Stressed schemes and employers should be allowed to reduce pension increases and gain easier access to PPF-plus benefit-restructuring methods in order to minimise “PPF drift”, a new academic paper has said.
The Greatest Good 2, launched on Wednesday and released by Cass Business School and the Pensions Institute, also recommended minimum contribution rates and a suite of new powers for the regulator, all aimed at enabling “second-best” outcomes for members.
A response to the previous government’s green paper on defined benefit, it agreed that most schemes are not systematically unaffordable, but argued that steps need to be taken to avoid what is termed "PPF drift".
The longer that stressed schemes run, the more members reach retirement age, meaning more pension increases receive protection under PPF compensation rules.
A politician’s got to stand up and find the time in amongst all of Brexit to get an outcome that is acknowledged as being not as good
Kevin Wesbroom, Aon Hewitt
The cost of securing PPF-level benefits therefore increases as the scheme matures, which can disproportionately impact the benefits paid to younger members when insolvency does occur.
“Billions of pounds of pension wealth is being destroyed by letting stressed schemes go bust,” said David Blake, professor of pension economics at Cass Business School, and co-author of the paper alongside Pensions Institute fellow Matthew Roy.
Blake said the paper’s recommendations were designed to avoid binary outcomes from schemes, which are currently destined either to pay out all benefits or fall into the PPF.
“We’d all like the first best outcome, but the first best outcome isn’t realisable in many cases,” he said.
Is second-best the best?
Second-best outcomes would be facilitated by allowing trustees to access a streamlined regulated apportionment arrangement process, with a relaxed insolvency test.
“I think you need to say it’s beyond reasonable doubt that the members will be better off [with a second-best option],” said Darren Redmayne, chief executive at covenant specialist Lincoln Pensions, which co-sponsored the report.
He added that adviser reports on the financial health of scheme and employer should be open to scrutiny to avoid employer gaming.
The regulator would also have the power to direct trustees to alter benefits where a scheme is under stress, and an early warning system would be developed to identify those in financial difficulty, under the proposals.
Meanwhile, trustees of stressed schemes would have to appoint a professional trustee, and demonstrate to the regulator that their funding strategy minimises PPF drift.
To deliver these changes, the report recommended a shift in pensions policy to focus on the greatest good for the greatest number, with regulatory powers akin to the section 50 options seen in Ireland.
The debate drifts on
However, some industry commentators remained wary of giving employers the ability to shirk their pension promises.
“Having done section 50 twice for two different schemes, it’s chaotic, arbitrary – it’s contributed to the spectacular collapse of DB pensions in Ireland,” said Brian Spence, a professional trustee with Dalriada.
Even if intervention to minimise PPF drift is logically sound, others remained sceptical about the political viability of the plans.
TPR and PPF call for muscular regulation
Last year both the Pensions Regulator and the Pension Protection Fund called for more wide-ranging, interventionist regulation of defined benefit schemes.
Modification of benefits would require the amendment of section 67 of the Pensions Act 1995 by MPs, and extra powers would need increased funding for the regulator.
“A politician’s got to stand up and find the time in amongst all of Brexit... to get an outcome that is acknowledged as being not as good,” remarked Kevin Wesbroom, senior partner at Aon Hewitt.
No return to MFR
To mitigate the growing moral hazard that employers will seek to argue that their DB schemes are unaffordable, the paper suggested introducing a statutory minimum contribution rate, to be applied wherever doing so would not force the sponsor into insolvency.
But Richard Butcher, managing director at professional trustee company PTL, pointed out the similarities between this and previous unpopular policy.
“We’ve sort of been here before: we had the minimum funding requirement and it didn’t work, so we got rid of it,” he said.
Instead of introducing new laws and powers, Mark Smith, partner at law firm Taylor Wessing, argued that the regulator should look to make more use of its existing powers.
“The existing contribution notices and financial support directives are sufficiently broad,” he said.
