Security and sustainability in Defined Benefit Pension Schemes
On 20 February 2017, the Department for Work and Pensions (DWP) published a Green Paper exploring the key challenges facing many private sector Defined Benefit (DB) schemes. It also sets out a number of proposed solutions to address these challenges in order to improve the ‘security and sustainability’ of the industry.
Recent high profile cases have focussed the mind of the Government on the ‘fundamental problems’ within the industry. In particular, the increased burden on sponsors arising from record low gilt yields and volatile investment returns has led to this wide-ranging review of the current framework.
The Paper is intended to encourage debate and seeks input in a number of areas that have been identified as problematic to restore confidence in both the system and the regulatory bodies who are expected to ensure the best outcome for all stakeholders.
The Paper focusses the discussion on four key areas:
– Funding and Investment: The DWP recognises that the current valuation measures are not only designed to manage risk to members, but also to spread the risk amongst both members and employers. They are happy that the current funding regime largely supports this, however they acknowledge the difficulties in striking this balance. Some of the changes considered to the current funding requirements are:
• Mandate or encourage schemes to publish a range of valuation measures. E.g. ‘smoothed’ assets & liabilities
• Better Government and industry communications about the meaning and context of valuations
• Allow the Regulator to request more regular valuations for high risk schemes, and a longer valuation cycle for lower risk schemes
• Reduce the timescale for valuations from 15 months to 9 months
• Introduce risk based reporting and monitoring requirements for schemes
• Mandate the use of professional trustees
Input is also sought on why investment strategies, in some cases, are ‘overly-cautious’ and shift the balance of funding from investment returns towards higher employer contributions. They query what encouragement can be given to facilitate the wider use of alternative asset classes and more optimal investment decisions.
– Employer contributions and affordability: The DWP is satisfied that there is no cause for concern with regards to the affordability of pension contributions for the majority of employers. However, for the minority of ‘stressed’ schemes, where contributions are deemed to be unsustainable, some of the considerations that the DWP suggests are to:
• make more use of existing flexibilities i.e. longer recovery plans
• introduce ‘new’ flexibilities i.e. deferred or ‘back-end’ loaded recovery plans
• reduce the value of accrued pensions by changing indexation (from RPI to CPI) or suspending indexation altogether where the scheme is distressed
• allow a ‘renegotiation’ of pension benefits in certain circumstances
• allow transfers to new schemes with lower benefits
The DWP understands the potential moral hazard issues, in particular to any changes in accrued benefits, and therefore has requested as much feedback on this topic as possible.
On the other hand, it also notes that some employers are not drawing on their ‘significant resources’ to plug the funding gap and therefore seeks views on how this could be encouraged.
– Member protection: The paper outlines that they believe overall regulatory protections are ‘working broadly as intended’ however there is a case to extend the power wielded by the Pensions Regulator in particular with regard to scheme funding powers as well as imposing a formal duty to cooperate and engage with the Regulator. The paper also queries whether certain corporate transactions should require regulatory clearance and whether trustees of ‘severely underfunded’ schemes should be consulted before dividends are paid.
– Consolidation of schemes: A large proportion of DB schemes are small, with high administrative costs proportional to their size. The paper considers the challenges and practicalities of aggregating multiple small schemes, on a voluntary and compulsory basis, to reduce administrative costs, create investment opportunities and improve governance. One of the considerations is the increasing scope to reshape benefits in order to better facilitate the consolidation process. Whilst the possibility of ‘Superfund’ consolidation vehicles has been considered, the suggestion for Government involvement is rescinded as it could be supposed unsuitable, though Government provision for the innovation of consolidation vehicles is regarded further.
Note the challenges concerning employer debts in non-associated multi-employer schemes will be looked at in a separate consultation.
The Ministerial Foreword in the Paper states:
“Through this Green Paper, we want to hear from as many people as possible. In order to ensure a balance between member protection, sustainability and affordability of these important pensions we want to continue the debate and to start building a consensus on what, if anything, we should do to further support the sector.”
The Green Paper is a wide ranging review of the regulatory framework of the industry and its objective is to ensure that no stakeholder loses out. It is an important debate with input requested from all areas of the industry. The consultation closes on 14 May 2017.
The paper can be found here.