Their view is that deficits will shrink for most schemes, if employers continue to pay into them, and that the evidence does not support the view that promised pensions are unaffordable for most employers.
That evidence and the various changes that have been suggested by stakeholders are divided, in the 100-plus page Green Paper, into four broad areas:
1. Funding and investment.
2. Employer contributions and affordability.
3. Member protection.
4. Consolidation of schemes.
With pension scheme deficits, on a buy-out / solvency basis, doubling since the current funding regime was introduced, despite £160bn of additional contributions from employers, the opportunity to strike the right balance between ‘security’ and ‘sustainability’ for DB pensions should not be missed. Everyone with a stake in the efficient operation of DB schemes and their sponsors should get involved in this debate.
Funding and investment
In relation to the DB funding regime, it has been concluded it is not clear that, in general, discount rates being used in schemes are overly pessimistic, and there is no strong evidence to demonstrate a systemic issue with the current flexibilities available.
However, when considering DB scheme investment strategies and asset classes, there is an appetite to explore whether there is scope to encourage or facilitate some schemes to make more optimal investment decisions, and to mitigate any barriers to the greater use of alternative asset classes. Also, with regards to the quality of scheme trustees’ investment decision making, further research is to be commissioned on this, and also to investigate the factors that influence investment strategies and the choice of asset classes.
Employer contributions and affordability
The government is not persuaded there is a general ‘affordability’ problem for the majority of DB scheme sponsors. For this reason, they do not agree that across the board action is needed to transfer more risk to members or to reduce members’ benefits in order to relieve financial pressure on employers.
However, it is recognised that there are exceptions and that new measures may be appropriate for ‘stressed’ schemes. Feedback on this area is sought, covering both options and the moral hazard issues that they raise.
Member protection
Ostensibly, the appetite for change is more evident under this heading with new powers for both The Pensions Regulator (TPR) and scheme trustees considered. The former could have new powers in relation to corporate transactions and information gathering. The latter may get more rights to demand information and engagement from employers. However, the government does want any changes to be proportionate and affordable (changes could mean an increased levy or even TPR charging for some services).
Consolidation of schemes
The final area considered is the issue of consolidation of schemes. It is observed that most DB schemes are small and that, according to the data, these schemes have higher running costs and less effective governance. Arguments for and against the aggregation of smaller schemes into one or more consolidation vehicles, including ‘superfunds’ are considered, with views invited on the optimum model.
The government does not, however, want to design and run them, and they are not convinced that compulsory consolidation is a ‘proportionate response’. There may though be encouragement, including requirements for DB schemes to publish information on their costs and charges.
The Green Paper also mentions that consolidation could be combined with widening the rules for the payment of winding-up lump sums (WULS) and simplification of members’ benefits.
Relaxation of trivial commutation rules is suggested too, as is rationalising rules on indexation of pensions, allowing schemes to move from RPI to a more modern measure of inflation for increases.
Evidence of the potential savings from consolidation and simplification can be found in JLT’s own research. We found that consolidating defined benefit (DB) pension schemes into master trusts could cut employers’ costs by £500m a year collectively.
The £500m savings would result from a reduction in administration and investment costs, as well as lower actuarial, covenant and legal costs, by consolidating the 5,500 smaller DB pensions schemes with less than 5,000 members to 500 larger schemes as proposed by the Pensions and Lifetime Savings Association (PLSA). This would equate to total savings of £10bn over 40 years, which is the estimated time by which all DB pension schemes will have closed entirely.
Further savings could be achieved by simplifying benefit structures, with many DB schemes currently having different benefit categories and, within each category, different tranches of benefits. While the exact savings would be scheme-specific, they could have a material impact, including:
Simpler administration, with reduced chances of error;
Far greater opportunity to adopt a 'self-service' approach to member requests thanks to greater automation; and
Savings on buy-out and buy-ins, because simpler schemes are more attractive to insurers.
DB schemes: facts & figures
There are 5,794 DB schemes.
£1.5 trillion under management.
There are 11 million members in a DB scheme.
Average DB pension is £7,000 p.a.
In the last 10 years, active memberships have declined by more than 50%.
Only 13% of DB schemes open to new members.
About 90-95% of schemes in deficit on Technical Provisions basis.
Average recovery plan is eight years.
Around 5,000 schemes have less than 1,000 members.
75% of schemes refer to RPI in respect of post-97 pension indexation.
Preliminary conversation
To conclude, the Green Paper is, as many others in the industry have alluded to, "very green", a preliminary conversation rather than real consultation, and almost devoid of any real direction of travel in terms of future policy. Also, when considering the factors affecting the funding of and deficits in DB schemes, life expectancy, economic uncertainty and investment returns are highlighted.
However, almost no mention is made of ‘regulation’, even though JLT’s own research found that additional benefit guarantees imposed by legislation has had a bigger impact than anything else. The promises that employers are forced to underwrite now bear little resemblance to the promises made when schemes were set up in the 1960s, 70s and 80s.
Most importantly, when asserting that we can, in effect, just ‘kick the can down the road’ for another potential 50 plus years, the paper fails to recognise that DB schemes do not operate in a vacuum. Only lip service is given to the wider consequences of sticking with the status quo: reduced corporate activity, intergenerational unfairness, legacy DB acting as a ‘drag’ on DC, and an adverse effect on the wider economy.
It is for these reasons that a lasting settlement for DB schemes is needed now, regardless of whether employers can theoretically still afford them.
John Wilson is head of technical of JLT Employee Benefits
Key points
The government recently published a Green Paper on the sustainability and security of DB pensions.
There is an appetite to explore whether there is scope to encourage some schemes to make more optimal investment decisions.
Further savings could be achieved by simplifying benefit structures.
