What the DB green paper might (not) change

Up to 1,000 private sector DB schemes are “stressed and unlikely to pay member pensions in full”, a 2015 Pensions Institute report said. Moreover, 4,312 schemes are in deficit, according to the Pension Protection Fund’s 7800 Index Update in April.

Specific examples of struggling schemes and sponsors, including the BHS scandal and Tata Steel case, have pushed the issue of defined benefits into the public spotlight.

Any major change would be difficult. We are looking at more tweaks around the edges

Hugh Nolan, Spence & Partners

In February 2017, the Department for Work and Pensions put out a green paper to search for a solution regarding DB security and sustainability.

While the paper covered a wide range of issues from conditional indexation to consolidation, it was criticised for its lack of urgency. The consultation is set to close on Sunday, but what is likely to change, if anything?

In general, the current pensions framework is “quite robust” and has roughly the right balance between employers and scheme members in terms of funding and benefit security, says Hugh Nolan, president of the Society of Pension Professionals and director at consultancy Spence & Partners.

Nolan says this is “lucky, because any major change would be difficult, particularly with Brexit happening”.

He points out that although politicians have been discussing pensions in the run up to the general election on June 8, trying to get time from parliament to discuss any major changes to pensions would be very difficult.

“We are looking at more tweaks around the edges,” he says.

Boosting pensions regulation

Of all the issues covered in the paper, Ros Altmann, former pensions minister, thinks that the most likely solution to be implemented is further powers for the Pensions Regulator. “I certainly hope that’s the case, because I think they do need some extra powers,” she says.

At the beginning of this month, prime minister Theresa May pledged that, if the conservative party remains in power, “any company pursuing a merger or acquisition valued over a certain amount or with over a certain number of members in the pension scheme would have to notify the Pensions Regulator, who could then apply certain conditions”.

Source: LCP 'Accounting for Pensions 2016'

But John Wilson, head of technical at consultancy JLT Employee Benefits, says that given that announcement, “it does seem that, rather disappointingly, the most likely outcome is just beefing up of the Pensions Regulator and possibly trustee powers, with a view to ensuring that a future BHS-type situation does not arise”.

He explains that, “if that is the only fallout from this consultation, then it’s not going to do anything to address essentially the issue that was the catalyst for having the consultation in the first place, and that was the growing black hole in DB pension schemes”.

Taking a holistic view

A JLT report published earlier this year says the total shortfall between the assets and the liabilities of the 6,000 or so DB schemes in the UK has ballooned over the past 10 years to around £800bn, on a buyout basis, from around £425bn.

Wilson argues that the fundamental problem with the green paper is that “it starts very overtly with the premise that there is no systemic crisis in UK defined benefit pension provision”.

However, “in making that statement, the government is looking at DB pension schemes very myopically, almost as though they operate in a vacuum”, says Wilson.

Instead, he says they should be looking at the issue holistically in terms of all the knock-on effects that the funding of DB schemes has. He pointed to how many companies are unable to conduct transactions or raise capital because of corporate DB schemes, and how employees with defined contribution pensions may find themselves “having to pay for legacy DB promises in the form of lower wages”. 

The consultation questioned whether the government should consider a statutory override to allow schemes to move to a different inflation index, as long as protection against price increases is maintained.

“There really is a strong argument for the override” to move from the retail price index to the consumer price index, Wilson says. He highlights a JLT survey conducted earlier this year, showing that 74 per cent of about 120 respondents, comprising employers and trustees, thought that it would be proper for the government to introduce an override.

Francis Fernandes, senior adviser at covenant specialist Lincoln Pensions, agrees that this could help some schemes, but notes that for many, making that kind of change would only make a small difference in the context of their overall funding deficits.

“It may be a help, but it’s not going to be the magic bullet that sorts it out,” he argues. And for some schemes, “if their covenant is not strong enough, they may need to…make more material changes to their benefits in order to effectively correctly size their scheme to the strength of their employer”, says Fernandes.

The thorny issue of benefit changes 

For some schemes and sponsors, it is too late for preventative measures. David Everett, partner at consultancy LCP, would like to see some assistance for stressed sponsors that enables schemes to compromise promised benefits to a degree, subject to safeguards.

“There are a number of schemes whose employers are never going to be in a position to pay the benefits that have been promised in full,” Everett says.

“But it doesn’t mean that the only alternative is for the employer to fail, for people to lose their jobs, and for the scheme to go into the [Pension Protection Fund], with considerably lower benefits and a strain on other DB schemes,” he argues.

The green paper discusses regulated apportionment arrangements, which enable a company to offload its scheme into the PPF with the regulator's approval. Everett says that the problem is that this mechanism was never intended for the purpose for which it is currently being used.

“You have to demonstrate that insolvency is likely over the next 12 months,” he explains. But it was “designed for an orderly insolvency, not for a benefit compromise”.

Therefore, “there is a need for a new facility that allows a benefit compromise to occur” so that the employer can continue and jobs would be saved, he argues. Although members would receive lower benefits than  they were originally promised, their pensions would be higher than had they been moved to the PPF.

A significant minority of pension professionals seem to agree, with a recent Pensions Management Institute survey finding 30 per cent were in favour of allowing changes to accrued benefits under certain circumstances.

The green paper states that he government “is not convinced that there is a general ‘affordability’ problem” for the majority of employers running a DB fund.

But Fernandes thinks otherwise. “If DB schemes were in such good shape, there wouldn’t be over 200,000 people already in the PPF,” he says.

Similarly, Altmann fears “that there’s a little bit of complacency on the affordability of DB and full buyout”.

She adds that “it’s better to get members close to full benefits than to make employers prisoners of their pension schemes so that they can’t walk away”.

In many cases, “they can’t do anything, they just have to stay until they go bust, in which case members end up in the PPF. And I think we’ll see more and more of those situations in the next five to 10 years”, she says.

Can consolidation help?

The paper also cited scheme consolidation as a way to tackle risks and costs, while highlighting practical issues.

Dan Mikulskis, head of DB pensions at consultancy Redington, also thinks that it is “hard to construct a model that is easy to implement but derives a lot of the benefits of consolidation”.

While small schemes in particular struggle to access economies of scale, “there has been a lot of improvement in terms of the solutions they’re able to access”, he says.

Everetts says that, for the consolidator to be able to deliver benefits of scale, “they need to have a simplified benefit structure to work on”.

Subject to certification, simplifying legacy benefit structures would not only reduce scheme administration costs and facilitate hedging and buyout options, he argues, but would also “be a necessary first step if voluntary consolidation of schemes on any scale is to be successful”.