The recent pensions White Paper gives an indication of how to protect defined benefit pension schemes.
A defined benefit (DB) pension is an employer’s promise to pay an employee member a predetermined retirement benefit, with the resultant pension being linked to the member’s earnings and length of employment.
DB pensions are expensive but most employers manage their schemes responsibly, fulfilling their scheme funding and governance obligations.
Since 2012, with the introduction of auto-enrolment and the growth of defined contribution schemes, the DB sector has changed, with most schemes now closed to new members and some closed to future benefit accrual.
Nevertheless, the DB sector continues to manage assets of around £1.5trn and its regulation affects around 10.5m scheme members.
Despite a few recent high-profile company insolvencies, the government believes that DB regulation is basically sound and that it provides employers and trustees with a wide range of options on how pensions liabilities are managed.
The Department for Work and Pensions’ (DWP’s) White Paper, Protecting Defined Benefit Pension Schemes, was published on 19 March 2018 and sets out the government’s proposals to clarify the relevant rules and to strengthen the powers of the Pensions Regulator (TPR).
What the White Paper sets out
The White Paper sets out the DWP’s proposed principal changes, including:
- Protecting private DB pensions by strengthening TPR's powers.
- Improving the way scheme funding works.
- Providing new opportunities for DB schemes to benefit from consolidation options.
These proposals are examined in turn below.
More effective powers for the pensions regulator
TPR already has wide-ranging authority to intervene in the management of DB schemes, including its so-called "anti-avoidance" or "moral hazard" powers.
The anti-avoidance powers were considered necessary to limit claims on the government’s Pension Protection Fund (PPF), which provides statutory compensation for DB scheme members whose sponsoring employers become insolvent.
The existence of the PPF means that, unless there are suitable safeguards, it is possible for unscrupulous employers to manipulate their affairs to transfer scheme liabilities to the PPF.
The pensions regulator's legal objectives include limiting calls on the PPF and protecting members' benefits.
Although the government does not believe there is wide-scale deliberate employer avoidance activity, it is recognised that the system must be tough enough to protect scheme members by ensuring TPR has sufficient power to take any necessary action.
Proposals to enhance the Regulator’s effectiveness include:
- Punitive fines - introducing an express power to issue a punitive fine in addition to the required funding contributions where the employer has deliberately and unlawfully attempted to avoid its obligations to a DB scheme.
- Criminal sanctions - legislating to introduce a criminal offence where directors have behaved in a wilful or grossly reckless manner in relation to a DB scheme and building on the existing powers to disqualify those whose behaviour falls short of the expectations of the role.
- Notifiable events and clearance - certain events occurring in relation to a DB scheme must be notified to TPR and pre-approval of some proposed corporate transactions is sought voluntarily by way clearance. The DWP intends to strengthen the notification and clearance regime. Currently, TPR must be informed “as soon as reasonably practicable” where corporate activity could have a detrimental effect on a DB scheme. Consideration will be given to whether TPR should be alerted earlier and in a wider range of cases. An earlier proposal for a mandatory clearance requirement is not being pursued.
- Information-gathering – the pensions regulator’s existing powers across auto-enrolment, master trusts, DC and DB arrangements are to be harmonised to increase effectiveness.
The intention is to improve significantly TPR's ability to act quickly and to deter against irresponsible employers putting their schemes at risk.
Improving scheme funding standards
There is a legal requirement for DB schemes to aim to hold sufficient assets to provide members’ benefits – the scheme funding regime.
The government believes there is no general affordability problem across DB schemes as a whole, but it thinks clearer scheme funding standards would be beneficial.
Proposals for change include publication by TPR of a revised, enforceable DB funding code of practice and encouraging trustee-employer collaboration on a long-term funding strategy.