The Impact Assessment published by the UK’s Department for Work and Pensions (DWP) revealed that the government’s plan to allow surplus extraction from defined benefit (DB) pension funds puts schemes at risk of underfunding and increases the chances of members not getting their full pensions.
The Assessment, published alongside the Pension Schemes Bill last week, reveals that surplus extraction creates risks to the retirement incomes of people who are members of DB pension schemes.
This was highlighted by the Pension Security Alliance (PSA), which is campaigning for pension scheme members to be consulted on changes that affect their pensions.
The Impact Assessment warned that surplus cash in pension funds helps protect members from economic shocks, and removing it puts their pensions at risk if schemes don’t have enough money to pay their pensions.
It noted: “If schemes choose to modify their rules to enable surplus extraction, this adds an indirect cost to members in terms of the increased likelihood of members not receiving their pension benefits in full.
“A scheme surplus can act as a financial cushion for members to absorb unexpected costs or investment losses for the scheme. Without this cushion, the scheme may be more likely to struggle to meet its obligations to members, especially in times of financial stress or economic shocks.”
The Assessment also highlighted that companies could use the extraction rules to improve their own finances at the expense of former employers’ retirement incomes.
“Accessing a surplus may improve the employer’s financial position, but may risk the pension scheme becoming underfunded. If sponsoring employers of underfunded schemes were to also become insolvent, these schemes may then transfer into the Pension Protection Fund (PPF), increasing its liabilities and may mean members potentially losing out,” it said.
If pension funds end up in the PPF, the members of these schemes can see their pensions cut by more than 10% over time, PSA warned.
However, despite the repeated warnings that removing surplus money from pension funds can increase the risk of harm to scheme members, ministers want to encourage employers to do so.
DWP said pension funds have around £160bn more than they need to pay out pensions to members, arguing that the surplus should be used by employers for their own purposes.
“Pension scheme members have worked to earn their pensions, and the money in pensions schemes is there to provide them with a secure income in retirement.
Pension Security Alliance
The PSA’s members include the Pension Insurance Corporation (PIC), Just Group, consultant John Ralfe, as well as an independent organisation for senior citizens in the UK, Silver Voices, and a charity promoting the rights and needs of older people, The Older People’s Advocacy Alliance.
The PSA said: “The government’s analysis proves that the government’s plans pose a risk to the retirement incomes of millions of members of defined benefit pension schemes. It’s shocking to learn that civil servants have told ministers that if these plans go ahead, some pension schemes could struggle to meet their obligations to pay pensions.
“Pension scheme members have worked to earn their pensions, and the money in pensions schemes is there to provide them with a secure income in retirement. This official assessment, prepared by independent civil servants, shows that the government’s plans put those retirement incomes at risk.
“Pension schemes are not a piggy-bank that politicians can dip into or a cash-cow for employers. Pension schemes exist to benefit members, and this is official confirmation that the government’s plans could harm members. That can’t be right.”
The PSA is urging pension scheme members to write to their MP and to pension scheme trustees to raise concerns about a policy that puts their retirement income at risk.
It said: “The millions of people who are members and beneficiaries of defined benefit pension schemes are the most important stakeholders in this debate, but the Government has neither informed nor consulted them about a policy that its own officials say is a risk to their retirement incomes.
“It is vital that politicians listen to the millions of people who rely on DB pensions schemes for a secure income in later life. It’s wrong to put pensioners’ incomes at risk like this.”
Too pessimistic
However, according to Jos Vermeulen, head of solution design at Insight Investment, the assessment is “too pessimistic”.
He said: “Every corporation should now be aware of the surplus in their pension scheme that might be available to them, and there is also a real upside here for members, who could negotiate for greater inflation protection or enhanced benefits. Only a few larger schemes opting to release surplus could exceed the assessment’s projections.”
Vermeulen acknowledged that trustees and members would benefit from the reassurance that a universal PPF protection would provide.
He said: “The DWP consultation only put forward a limited, unrealistic model for PPF protection, so we think reconsidering this should be a priority. Such protection could dramatically increase the amount that DB schemes release and also offer reassurance of retirement security.”
Joe Dabrowski, deputy director of policy at the Pensions and Lifetime Savings Association (PLSA),said: “The PLSA supports the measures in the Pension Schemes Bill which enable schemes to permit surplus sharing. It’s important that the decision to allow this remains with the trustees, as set out in the legislation; this is a vital safeguard to ensure members’ benefits continue to be protected.”
He said that with the right safeguards, allowing trustees and employers to use surplus funds productively – such as enhancing member benefits, boosting defined contributions (DC), or investing in growth – could bring real advantages to both savers and pension funds.
“The PLSA supports strong saver protections and looks forward to clear guidance from The Pensions Regulator to make sure any changes strike the right balance between opportunity and security. Managing potential variations in scheme funding is a very familiar concept for trustees, so we don’t foresee any issues with them managing this change in practice,” Dabrowski added.
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