29 March 2017

The government believes there is no "significant structural problem" with the legislative or regulatory framework for DB schemes. On funding it says "there is no single or immediate crisis in DB funding for the system as a whole". Within those boundaries the government seeks views on a wide range of issues.

In this briefing we summarise a selection of them with trustees and employers particularly in mind.

As it discusses possible changes to the legal and regulatory framework, the government often returns to these themes:

  • the business agenda: if advance clearance from the Pensions Regulator (TPR) were to be mandatory for certain types of corporate restructuring "we would have to ensure that it did nothing to damage the competitiveness of UK business, and did not in any way inhibit legitimate business activity",
  • the key role of investment decision making by trustees: "There is a question about whether trustees are always sufficiently skilled to make decisions about the deployment of funds in what is an evermore sophisticated investment market",
  • risk sharing: the DB funding regime "is not designed to eliminate all risk to members' benefits at all times" and
  • proportionality: "increasing the powers of the Regulator is not something that should be undertaken lightly - it is important that any powers are proportionate to the issues at hand, and that clear principles are applied in assessing what those powers should be".

On the whole, as would be expected in a Green Paper, the government does not take a position on the ideas it floats. But there are exceptions: it says it sees a strong case for amalgamating smaller schemes, for example.

All the policy options and possibilities we mention come from the government, albeit that some draw on informal consultations it held with stakeholders last year. Others owe something to recent work on DB schemes by the House of Commons Work and Pensions Committee.

They are all embryonic. Those that are adopted will require detailed definition.

Responding to the paper

Burges Salmon will be responding to the Paper. We will draw on our experience of how the legal and regulatory rules work in practice. We regularly advise trustees and employers in many areas the Paper discusses, like funding, investment, enforcement actions by TPR, regulated apportionment arrangements, scheme mergers and divisions, liability management and corporate restructurings.

As a client we would be delighted to support you in responding to the Paper on any points of particular interest, or to make a response on your behalf. If this is of interest, please get in touch with your usual contact or with Richard Knight.

The government puts policy options under four headings.

Funding and investment

Are trustees sufficiently skilled in investment decision making? Are they overly averse to riskier asset classes, increasing reliance on the sponsor? The Paper outlines a number of options to address these concerns, including:

  • requiring trustees to have specific skills or qualifications
  • confining the trustee role to appropriate professionals
  • giving TPR a more central role influencing or determining the level of investment risk a scheme should be taking.

The government will gather more information to improve its understanding of what drives trustees' approach to investment and the interplay with valuation measures.

The three yearly valuation cycle has been criticised for adding to a short term focus and for being insufficiently flexible. The Paper suggests risk-based reporting and monitoring requirements could be introduced to reduce the burden on low risk schemes and to allow proportionate monitoring for those of higher risk.

A general question the Paper puts on funding is whether full use is being made of the flexibilities currently available?

Members' understanding of funding information (e.g. different valuation bases) and what it means for the security of benefits is often limited. The government thinks that, along with the pensions industry, it could do more to help members recognise the value of a DB pension and appreciate the risk of it not being paid in full.

One possibility would be for schemes to report their funding on a range of different measures, giving a "richer, more rounded view", the better to communicate "risks and expectations to members".

Employer contributions and affordability

The government believes the evidence is that "overall most sponsors can manage their DB schemes including any DRCs [deficit reduction contributions] and some could potentially afford higher levels of contributions".

It does not think the case has been made out for a general resetting of the DB promise in the name of sustainability. Besides "measures to reduce pensions would be highly controversial and would have significant legal implications… If the Government were to consider across the board measures to reduce DB liabilities by reducing benefits, very compelling evidence would be needed."

On the other hand, the government acknowledges sponsors and schemes are in widely differing circumstances and suggests it might make sense to have approaches tailored to different levels of stress. It invites comments on various scenarios.

Sponsor with significant resources and a severely underfunded scheme. Such sponsors could be pressed to repair deficits faster to reduce risk to members. This might be done by limiting extensions to recovery plans or by setting hard limits on their length. Another possibility would be to set interim funding targets for severely underfunded schemes with close monitoring by TPR until they are met.

