PMI - The Government's Green Paper: What's in it for DB?

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  • 14 mins 56 secs
Claire Carey, Partner, Sacker & Partners LLP, discusses increasing pension schemes and its issues, superfunds, the pension protection fund and what trustees who have a CB scheme could do now.


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PRESENTER: On the 20th of February 2017 the Government published a Green Paper looking at the sustainability and security of DB private sector pensions, and setting out evidence about the challenges that they face. To talk about that we’re joined by Claire Carey, who’s a partner at Sacker and Partners LLP. Claire, leading up to the publication of this Green Paper there have been a number of reports haven’t there?

CLAIRE CAREY: Yes, I mean taking a step back it’s worth bearing in mind why we are where we are, which is I think DB schemes have been under increasing pressure over the last decade, there are a number of factors influencing this, which includes the economic background, such as a prolonged period of low interest rates coupled with market volatility. But also some scheme specific issues legislation which is quite complex, which has then led to certain benefits perhaps being entrenched within scheme rules unwittingly, and also core benefits being payable for longer, which obviously has an expense issue for both the employer and the trustees.

The reports that we’ve had in 2016, there was quite a rash of them, and perhaps not surprising it all came to a bit of a head. We had BHS going on last year, which was obviously quite a high profile case of a struggling scheme, and a Work and Pensions Select Committee set up to look at that. We also had the Government issue a consultation on British Steel Pension Scheme; another scheme which had quite a large deficit, many members, making it quite unwieldy to ask members to consent to changes to their pension benefits, and also an employer that couldn’t really sell the company unless it was perhaps separated from the pension scheme. So the Government issued a consultation really just focusing on that pension scheme offering up some suggestions for possibly allowing that scheme to be separated from the employer.

So the options there included for example allowing the scheme to be unilaterally amended by the trustees to reduce the amount of pension increases, both in relation to increases on pensions in payment, but also where you have a deferred benefit, that inflationary increase that somebody’s entitled to.

PRESENTER: So really what are the key themes that are addressed in this Green Paper?

CLAIRE CAREY: Well, there’s a lot of issues around funding and investment. So for example the Government really tries to do a little bit of myth busting as to this general perception that employers cannot afford to pay for DB schemes, that DB schemes are struggling and they have substantial deficits across the board, and that members benefits are at risk. And what it says is that yes there are some stressed employers who can’t perhaps afford to pay for their DB schemes, but that’s not an across the board message. That’s not a one size fits all issue for the industry. And there are lots of employers it says that can afford to pay their contributions, and even afford to pay off their deficits. And it gives a few examples, for example some employers can even afford to pay five times more out on dividends than they’re actually paying into their pension schemes. But of course there’s a balance there, because employers need to be able to invest in their business, they need to encourage investment in order to grow and obviously be economically viable.

So what the Government suggests is that it’s really going to focus on some stressed employers, and suggest perhaps allowing them to cut or renegotiate the level of their benefits, or perhaps allowing them to be separated more easily from their pension scheme to make them more of a viable business, and perhaps giving the regulator the power to do this. But it recognises that this is quite a highly contentious and radical suggestion, so I don’t think it’s going to go into it quickly. I think it’s going to weigh up all the pros and cons. It also looks at any number of other suggestions, such as pension increase levels, perhaps giving the regulator more powers, and perhaps also looking at the issue of consolidation, consolidating small schemes. But I think we’re going to touch upon those in a minute anyway.

PRESENTER: Sure, so this increase in pension schemes, why is it such, because there’s been a lot of talk around the increases in pension schemes, why does it appear to be such a problem?

CLAIRE CAREY: Well pension increases on pensions and payment were only introduced on 6th of April 1997, and they were really just introduced to make sure that once they came into payment pensions were kept up to date with inflationary increases so that they wouldn’t fall behind. And of course pensions are being payable for longer because people are living for longer. But across the years the Government’s obviously made some changes. Originally the level that they had to be increased at was around 5% or RPI, and that was built into the legislation. That was a minimum requirement.

The Government since then reduced that level to 2½% or RPI, and then more recently in 2011 it’s been changed from not RPI as the Retail Prices Index, is the index, but the Consumer Prices Index, which obviously is a different basket of goods. And for many schemes the way that their rules have been built up and amended, the requirement to provide PRI increases has been entrenched into those schemes, so there’s a bit of a scheme rule lottery. And the argument goes that CPI is a lower inflationary measure, so it generally produces a lower figure. It may not always but generally produces a lower figure than RPI. And so for many schemes it would save them a lot of money if they were allowed to switch to using CPI rather than RPI. But as I say they’re having difficulties addressing that because of that provision being entrenched in their own scheme rules.

