the scheme from the employer or wind up the scheme in specific circumstances, all have significant drawbacks. This also led to a 2017/18 consultation started by the PPF in February 2017 (and now ended) on a levy rule for schemes without a substantive sponsor. This resulted in the PPF changing their levy rules to allow for schemes without a specific sponsor.
  • Concerns could be raised regarding ‘moral hazard’ issues, where sponsors might be tempted to look to reduce their liabilities by taking advantage of any relaxations available for ‘stressed’ schemes or employers.

Select committee view

  • Trustees should agree changes to the indexation of pension benefits in instances where such changes are needed to make a scheme sustainable, including conditional arrangements that will revert to original uprating when good times return.
  • Scheme members should be given greater flexibility to take their pensions as lump sums. This could prove to be in the interests of both the individual and the longer-term viability of the pension scheme.
  • Facilitating scheme restructuring in mutual interest -The Regulated Apportionment Arrangement (RAA) is a means of negotiating an outcome for scheme members that is better than the PPF in instances where a sponsoring employer is in mortal danger. When agreed, it can produce results that are better for pensioners, better for employers and better for the PPF than insolvency. It is, however, very rarely used. It is an emergency measure, but it does not operate at an emergency pace. TPR should take a more active approach to its involvement in their negotiation. The Government should consult on streamlining the RAA process and amending the barrier of imminent and inevitable insolvency.

Our view

Employers have been hit hard by ever increasing employer contributions costs and this should be recognised by Government. The Pensions Regulator has itself previously acknowledged affordability issues for certain employers who have struggled to fund their schemes as shown by numerous funding agreements. Also our experience is that flexible benefit options in DC pension arrangements have led to an increase of transfers member benefits out of DB schemes to DC schemes and member concerns about the possible funding issues that their DB schemes may face in the future have also fuelled such requests.

Member Protection - at the heart of the DWP’s policy

The Regulator is there to protect members but should its powers be extended? The DWP has have looked at changes to the Regulator’s scheme funding, corporate restructuring and information gathering powers. But any changes would need to be proportionate, and take into account the impact on the Regulator’s resources and the levy on pension schemes which funds its activities.

  • Should the Regulator should take a more proactive role in scheme funding and be more explicit about the level of risk it is appropriate for a scheme to take?
  • On the issue of corporate restructuring, would the Regulator be more effective if it had powers to act proactively in order to prevent certain corporate activities? The DWP view is that a blanket requirement on parties to obtain clearance from the Regulator ahead of any planned corporate actions would be disproportionate. There is, however, considered a case for the Regulator to have a clearance regime in certain specified circumstances, although there are very significant difficulties that would need to be overcome before such an approach could be considered 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.
  • On information gathering powers, should a new duty be created, applicable to all parties responsible for a scheme, to co-operate with the Regulator, giving the Regulator a power to interview relevant parties supported by a sanction for non-compliance.

Select Committee view

  • Mandatory clearance in certain circumstances - The voluntary practice of seeking TPR clearance for major corporate transactions has fallen out of fashion: there were just 9 cases in 2015–16 compared with 263 in 2005–06. There is a strong case for clearance to be mandatory in certain circumstances when there is the greatest risk of material detriment to pension schemes. We recommend the Government consult on rules regarding the size of the pension deficit relative to the value of the company and the viability of the ongoing plan for supporting the pension scheme as the basis for a mandatory clearance when corporate changes could damage a pension scheme.
  • A nuclear deterrent to avoidance - The existing anti-avoidance powers of TPR are retrospective and often exercised through drawn-out legal battles. An employer seeking to avoid responsibilities may well take a punt on risking enforcement action, leaving pensioners in extended limbo. We wish to deter such behaviour and encourage sponsors to properly fund schemes and seek clearance for corporate transactions which may be to their detriment. We recommend the Government consult on proposals to empower TPR to impose punitive fines that could treble the amount payable. The intention would be that such fines would not need to be imposed: they would act as a nuclear deterrent to avoidance.
  • Empowered trustees and scheme members -we want to arm trustees with the powers necessary to represent the interests of scheme members. It is unacceptable that scheme sponsors can keep them in the dark: trustees should be able to demand timely information.
  • A PPF levy that fairly reflects risk - to incentivise key aspects of good scheme governance; and ensure particular types of employer, including SMEs and mutual societies, are not unfairly disadvantaged.

Our view

The Regulator should be more pro-active in scheme funding and setting expectations. Many corporate restructurings falls through the net of the current legislation for a variety of reasons. This is not always a bad thing but sometimes it is. More certainty on clearance would be helpful and getting the Regulator to start using its information gathering powers seems more appropriate than giving it new and further information gathering powers. In our experience, corporate transactions need to consider the potential of clearance applications at a much earlier stage as time restraints can prevent applications being submitted.

Scheme consolidation

Most DB schemes are small, and small schemes have higher administrative costs, are unable to benefit from the economies of scale available to larger schemes, and tend to have less effective governance. The DWP has looked at the arguments for and against the aggregation of smaller schemes into one or more consolidation vehicles to reduce costs, improve investment options and governance.

  • A number of consolidation models and their pros and cons have been considered, together with the question of whether a move to greater consolidation should be a voluntary or compulsory act and, if a compulsory approach were taken, how this might work.
  • The DWP view is that there appears to be a strong case supporting greater voluntary consolidation but no case for compulsion.
  • The DWP has looked to the government to design and run them superfunds through an arms’ length body but have concluded it would not be appropriate. However is it appropriate for the government to provide some structures or incentives to encourage the pensions industry to innovate and to provide new consolidation vehicles?

Select Committee view

The Government to consult on proposals to enable trustees, subject to TPR approval, to consolidate small schemes in an aggregator fund to be managed by the PPF, creating economies of scale for both schemes and TPR.

Our view

Although some new consolidated products have emerged in the market), in a number of circumstances scheme consolidation has not worked well historically for non -associated employers. Additionally many of the most significant legal issues arise from the application of current pension legislation to non associated schemes which does not work well for consolidated type schemes. The main concerns from employers have been potential inadvertent responsibility for funding other employers’ pension liabilities and lack of control and management. We do however think the DWP should make it easier for employers in the same group to be able to merge their schemes as currently this is often a costly and time consuming process.

Call to action - the consultation runs until 14 May 2017

The Green Paper seeks the views of as wide a range of people and organisations with an interest in private sector DB pension schemes as possible - including members, scheme trustees, sponsoring employers and scheme professionals to foster an informed debate and to see if there is any consensus on what, if any, changes to the legislation or regulation may be needed so please do consider if you want to get involved.

Responses to this consultation are via www.gov.uk/government/publications, email us at defined.benefit@dwp.gsi.gov.uk or write to us at DB consultation, Private Pensions, 1st Floor, Caxton House, 6–12 Tothill Street, London, SW1H 9NA.

Pensions Law Update - April 2017

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