Stressed sponsor with a stressed scheme. The government acknowledges that making adequate deficit reduction contributions (DRCs) is a challenge to a significant minority of sponsors. It accepts some would face insolvency even if they were not paying significant DRCs. But it believes others might continue in business (perhaps with restructuring) and still provide a good outcome for members if DB provision was less onerous.

The Paper mentions issues for consideration if additional breathing space were to be offered. These include the definition of a "stressed" sponsor or scheme, the specification of the circumstances in which extra flexibility would be available and the moral hazard risk of sponsors and schemes manoeuvring to take advantage.

Measures floated include:

  • widen the circumstances in which there can be an agreed (by TPR and the PPF) exit from a scheme beyond the regulated apportionment (RAA) route that requires evidence the sponsor will go insolvent within a year,
  • cut or renegotiate benefits e.g. a proportionate cut in pension, tiered cuts at different levels of entitlement, reduced indexation and revaluation and wider powers for TPR to separate a scheme from its sponsor,
  • intensive care by TPR including e.g. review of the structure of the business and mandatory appointment of a professional trustee with turnaround experience and
  • a consolidation or discontinuance fund – see below.

Reducing benefits where a scheme and the sponsor continue. If there were to be an option to reduce or renegotiate benefits where the scheme and the sponsor are to continue, that would be "highly contentious", the government says. The bar for any such easement would need to be set "very high".

(Conditional) revaluation and indexation. The government does not think the evidence suggests inflation protection should be abandoned or reduced across the board. But it accepts some schemes are hard wired to historic inflation measures and sees a possible case for rationalisation "so that there is a level playing field across the sector". Another option canvassed is that inflation protection might be conditional i.e. it could be suspended in specified circumstances. Views are invited on what those circumstances might be.

Wider power for TPR to wind up a scheme. TPR's current power to wind up a scheme requires there to be a need to do so in the interests of the members. One option might be to include some of its statutory objectives as additional triggers e.g. to protect the PPF. But its other objectives, e.g. protecting benefits, might compete. Absent hard criteria for wind up, TPR would be left making difficult judgements.

Special measures. TPR could produce guidance specifically for sponsors and trustees of stressed schemes. It could also offer a "special measures" intensive care regime. But if a sponsor is paying all it can and the scheme has limited its risk appropriately there might be little TPR can do without new tools.

Liability management. Views are invited on the appropriateness of the rules around trivial and small pot commutation.

Member protection

Corporate restructuring. The government assesses that "the vast majority of members can be expected to receive their full pension. We also think that where sponsoring employers are able to meet their pension promises, they should, and must, do so". It discusses replacing the current scheme specific funding approach with explicit, binding funding standards to shore up member protection. These could be laid down in legislation (at the price of inflexibility) or could be set under powers conferred on TPR to allow a nimbler response to changing conditions.

The government is cool on the proposal from the Work and Pensions Select Committee that corporate restructuring that could be materially detrimental to a scheme's funding should be subject to mandatory advance clearance by TPR. Currently clearance is voluntary and TPR's main enforcement powers (to seek a contribution notice (CN) or financial support direction (FSD)) are exercisable after the event.

In the Committee's proposal, mandatory clearance would be backed by powers for TPR to issue punitive fines for non-compliance to a total of three times the amount that might be sought under a CN or FSD.

The government says it would need to ensure any such measure "did nothing to damage the competitiveness of UK business, and did not in any way inhibit legitimate business activity. It would need to be very narrowly limited to avoid potentially significant disadvantages to business".

In addition, the government thinks it would be difficult to design a clearance regime that would not have a chilling effect on business, risk overwhelming TPR or be detrimental to the sustainable growth of sponsors or the corporate turnaround culture.

It floats a less stringent option that would not require clearance but if the activity was shown to have been detrimental to the scheme without appropriate mitigation, TPR would have power to levy a significant fine in addition to pursuing the employer for support.

Information flows. Views are invited on improving the flow of information between TPR and the regulated community. Suggestions include a statutory duty on the parties involved with a DB scheme to co-operate with TPR and for more information gathering powers to be backed by civil fines for non compliance. (Some criminal sanctions already exist.)

There are several suggestions to strengthen the hand of trustees. One would give them stronger powers to require timely information from sponsors, an idea supported by the Work and Pensions Committee. Another idea is to require the sponsor of an underfunded scheme to hold a formal consultation with the trustees if it is considering making dividend payments.

