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IPE special report May 2018

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UK government sets out scope for DB reform

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The UK government has launched a wide-ranging “green paper” exploring ways of strengthening the country’s defined benefit (DB) pension system and easing the burden on “stressed” scheme sponsors.

The paper was designed to “begin a conversation” regarding new powers for the Pensions Regulator (TPR), flexibilities for sponsors tackling deficits, and potential consolidation.

A key idea in the paper is a change to indexation rules which would allow underfunded schemes to stop linking benefits to inflation.

“There could be a case to suspend indexation in cases where the employer is stressed and the scheme is underfunded,” the paper said. It also raised the possibility of allowing all schemes to use the consumer prices index (CPI) as the basis for inflation indexation rather than the alternative Retail Prices Index.

The paper and consultation come after the government became involved in several high-profile cases last year. It issued a report on the British Steel Pension Scheme early in the year as its sponsor, Tata Steel, was seeking to exit the business.

In addition, the Work and Pensions Committee of the House of Commons (the lower house of Parliament) launched an inquiry into British Home Stores’ pension fund, which was left with a substantial deficit when the company collapsed.

In the 103-page paper launching the consultation, the government dismissed concerns that there is an affordability crisis in the UK’s DB system, arguing that “most sponsors” can comfortably afford contributions.

“The government is not persuaded that there is a case for across the board changes that would reduce members’ benefits in order to relieve the pressure on employers,” the paper said.

“The government believes that DB pensions are hard promises – they are debts like any others, and debts should be honoured where sponsoring employers are able to do so. Measures to reduce pensions would be highly controversial, and would have significant legal implications, given that a pension is regarded as deferred pay, and is the property of the member.”

Instead, the government is seeking feedback on valuation metrics, access to alternative asset classes, barriers to consolidation of small schemes, and how TPR can facilitate these aspects.

The deadline for responses is 14 May. The full paper is available here.

Minister for pensions Richard Harrington, who led the report, said: “People need to have confidence in their pension and it is vital that they feel that they are secure. With recent high profile cases highlighting the risks inherent in defined benefit pensions, we want to ensure that these important pension schemes remain sustainable for the future and that the right protections are in place for members.

“Over the coming months we’ll be working closely with the pensions industry, employers and scheme members to see what more can be done to increase confidence in defined benefit pensions.”

Industry reacts 

Raj Mody, global head of pensions at PwC

“For many schemes, pension increases far outstrip modern inflation measures, due in part to the lottery of how they were set up and layer upon layer of subsequent legislation. Allowing these to be eased in cases of distress is sensible.

“Other suggestions in the Green Paper, such as improving the efficiency of regular funding valuations, are also timely, particularly as the ability to use technology to manage pensions risk has evolved significantly since current legislation was written.” 

Graham Vidler, director of external affairs at the Pensions and Lifetime Savings Association

“The green paper asks the questions necessary to move forward the increasingly pressing debate about the future of defined benefit pensions in the UK. The interim report published by our DB Taskforce last year identified how the challenges facing DB are posing a material risk to members’ benefits, to employers and the wider economy.

“We firmly support the government’s desire to explore consolidation as a way to secure the defined benefit pensions of millions of savers. The DB Taskforce’s next report, to be published in March, will look at consolidation in more detail.”

Hugh Nolan, president of the Society of Pension Professionals 

“Pensions are a long-term investment and we strongly agree that policy should be made calmly and carefully rather than as a knee-jerk reaction to individual problem cases, which are not always a fair reflection of the broader landscape. 

“We are concerned that some employers are really struggling to fund sizeable deficits. The fact that only 13% of DB schemes were still open to new members in 2016, suggests that there is a genuine problem with ‘affordability’, even if most schemes and employers are currently surviving. It is important to maintain regulatory flexibility to support stressed schemes and buy employers the time they need to fund these deficits.”

Jon Hatchett, head of corporate consulting at Hymans Robertson

“While it’s important to debate how much cash should flow into schemes in current market conditions, throwing more cash at deficits could make schemes less affordable and redirect funds from valuable business investment. A strong business means a strong covenant. And, as a strategy, simply pouring more money into schemes hasn’t worked for the last 15 years so it is not obvious it will work over the next 15.”

Frances O’Grady, general secretary of the Trades Union Congress

“It’s encouraging that the green paper concludes that defined benefit pension schemes are affordable. We now need to make sure that reforms deliver greater security in retirement for working people, and not just higher returns for shareholders.”

Neil Carberry, director of people and skills at the Confederation of British Industry

“The green paper is a sensible start to what is a complex conversation about how we both boost growth and honour pensions promises. What we need to avoid are any measures that risk damaging the health of the sponsoring employer, and therefore the security of the scheme, like mandatory clearance on certain corporate transactions. Actions like moving to the official measure of inflation for indexation and encouraging different ways to accurately and appropriately measure the funding position of schemes, could provide real support to businesses.”

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