Tuesday, 12 December 2017

    Post-election pension reform

    Are we turning our back on meaningful change for defined benefit schemes? Charles Cameron, Partner, Slaughter and May; Tim Morris, Director, Hanover Communications examine the evidence

    When Theresa May launched the Conservative Party’s 2017 general election manifesto she talked about the need to make “hard choices”. The manifesto’s pledges of reform to funding adult social care fuelled an important debate around fairness between generations. There’s little alternative to the “hard choice” of age - as many who have suddenly found themselves with another year at work to fill will attest. 

    A crucial part of the intergenerational debate focuses on pension provision. For the 11.5m members of the 6,200 UK defined benefit (DB) pension schemes, their trustees and sponsors, that’s about DB pension sustainability.

    But where does the debate about the future of DB provision now sit, with the smallest of Government majorities (through the support of the DUP) and a Queen’s Speech devoid of pensions reform?

    How did we get to here?

    The challenges facing the sustainability of DB schemes have been a long time in the making. While fundamentals like longevity and bond yields are wholly or largely outside government control, a regulatory regime that puts more pressure on DB schemes clearly sits with those who run the country.

    The regulatory regime has expanded over several years through different governments. Notable examples include: the almost blanket prohibition of amendment to accrued rights (even if scheme rules permit them); mandatory inflation increases in deferment; the material penalty of a section 75 debt; no employer control over scheme investments and the PPF levy; and the fairness of its allocation between schemes. Unfortunately, in the view of many, the previous government’s DB Green Paper seemed to largely duck these issues at a scheme, trustee and sponsor level.

    Throughout all the regulatory developments there has been a significant focus on the anti-avoidance regime, for example through s38 and s38a contribution notices. This is absolutely as it should be – scheme members have generally worked hard all their lives and built an understandable expectation of their post-retirement future.

    But, however unfairly, high profile examples like BHS have drawn attention to perceived failures of both the legal/regulatory framework and the Pensions Regulator (tPR). Whilst there have undoubtedly been examples of egregious acts, these are relatively rare. Most sponsors fight to maintain a responsible balance between calls on their cash. Systemically, the current framework carries its own inbuilt challenges. The regime is extremely broad, there are very few published cases and the 2004 “clearance” regime is rarely used.

    The current regime has created a ‘perfect storm’ of circumstances impacting both tPR and scheme stakeholders: extreme prudence of some trustees in investment policy; overwhelming deficits and future service costs; subjectivity in covenant assessment; and a lack of clarity about allowable flexibility. For everyone involved there is a heightened fear of public backlash.

    What happened to a new political environment for change?

    The Conservative manifesto set out a broad acknowledgement of intergenerational unfairness – the triple to double lock switch being Exhibit A. There is a genuine belief amongst those who wrote the manifesto that there is a real division to be fixed, however this is now being played out in the post-election blame game. But the focus at a scheme level on ‘anti Philip Green’ measures, whilst politically unmissable, left most of the measures needed for better sustainably prospects untouched.

    The opposition parties, and crucially the new king-makers of the DUP, remained committed to the triple lock at headline manifesto level. But there were indications in specialist press interviews of some pragmatic thinking at scheme level (for example, more flexibility on indexation and valuation approaches compared to today’s rigid straightjacket).

    However, manifesto and policy positions have been overrun by the new political reality. The election result backlash within the Conservative party has seen several of the key proponents of intergenerational fairness policies publicly dropped. Practically, the narrowness of the government’s majority and the sheer volume of Brexit legislative requirements means that the potential for other key proposals has been kicked deep into the long grass.

    What’s possible without legislation?

    So, legislation to address DB problems is off the agenda for the foreseeable future. What changes can happen without primary legislation?

    We would argue that the current DB framework requires meaningful reform if it is to deliver the outcomes that both voters and politicians want – ‘fairness’ to scheme members, real wage growth to workers and greater investment from sponsors in the economy. Whilst there are a number of areas of the DB legal and regulatory framework that we believe should be reformed, there are three key areas for discussion.

    • Improve tPR’s clearance procedures There was much pre-election debate between the political parties on strengthening the power and “bite” of tPR. One suggested way of doing this, was by making the clearance procedure compulsory for certain types of corporate activity. The existing clearance procedure, introduced to enable companies undergoing restructuring to gain assurance that tPR’s anti-avoidance powers would not be used in relation to the transaction and enabling tPR to tackle potential moral hazard issues head-on rather than after the event, can be enhanced to make it more effective. More prescriptive guidance on specific situations which are regarded as acceptable or not by tPR, which would not require legislation, would be a great start and would go some way in altering the current ‘self-regulation’ of parties making a judgment as to how tPR will react to corporate transactions.
    • Review section 75 The way trustees respond to section 75 debts can impede perfectly legitimate corporate restructuring exercises that would benefit scheme members by leaving their employer in a stronger position in the future. We would like tPR actively allowing section 75 to facilitate responsible business activity while also ensuring that members’ pensions are properly protected. To that end we would like to see a debate around tPR taking a position on “safe harbour” events where it would accept trustees using existing powers to waive the immediate payment of section 75 debts, for example in situations where a restructuring would leave a no less favourable employer covenant.
    • Reconsider indexation The DB Green Paper raised hopes that indexation may be back on the agenda where there may be a substantial case to suspend it for an employer that is stressed and a scheme that is underfunded. There is sensitivity and case law surrounding this area, and a real political will would be needed to effect measures to responsibly allow schemes the scope to relax historic indexation provisions. We think this does need to be looked at as part of an overall response to underfunded pension schemes.

    Let’s hope that there is both the political interest and creativity to continue to pursue the meaningful reform that the DB landscape needs. But this is pensions. The issues are complex. The risk of unintended consequences is high. And the politics are difficult.

     

     

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