So the Government has been looking at this. It’s looking as I say at stressed employers, and thinking about well can we do anything for them around the whole increases issue? And one of the things it suggests is perhaps allowing conditional indexation for those employers. So perhaps allowing them to reduce increases when the going gets tough, but reinstate them when the good times return. I mentioned the Work and Pensions Select Committee earlier. It issued a report back in December 2016, which looked at a similar possibility for increases to allow this sort of conditional effect. The other thing that the Government is also looking at is whether there is a case for a wider power to allow schemes to adjust from RPI to CPI as the inflationary measure. But as I say it’s still an open-ended question as to whether that will be somewhere the Government goes.

PRESENTER: What about the Pensions Regulator, can we expect more powers for the regulator?

CLAIRE CAREY: The Government’s definitely looking at whether the regulator needs more powers. It’s looking for example to, looking at whether it needs to introduce legislation to allow the regulator to set binding standards of behaviour, for example, or whether it should just be encouraged to produce more codes of practice that sets out its expectations of what it feels trustees and employers should be doing. And a good example of that is the DC code from July 2016, which did set out clear expectations that the regulator wanted trustees to do. The other possibility it’s looking at is making clearance mandatory in certain circumstances. It doesn’t really elaborate on what those circumstances might be, but again the Work and Pensions Select Committee’s report back in December recommended perhaps where there’s a material detriment to the pension scheme. And this could be for example where the size of the employer is just vastly outweighed by the size of the deficit in the pension scheme. It’s also looking at making member communications clearer, so that members actually understand the risks inherent within a defined benefit scheme.

PRESENTER: Tell me about superfunds, the idea of consolidating schemes, which I believe is mentioned in the Green Paper, also in the DB task force’s recent report.

CLAIRE CAREY: Yes, so the PLSA’s DB task force, which was another big report from last year, and they issued a final report in March which really focused on the case for consolidation as a way of addressing struggling DB schemes. The Government picks up this theme and suggests that rather than creating a superfund it would perhaps encourage voluntary consolidation, and look to the industry to innovate here. And this has many advantages of course. It has the advantage of bringing governance under one roof. It has potential investment and funding savings in terms of cost generally in economies of scale.

There would also of course be a number of hurdles to overcome. For example what would you do about benefit design? Would you have different benefits design within this aggregated fund, superfund, whatever it might ultimately be called? Or would you require a standardisation of benefits? There are also going to be data issues, because obviously when you are trying to do anything with scheme benefits, move them from A to B, buy out policy, whatever, you need to get your data in order and make sure that it’s nice and accurate and reflects actually everyone’s benefits. So there’d be also issues around that – so quite a lot for the Government still to think about on this issue.

PRESENTER: And also might it stop schemes going into the pension protection fund? If such a compromise existed, there might be less of an opportunity for them to fall back on the pension protection fund?

CLAIRE CAREY: That’s definitely a possibility, but I think also the Green Paper recognises that when you look at scheme funding, it’s very much, it’s not a perfect world, that when you fund you don’t fund to buy out levels, there is always going to be an element of risk. And one of the things actually the Government’s also looking at is what drivers are lying behind trustees’ investment strategies and their choice of investments for example, because one of the suggestions that it comes up with from feedback from the industry is that there’s a tendency towards conservativism when investing. And of course the pension protection fund is there to underpin all of this, so it’s meant to be a fall-back position. So it could stop more employers going into the pension protection fund, absolutely, but it depends on how easy it would be for schemes, particularly small schemes to consolidate.

PRESENTER: When might we hear more from the Government on this issue, and what should trustees who maybe have a DB scheme that is running into difficulties now be doing?

CLAIRE CAREY: Well the consultation doesn’t close until the 14h of May, and I think we probably won’t expect to hear more from the Government until the autumn, and certainly hopefully by the end of the year that’s the existing timeframe. What employers could do now, there are things that they can do now. Legislation is a little bit tricky. As I mentioned there’s the whole pension increases issue. But also there’s legislation that perhaps makes it more difficult to do a bulk transfer from one scheme to another without member consent if you’re not matching absolutely the benefits payable in both arrangements. But nonetheless we did get involved in a case last year: an adviser scheme managing a process where it asked members for consent to transfer from their existing scheme to a scheme that was offering lower increases. And over 90% of the membership actually consented to that.

So there are things that obviously schemes with their legal advisers and other advisers can do now, but obviously it’s not necessarily straightforward because there are legal hurdles. That said if the Government does go down the route of encouraging consolidation of schemes that won’t be something that happens overnight. I think it will take time to come through. So for some schemes doing something now might be actually quite vital.

PRESENTER: Claire, thank you for looking at all this for us, and I hope that you’ll come back and give us an update when more becomes clear.

CLAIRE CAREY: Absolutely, thank you.

PRESENTER: Claire Carey from Sacker’s, thank you very much indeed.

CLAIRE CAREY: Thank you.