Last Monday, 20 February the Government published its long-awaited Green Paper, "Security and Sustainability in Defined Benefit Pension Schemes". It focuses on the "central challenge" for DB pension schemes, namely how best to provide a high degree of security in income in a world where nothing can be certain or guaranteed. The aim of the paper is to stimulate discussion about, and start the process of mapping-out the way forward with regards to, the various issues that afflicted private sector DB schemes in such a high-profile way during the course of 2016.
1. Background Who in the pensions industry will forget 2016, a year which saw the legal and regulatory framework within which DB pension schemes operate called into question like never before. Central to this was the emerging concept of 'stressed' or 'distressed' schemes, suffering from major underfunding and sponsored by entities which – whilst not facing imminent insolvency – were the subject of serious doubts as to their ongoing ability to provide the requisite levels of financial support. Of equal concern in a different context was felt to be the speed and manner with which the Pensions Regulator would take action, when faced with corporate activity posing the threat of a materially-detrimental effect on DB schemes. Cases involving wellknown entities such as British Steel, Halcrow and BHS led to a gathering momentum which of course culminated, late last year, in recommendations by the Work & Pensions Select Committee for a radical overhaul of certain aspects of that overarching regime. ∧ Back to top 2. Green Paper The Green Paper aims to progress some of those recommendations and seeks to explore the viability of others. It starts from the premise that we are fortunate to have a robust and flexible system of pension protection in the UK – a view not necessarily shared by commentators in the months prior to the Select Committee issuing its findings. It continues, however, that because of this widely-held view that aspects of the regime could be changed to deliver better outcomes (and/or increase confidence in 27 FEBRUARY 2017 London Table of Contents 1. Background 1 2. Green Paper 1 3. Areas for potential change 2 Affordability 2 • ....Easements for stressed schemes 2 • .... Indexation 2 Member protection 3 • .... Heightened regulatory oversight 3 Consolidation 3 4. Where next for DB pensions? 4 Related links > Herbert Smith Freehills homepage > Pensions homepage > Latest Thinking – Herbert Smith Freehills > Latest Thinking – Pensions A DOSE OF ECONOMIC REALITY – THE PENSIONS GREEN PAPER HERBERTSMITHFREEHILLS Page 2 "Various commentators have suggested … that DB has become an unsustainable drag on employers' resources… [W]e do not believe that this case has been made…" "It is clear that a significant minority of employers are struggling to meet their obligations to their DB pension schemes, and some will indeed suffer insolvency … [but] that is exactly why the PPF was set up…" pensions savings) and in line with Government's responsibility to ensure that the system remains fit for purpose, a properlyinformed discussion on the best way forward needs to take place. The Green Paper begins by stating the Government's stronglyheld view that there is not a significant structural problem with the current regulatory and legislative framework. It indicates how there is little evidence to show that pensions are generally unaffordable for employers, or that funding deficits are driving them to insolvency – there is no evidence of an imminent crisis affecting the sustainability of DB pension schemes generally, it says. It suggests that, on the whole, the regulatory system applying to defined benefit pension schemes is satisfactory, and that the funding regime fairly balances the interests of employers and trustees/members. Perhaps the Government's overall stance can be best summed up by one quote from the Green Paper itself: "DB pensions are hard promises – they are debts like any others, and debts should be honoured where sponsoring employers are able to do so". Against this backdrop the Green Paper goes on to consider four broad areas – funding and investment, pension scheme affordability, member protection and scheme consolidation – and whether there is scope for change. The approach taken clearly errs on the side of caution, recognising the "significant drawbacks" inherent in many of the changes being mooted; and those who were quietly hoping for a regulatory shake-up following last year's Select Committee report are sure to be disappointed. A number of the Select Committee's (undoubtedly well-intentioned) recommendations are felt by the Green Paper to be just not viable: more about these later. But that all said (and particularly where adequate safeguards can be found to minimise 'moral hazard' and the risk of abuse by unscrupulous employers) the Government does appear willing to listen, and to explore solutions to some of the more pressing issues that the industry is recognised to be facing. The industry's pleas that businesses are struggling to honour promises that were made in a very different environment have not entirely fallen on deaf ears. ∧ Back to top 3. Areas for potential change Of the four broad areas considered by the Green Paper, those of 'affordability' and 'member protection' appear the most pertinent from a legal perspective whilst 'consolidation' appears the most intriguing. Affordability • Easements for stressed schemes: Government's view is that no case has been made out for an industry-wide facility to reduce the level of benefits promised by DB schemes. The Green Paper also actively seeks to dispel assertions that the current system leads to outcomes that are essentially binary in nature (i.e. benefits paid from a scheme in full, or an employer failure as a result of which the scheme enters the PPF): statistics are said to illustrate how approximately 700 schemes have transferred to the PPF to date, a further 100 have secured benefits above PPF levels of compensation following an employer failure, and a final 40 have been rescued following sponsor insolvency. The Government does nonetheless recognise that there may be a case for less rigid arrangements to apply to stressed schemes and their sponsors. Examples would include: • a relaxation of the 'regulated apportionment arrangement' regime whereby sponsors can separate themselves from unaffordable schemes (for example by loosening the requirement that insolvency must be demonstrably likely within the next 12 months); • permitting such schemes to 'run on' without a sponsor, rather than falling into the PPF or going into wind-up; • broader powers for TPR to either wind a scheme up or to sever it from its sponsoring employer; • allowing benefit levels to be cut in certain, very limited circumstances (despite the "radical … and highly contentious" nature of such an idea); and • providing more intensive ongoing support from both the Pensions Regulator and the professional trustee community. The existence of adequate safeguards to prevent abuse would need to be a given for any such potential changes to be progressed; as would a precise definition of the very concept of 'stressed scheme' to which such easements could potentially apply. • Indexation: The Government continues to appear vexed by this most unwanted hot potato. On the one hand the Green Paper volunteers that allowing all schemes to move from RPI- to CPI-based indexation "would have [a] significant impact