Pensions Alert: Green Paper on Defined Benefit Schemes

Pensions Alert (UK)

Last week the DWP published its much-anticipated Green Paper on security and sustainability in Defined Benefit (DB) pension schemes (Paper) which considers various issues and ideas about the regulation of private sector DB schemes. In this Pensions Alert we provide an overview of some of the key points in the Paper that may be of interest to sponsoring employers and trustees.

The purpose of the paper

The backdrop to the Paper is that increased deficits, combined with a number of high profile cases, have led some commentators to conclude that there is a fundamental problem with the funding and regulation of DB schemes. Whilst the Government recognises that the system may not be operating optimally in all areas, its main conclusion is that there is not a significant structural problem with the regulatory and legislative framework. The Government also thinks that, whilst some employers are finding their scheme deficit is having a significant impact, there is no evidence of an imminent crisis affecting the sustainability of DB pensions generally.

However, the Government recognises concerns that have been expressed and thinks that it is the right time to ask questions about whether more could be done to help the sector operate more efficiently and to help to minimise burdens on employers and losses to individuals as much as possible.

The Paper therefore reviews the issues and sets out various options suggested by stakeholders and explores their pros and cons. A key point to note is that the options considered in the Paper are not Government proposals. It is made clear that the discussion of potential changes in the Paper is "not intended to suggest that the Government thinks that those changes are viable or desirable". Rather, the purpose of the Paper is to start a conversation and encourage an informed debate about what, if anything, the Government may need to do. We would encourage employers and trustees to read the Paper and respond on the issues which affect their schemes (by the deadline of 14 May).

The Paper looks at four broad areas: funding and investment; employer contributions and affordability; member protection; and consolidation of schemes, and poses questions in relation to each area. The Paper is lengthy and covers a range of ideas. We set out below a selection of the issues explored in each of the four broad areas.

Funding and investment

In relation to funding, the Paper considers valuation cycles and asks for views on whether shorter valuation cycles for high risk schemes, and longer cycles for those that present a lower risk should be considered, and whether the valuation timescale should be reduced from the current 15 months. It also looks at the setting of discount rates and, while the Government states that it is not convinced that there is strong evidence of a systemic issue with a lack of flexibility with the setting of discount rates, it asks for views on whether the flexibilities are being used appropriately.

On the subject of investment, the Government notes that some commentators argue that the valuation approach may be causing significant volatility in the deficit measure and driving some overly conservative investment strategies to mitigate this volatility. The Paper asks whether there is any evidence to support the view that current investment choices may be sub-optimal. It also seeks views on various options that have been suggested to bring about a change in investment approach including: whether it would be appropriate for the Regulator to take a lead in influencing or determining an acceptable overall level of risk for a scheme in a more open and transparent way; and whether measures are needed to improve trustee decision-making such as enhanced training, more Regulator guidance or the professionalisation of trustees.

Employer contributions and affordability

The Paper reports that the Government is not persuaded that there is a case for across the board changes that would reduce members' benefits in order to relieve the pressure on employers. It states that if the Government were to consider such changes, very compelling evidence would be needed, and whilst the Government has not seen such evidence, it is interested in views on this.

It is noted that there is a wide range of circumstances for sponsors and schemes and that a tailored approach might make sense. Part of this section of the Paper therefore focuses on stressed schemes/sponsors, looking at how "stressed" could be defined and whether there is a case for new or enhanced flexibilities for such schemes. Issues considered include whether there are circumstances where: stressed employers should be able to separate from their schemes without having to demonstrate that they are likely to become insolvent in the near future; employers should be able to renegotiate DB pensions and reduce accrued benefits; or schemes should be allowed to suspend indexation.

Also on the theme of a more tailored approach, the Paper asks whether the Government should consider measures to encourage employers who have significant resources but significant DB deficits to repair them more quickly.

As well as looking at the possibility of conditional indexation for stressed schemes, the Paper also states that there may be a case to rationalise indexation arrangements more generally, noting that "the current arrangement where some schemes are prevented from moving to CPI by scheme rules is something of a lottery". In the context of its general question for this section on whether there is a case for special arrangements for schemes and sponsors in certain circumstances, a question is raised as to whether the Government should consider a statutory override to allow schemes to move to a different index, provided that protection against inflation is maintained. It also asks whether this should apply for revaluation as well as indexation.

Other questions raised in this section include whether it should be easier to take small pots as lump sums through trivial commutation, and whether the Government should consider allowing or requiring longer, deferred or back loaded recovery plans in certain circumstances.

The Paper is not specific about the application of the various options, and in particular whether certain options might be open to all schemes and not just those which are stressed.

Member protection

In relation to member protection, the Paper states that one way to ensure that employers pay the necessary contributions and do not seek to evade their responsibilities might be to strengthen the powers of the Regulator or the position of trustees. However, it notes that increasing the Regulator's powers is "not something that should be undertaken lightly" and that it is important that any powers are proportionate and that clear principles are used to assess what the powers should be.

In relation to the Regulator's powers, options considered include: whether greater clarity over the requirements for scheme funding would be helpful and if so whether this would be better set out in legislation or through increased guidance; and whether the Regulator should have new information gathering powers. The Paper also considers the issue of compulsory clearance for certain corporate transactions. It states that such a system would need to be very narrowly limited, notes some of the difficulties that could arise, and states that it would be challenging to design a regime that delivers benefits without potentially significant detriment to legitimate business activity. The Paper therefore seeks views on whether it is possible to design a system for certain corporate transactions without significant detriment to legitimate business activity.

Options considered in relation to the role of trustees include whether they should: be given extra powers such as powers to demand timely information from sponsors; and be consulted when the employer plans to pay dividends if the scheme is underfunded.

Consolidation of schemes

This section notes the potential benefits of consolidation, such as economies of scale, access to more investment opportunities and improved governance, and states that the Government thinks that consolidation is worth exploring. However, it also recognises that there are challenges to consolidation. The Paper considers a number of consolidation models including ring-fenced consolidation and full consolidation. The Paper asks a number of questions on the theme of whether the Government should act to encourage, incentivise or, in some circumstances, mandate the consolidation of smaller schemes.

A note on non-associated multi-employer schemes

In March 2015 the DWP published a call for evidence in relation to section 75 employer debt in non-associated multi-employer DB schemes which looked at suggested approaches raised by stakeholders, such as greater flexibility in relation to repayment plans and changes to when employment-cessation events arise. The response to that consultation has not yet been published but the Paper states that the Government intends to consult on a new option that employers can consider to manage the employer debt in these circumstances, although it does not state what that option is.

Next steps

As the Government is simply exploring a range of suggestions at this stage, rather than setting out proposals, there is no need for any action by employers or trustees to prepare for any imminent changes. However, some of the areas covered by the Paper could be significant for DB schemes if the Government does decide to make changes. Employers and trustees need to be aware that a discussion is taking place and we would encourage them to take part in that discussion by submitting a response (by the deadline of 14 May) giving their views on the options that are being considered. Evidence relating to a wide variety of schemes is crucial to the formulation of a policy which works for the industry as a whole.

If you would like further information or to discuss the Green Paper please get in touch with your usual DLA Piper pensions contact.