DB schemes: Green Paper on security and sustainability

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

In its Green Paper on security and sustainability in defined benefit schemes, the Government concludes that there is no significant structural problem with the current regulatory and legislative framework. It also believes that the majority of employers should be able to continue funding their schemes, although a significant minority are struggling to meet their obligations. The paper considers various areas where changes could be considered to deliver better outcomes. It contains no firm proposals for radical change.

Views on the issues raised in the paper are invited from anyone with an interest in DB pension schemes. The consultation closes on 14 May 2017.

Underpinning the consultation is the Government’s view that DB benefits constitute a “hard promise” to members which should be honoured. The paper considers four key areas:

Funding and investment

On funding, the paper considers whether the current valuation cycle is appropriate or whether a shorter period would work better or if more flexible risk-based reporting and monitoring should be introduced. Suggestions include reducing the valuation timescale from 15 to nine months and giving the Regulator a more proactive role in scheme funding and risk management.

There seems to be a general view that many schemes are too cautious in their investment approach. The paper looks at whether there is scope to encourage or facilitate different investment decisions and the wider use of alternative assets classes (such as infrastructure projects). Also considered is whether there should be a requirement for all trustees to be professionally qualified. There is likely to be further investigation into trustee decision making and the factors affecting investment strategies and asset choices.

Employer contributions and affordability

The overall conclusion of the Government is that most sponsors can manage to support their DB schemes and may even be able to afford to pay more contributions. There are other employers whose business will fail, regardless of the pension deficit.

There is however a relatively small group of employers (“stressed sponsors”) where reducing the the burden of supporting the pension scheme could result in a better outcome. Views are welcomed on how to identify and define a stressed sponsor, what options should be available for separating a stressed sponsor from its scheme and what if any reductions should be allowed to benefits. One specific issue here is whether conditional indexation should be allowed (for example, suspending pensions increases in certain circumstances).

On a separate point the Government asks for views on whether a statutory override should be provided to enable all schemes to move from RPI to CPI for indexation and revaluation if they wish to do so. Currently some schemes are prevented from making the switch because of the specific wording of their rules.

Member protection

The Government considers that the current framework for protecting benefits is working broadly as intended but the paper considers whether changes should be made to the Regulator’s powers over scheme funding. This might allow it, for example, to set recovery plan periods or define standards of prudence.

It also looks at whether there should be compulsory clearance of certain corporate transactions (an issue raised in the context of the enquiry into the BHS pension scheme). The difficulty here is balancing member protection and legitimate business activity. Compulsory clearance could impact on corporate transactions, make turnarounds more difficult and make employers with DB schemes unattractive investment targets.

Another option under consideration is whether the Regulator should have the power to impose significant fines, in additional to any financial support for the scheme where an activity has had a detrimental effect. The danger in this might be to drive employers to seek clearance when they otherwise wouldn’t, overwhelming the Regulator and slowing corporate activity.

Consolidation of schemes

The final section of the paper explores the benefits and challenges of consolidating DB schemes. The Government’s preferred option appear to be the encouragement of voluntary consolidation and views are invited on whether there are any current barriers to achieving this. Benefits of consolidation might include more efficient (and cheaper) administration, access to more investment opportunities and more cost effective buy-out opportunities. There are some obvious difficulties in consolidating schemes where the employers are unrelated including how to deal with different benefit structures, covenant strengths and investment and funding strategies. Recent problems in the plumbing industry pension scheme highlight some of the risks for employers in a DB scheme where the employers are not connected.