The government is not shy of saying that DB schemes entail risks for members. More could be done, it says, to help members understand these and what can be done to mitigate them. An expanded annual statement could help here.

TPR resources. Increased powers for TPR might require more resources. One option would be for some services to be paid for by users e.g. clearance for corporate restructuring.

Consolidating schemes

There are a lot of small schemes: 10% of DB members are spread over 80% of the 6,000 or so DB schemes and a third of schemes together hold just 1% of total assets.

The government sees potential advantages in amalgamating schemes:

  • economies of scale,
  • better investment performance through access to more investment opportunities, and a more sophisticated investment strategy,
  • higher standards of governance and trusteeship,
  • providing smaller schemes with a cost effective alternative to buy-out and
  • adding to the options for stressed schemes and sponsors.

But it sees significant challenges, costs and risks, including:

  • different benefit structures and funding levels,
  • integrating the running of multiple schemes of different maturities,
  • hurdles in the way of harmonising accrued benefits (e.g. individual consent or actuarial certification),
  • up front costs for sponsors,
  • trustee willingness to relinquish control and
  • substantial call on TPR's limited resources.

Overall the government thinks there is a strong case for voluntary consolidation based on vehicles to be provided by the market, not the state.

The Paper sketches different models for consolidating.

Ring-fenced consolidation. In the simplest form, the assets and liabilities of each consolidating scheme would be held in a separate fund. Only back office functions (e.g. administration and professional services) would be common.

In a fuller form, assets would be pooled and there would be a single investment strategy. Or a range of funds with different characteristics could be made available to allow some scheme choice.

Cost savings would depend on the size of a fund and the degree of harmonisation it achieves.

Full consolidation. This would pool assets and liabilities as well as services. The hurdles would be higher e.g. handling cross subsidy and the ultimate allocation of risks. The incidence of the PPF levy would also need consideration as would the concerns of transferring trustees. Up front costs could be significant.

If full consolidation led to wind-ups, winding-up lump sums (WULSs) could be paid to extinguish small pensions. But, under current rules, there are penalties if HMRC considers the wind-up was triggered for the purpose of releasing WULSs. Winding-up is also a trigger for the s.75 employer debt. The government is interested in proposals to change the legislation on WULSs and to reduce the risk of inadvertent s75 debts.

 "Superfund" consolidators. The Work and Pensions Committee recommended the creation of a statutory consolidation fund for small schemes. The government agrees there is a gap in provision for small schemes that are close to fully funded on a buy-out basis. Unlike large schemes, these can find insurers are not interested in offering terms. The government does not see itself creating such a vehicle but is willing to consider measures that might incentivise the market.

On one approach a fund could have a single benefit structure and a single pool of assets and liabilities. It could use a low risk investment strategy with the idea that trustees and employers might be discharged on transfer.

Legislation enabling such a fund would need to address the allocation of risks in what would be a private sector vehicle without taxpayer support.

Voluntary or compulsory? The government does not see a case for the compulsory consolidation for small schemes (e.g. because those with under 100 members are in aggregate the best funded). However, it sees a strong case for voluntary consolidation and invites views on the legal and regulatory barriers.

Stressed schemes. The Paper floats the idea of a consolidation vehicle for stressed schemes with stressed employers as a possible way for high risk schemes to achieve a better outcome than current options. But it accepts this would be difficult to design and involve hard choices about who would bear what risks.

Employer debt: multi-employer schemes and orphan liabilities. The government will be consulting on a new option for managing the s.75 employer debt in multi-employer schemes for non-associated sponsors when an employment cessation event happens. No details are given.

Views are sought on the current inclusion of orphan liabilities in the calculation of the debt in multi-employer schemes. These are pension liabilities attributable to employees of former scheme employers that are left to be funded by current employers. They can represent a large proportion of what an employer is required to pay.

The Green Paper is here: https://www.gov.uk/government/consultations/defined-benefit-pension-schemes-security-and-sustainability

The consultation period closes on 14 May 2017.

Key contact

Richard Knight

Richard Knight Partner

  • Head of Pensions Practice
  • Pensions Services
  • Pensions Legal Advice

Subscribe to news and insight

Pensions Services

Our widely respected pension lawyers provide expert pension law advice in non-contentious and contentious pension matters.
View expertise