Briefing: What's in the green paper on the future of DB?
What does the government have in store for the defined benefit sector?
The government has published its long-awaited green paper on the future of defined benefit schemes. The paper outlines the key challenges facing the sector and sets out a number of proposals, including changing indexation rights, encouraging scheme consolidation and awarding the Pensions Regulator more powers.
The paper is a response to concerns that have grown louder over the last few years that there are fundamental problems with the way DB pensions were funded and regulated. This argument has been fuelled by persistently high deficits and high profile cases like BHS and Tata Steel.
The government dismissed claims that deficits were generally unsupportable, or were driving sponsors to the wall, however. It concluded that there was “not a significant structural problem with the regulatory and legislative framework”.
But the paper puts forward a number of proposals to tweak DB regulation to “deliver better outcomes”, and to ease the burden in the small number of cases where deficit recovery contributions are unsustainable.
The government’s suggestions fall into four broad categories: funding and investment, contributions and affordability, member protection, and consolidation.
After an informal consultation last year, the government has concluded there is “no single or immediate crisis in DB funding”, and that the funding regime sets a fair balance between the interests of members and sponsors.
But it is consulting on whether schemes are making full use of flexibilities on offer when setting discount rates, if alternative valuation methods should be used, and whether stressed schemes should have shorter valuation cycles.
The government is also looking for views on how members could be better informed on funding levels and how schemes could access a better range of investment options.
The paper acknowledges that 90-95% of schemes are in deficit on a technical provisions basis, but finds that deficit recovery contributions are, on average, not unaffordable. It notes, however, that some sponsors are struggling.
“While we do not believe the case has been made for across the board reductions in benefits paid by DB schemes, there may be a case for changing the arrangements for stressed schemes and sponsors,” its authors write.
These changes include a statutory over-ride to allow schemes to use a generally lower measure of inflation to index benefits, and allowing schemes to suspend indexation in some circumstances.
But the government is concerned these measures could be taken advantage of by some employers, and is seeking views on how to define ‘stressed’ sponsors, and how to prevent abuses by other firms.
On member protection, the paper looks at beefing up TPR’s powers in a number of ways, although the government seems generally lukewarm on the idea. Proposals include setting more prescriptive funding requirements, making it compulsory for the regulator to clear certain corporate transactions, and giving it the power to issue punitive fines.
It also looks at handing the watchdog, and trustees, more information-gathering powers, and giving trustees a say over dividend levels where schemes are underfunded. But the government is also exploring how to stop these powers affecting “the competitiveness of UK business or the attractiveness of the UK market”.
The report makes clear that consolidating the UK’s 6,000 schemes into a more manageable number would have many benefits. But it also recognises that this is fraught with difficulties.
The government is certainly in favour of voluntary consolidation, and asks in the consultation whether there could be a case for mandatory consolidation. It also explores the possibility of simplifying benefits and allowing them to be reshaped without member consent to encourage mergers.
The paper also explores the use of consolidation schemes, generally and for stressed schemes in particular, as an alternative to insurance buyouts or the Pension Protection Fund.
Initial responses to the paper have focused on the proposals around indexation, with many welcoming the fact that stressed schemes may be given more flexibilities.
Association of Consulting Actuaries (ACA) chairman Bob Scott said: “The ACA believes that there is a case to rationalise indexation arrangements to remove the ‘lottery’ that has applied since the government changed its statutory measure of inflation from RPI to CPI in 2010. We also support moves towards conditional indexation, with appropriate safeguards, something that the ACA has advocated for many years.”
Scott said both these measures would make it easier for employers to provide healthier defined contribution pensions their current workforce, which would ease inter-generational tensions.
But Royal London director of policy Steve Webb warned relaxing indexation requirements on accrued benefits would put living standards at risk for millions.
“With rising inflation, annual indexation is an important part of protecting the living standards of the retired population,” he said. “There is a significant risk that relaxing standards on inflation protection with the best of intentions for exceptional cases could be exploited and lead to millions of retired people being at risk of cuts in their real living standards.”
The consultation closes on 14 May. Click here to read it in full.