Lords commit TPR to preserving open DB schemes

Liberal Democrat peer Sharon Bowles, backed by a coalition of high-profile members including Ros Altmann and Jeannie Drake, moved a change to the government’s pensions policy late on Tuesday.

The amendment requires the secretary of state for work and pensions to treat DB schemes “that are expected to remain open to new members, either indefinitely or for a significant period of time” differently to any other schemes. In practice, the change could capture schemes for former public sector workers, such as the Railways Pension Scheme, or even the under-pressure giant Universities Superannuation Scheme. 

This amendment will help the small number of large, open DB schemes and help keep their contribution rates down. We suspect it is not enough to lead to many employers wanting to reopen DB schemes though

Alistair Russell-Smith, Hymans Robertson

Specifying how this treatment should differ, Lady Bowles stipulated that the government and its regulators should make sure that expectations on liquidity and investment risk must be proportionate to the maturity of the scheme in question, while “affordability of contributions” for both employers and members must be maintained.

The closure of these schemes must not be accelerated, and trustees should retain the discretion to act in members’ best interests.

“The liquidity profile of an open and active scheme that is receiving regular, significant cash contributions is very different from a closed scheme. This amendment seeks to ensure that they are treated differently accordingly," Lady Bowles wrote in her explanation to the amendment.

Rerisking of open schemes

The amendment is designed to preserve the ability of open DB schemes to pursue higher-risk, more volatile investments than the fixed income-heavy portfolios employed by closed plans, typically involving an increased allocation to the equity risk premium. By pursuing a higher long-term return, a greater discount rate can be applied to the cost of funding future accrual, preserving affordability for employers.

In theory, the strong cash flows and long time horizons enjoyed by open DB schemes mean that shortfalls caused by cyclical market downturns can be weathered.

The bill change is a direct response to the policies pursued by the Pensions Regulator. While its latest thinking on DB funding links its expectations to schemes’ proximity to “significant maturity”, the watchdog places a strong emphasis on covenant – the ability of employers to make good investment losses – and has been seen in some quarters to have increased the pressure on DB sponsors to derisk.

Lady Bowles said that “thriving open DB schemes... are under threat because TPR does not recognise the substantial difference between open and closed schemes”.

The amendment won the support of both Labour and Conservative peers, compounding the headache for the government on a night when it lost four key votes. Other opposition amendments put new requirements on pensions dashboards, while trustees of collective defined contribution schemes would have to report on the fairness of the scheme to different member cohorts.

Cross-bench support

Lady Drake, Labour peer and former trade unionist, said the amendment would provide help to schemes such as USS, where they feel they are being forced into premature derisking. 

“Running on with employer support could be an acceptable long-term strategy for a materially open scheme. The amendment is consistent with any reading of the government policy in the white paper, but it seeks to ensure that it happens,” she said.

Meanwhile, Lady Altmann told Pensions Expert that there are more than 1,000 open schemes in the UK, and used the example of the Bank of England’s scheme, which invests heavily in gilts and has an accrual cost of up to half of pensionable salary, to illustrate the impact of derisking.

“Especially in the teeth of [quantitative easing], it makes little sense for policy to drive down gilt yields while also driving pension schemes to buy ever higher-priced gilts,” she said.

“A scheme that is closed and looking to wind up may be better advised to steer clear of investment risks, but open schemes need to embrace the potential of higher returns that are associated with taking some risk.”

Steve Webb, former pensions minister and LCP partner, said that increasing risk in the system might be an acceptable cost of providing members with high-quality benefits.

“The draft funding code focused very heavily on the funding of closed schemes and gave little attention to the very different needs of open schemes,” he said.

“Where a scheme is still open to new members, it has a funding horizon running over decades. Forcing such schemes to derisk prematurely will greatly increase the cost of running such a scheme, and could easily lead even more open schemes to close. It is hard to see that this is a good outcome for members.”

Alistair Russell-Smith, head of corporate DB at Hymans Robertson, said: “This amendment will help the small number of large, open DB schemes and help keep their contribution rates down. We suspect it is not enough to lead to many employers wanting to reopen DB schemes though.

“It will likely ensure that schemes that are open remain open, because closing even to new hires will put them on a decreasing time horizon and a forced derisking.”