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 several proposed solutions to address these challenges to improve the “security and sustainability” of the industry. The Paper focusses on four key areas:
Funding and Investment
Although the DWP recognises that the current valuation measures are largely adequate, it has proposed some potentially problematic changes. For example, reducing the valuation timescale from 15 to nine months might seem sensible, but is likely to cause difficulties, particularly where there are active members and updated salary information is required from the Company before the valuation process can commence (it can often take nine months to get the data!). More regular valuations for high-risk schemes adds to costs, and it is highly likely that the high-risk schemes are those where affordability is already an issue.
Mandating the use of professional trustees, whilst seemingly sensible, also adds another layer of cost to running schemes, particularly small schemes.
Regarding investment, I find it strange that the DWP questions the “overly-cautious” investment strategies of pension schemes, having sat through several conference calls with the Pensions Regulator (tPR), where trustees have been admonished for having strategies that are too aggressive.
Employer contributions and affordability
Again, some of the suggestions within this area seem to conflict with tPR’s stance. Longer recovery plans and back-end loading have always been frowned upon. Allowing a reduction in benefits under certain circumstances is probably a good thing if it isn’t abused – the difficulty here is trying to decide which circumstances should be accepted and who ultimately makes that decision, the trustees or tPR.
Member protection
The Paper outlines the belief that, overall, regulatory protections are “working broadly as intended”. However, there is a case to extend the power wielded by the Pensions Regulator in particular regarding scheme funding powers as well as imposing a formal duty to cooperate and engage with tPR. 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.
Anything that strengthens member protection should be welcomed, but it must not come at the expense of hindering the sponsoring employer’s development.
Consolidation of schemes
Apparently, the DWP believes a large proportion of small DB schemes have high administrative costs proportional to their size and suggests the aggregation of small schemes to reduce administrative costs, create investment opportunities and improve governance.
Personally, I’m not convinced by these arguments, having seen some DB master trusts levying costs higher than Quantum’s standard charge for small schemes. If the DWP wants to reduce costs, less red tape would be a good start!
We all want a good “balance between member protection, sustainability and affordability of these important pensions” as the Paper puts it, but some of the suggestions are either conflicting or unworkable.
Mark Vincent
mark.vincent@quantumadvisory.co.uk