UK government policy on defined benefit (DB) pension funds is based on the flawed assumption they will be able to pay full benefits and must be changed to avoid a worst-case scenario of up to 1,000 schemes falling into the Pension Protection Fund (PPF), an academic research organisation has argued.

Published yesterday, ‘The Greatest Good for the Greatest Number’ is a discussion paper from Cass Business School’s Pensions Institute aimed at the trustees and sponsors of “stressed” DB schemes.

Professor David Blake, director of the institute and one of the authors, said the paper challenged the “rose-tinted” view private sector employers with DB schemes would survive long enough to pay benefits in full, an assumption on which UK government policy is predicated.

The “crushing reality”, however, is that many schemes are stressed and their trustees face “seemingly impossible conflicts of interests” between diverse stakeholders.

Moreover, this situation is not publicly acknowledged or debated but subject to “collective silence”.

“The overarching finding of the discussion paper, therefore, is that if the government does not accept and act on the reality we identify and describe, the result will be far from optimal and far from even ‘second-best’,” the authors write.

The discussion paper flags the risk of up to 1,000 schemes – representing one-sixth of those in the PPF index and including about 25 of the largest in the country – becoming insolvent.

The figure is a broad estimate and represents a worst-case scenario surpassing the PPF’s own calculations, according to the authors. 

A new approach to managing pensions could avert the institute’s envisaged worst-case scenario, according to the paper.

This approach would involve being prepared for many more schemes to pay less than full benefits on a planned and co-ordinated basis, with all parties in agreement on how best this would be achieved.

“Freeing an employer,” the paper states, “from the burden of its pension fund, whilst avoiding insolvency, can create extra value that can be shared with the members to achieve a better outcome.”

The institute submits seven proposals but does not make firm recommendations as it would normally do in a practitioner report.

This reflects a more cautious approach taken by the institute due to the lack of “essential data for evidence-based recommendations” and a “surprising polarisation” in the expert opinions gathered.

The proposals go to the heart of the legal and regulatory framework governing the relationship between a DB scheme’s sponsoring employer, scheme members and the PPF.

They are wide-ranging, foreseeing changes for the UK pensions regulator, trustees, the PPF and employers.

The proposals include changing the remit of The Pensions Regulator (TPR) for trustees of stressed schemes from protection of member benefits to protection of member interests.

They also call for the introduction of a requirement for TPR to alert trustees and sponsors when it identifies a sponsor’s covenant is “weak”.

Proposals affecting the PPF include the introduction of a pre-assessment period to facilitate early intervention by TPR and changing the PFF’s cliff-edge compensation rules to create greater equity between member cohorts.

Employers, meanwhile, should give an annual statement to trustees about the medium-term outlook for the business, including any plans for corporate actions, which would “align the regulation and governance of sponsoring employers with the concerns of trustees”.

Other proposals are for non-statutory pension increases to be made contingent on a scheme’s funding level, either by giving trustees the ability to apply to TPR for such power or giving TPR the power to direct trustees in this way, and for trustees of stressed schemes to be given guidance on the appointment of specialist advice.