In March 2018 the Department for Work & Pensions published a White Paper entitled Protecting Defined Benefit Pension Schemes, which set out proposed changes for defined benefit schemes in three key areas:
- strengthening the powers of the Pensions Regulator;
- scheme funding; and
- consolidation of schemes.
The proposed changes build upon last year's Green Paper on the Security and Sustainability in Defined Benefit Pension Schemes and come amid high profile failures of companies with large pension scheme deficits (such as BHS, Tata Steel and Carillion) and an increasingly vocal Work and Pensions Select Committee.
Although changes to primary legislation are not likely to materialise until the 2019/20 Parliamentary session, some of the proposed measures (such as the strengthening of some of the Pensions Regulator's powers) could apply retrospectively to 19 March 2018. In the meantime, we suspect that both sponsoring employers and pension scheme trustees will wish to adapt their approach (where necessary) to be more closely aligned with the proposed regime.
Strengthening the powers of the Pensions Regulator
A key component of the White Paper is the strengthening of the regulatory framework and the Pensions Regulator's powers. Proposals include:
- Introducing penal (rather than compensatory) contribution notices for those 'who deliberately put their pension scheme at risk'.
- A new criminal offence to punish 'wilful or grossly reckless behaviour [of directors and any connected persons] in relation to a defined benefit scheme' and building upon existing processes to support director disqualification.
- A review of the notifiable events and clearance regimes (although the paper stops short of requiring mandatory clearance in certain circumstances).
- Certain transactions (which pose the 'highest risk' to a defined benefit scheme) will require sponsoring employers, in consultation with trustees, to issue a 'statement of intent' (demonstrating that they have considered the impact on the affected defined benefit scheme and setting out how the employer proposes to mitigate any detriment).
- Improving the Pensions Regulator's information-gathering powers (including a new power to compel attendance at interview and greater powers to inspect documents and records).
- Civil penalties (as an alternative to criminal sanctions) for failure to co-operate.
- As with the Pensions Regulator's original moral hazard powers, some of the increased powers are intended to act as a deterrent. Others are intended to improve accountability and act as an early warning system, allowing earlier investigation and intervention by the Pensions Regulator where there is a potential detriment to the scheme.
It is fair to say that some aspects of the proposals have created uncertainty, for example, the extent of the penalties which the Pensions Regulator may issue and the type of transactions which will be classified as the 'highest risk'. Further consultation, guidance and legislation will be required to iron out these uncertainties.
We anticipate that there will be a bedding-in period following the introduction of any changes. If there is a broadening of the types of transaction caught by the notifiable events and clearance regimes or the point at which the Pensions Regulator must be notified is brought forward, we are likely to see increased numbers of clearance applications and earlier engagement with the Pensions Regulator in the context of corporate transactions or restructurings (at least until the new regime beds in).
Concern has been expressed in some quarters that strengthening the Pensions Regulator's moral hazard powers could adversely impact business and provide too much 'red tape'. The Government has, however, committed to ensuring that the measures do not have an adverse effect on legitimate business activity and the wider economy, but instead target the minority who evade their responsibilities.
The White Paper suggests that work will commence later this year on the Pensions Regulator revising its Code of Practice on funding defined benefits. This will focus on:
- demonstrating prudence when assessing scheme liabilities as part of the triennial valuation process;
- the factors which will be appropriate when considering and setting a recovery plan; and
- ensuring that a long-term view is taken when setting the statutory funding objective (SFO) of the scheme.
It is proposed that legislation will be passed requiring defined benefit schemes to appoint a chair (if they do not already have one) and the chair will need to submit a statement to the Pensions Regulator with the scheme's triennial valuation. Amongst other matters, the chair's statement will need to set out the trustees' approach to risk management, how the SFO is being set with a long-term perspective and how this has informed the setting of the scheme's technical provisions and recovery plan.
The Government also intends to legislate to allow the Pensions Regulator to take enforcement action where 'some or all of the clearer funding standards' of the revised Code of Practice are not complied with by trustees and employers.
In more welcomed news, the Government has decided against changing the frequency of scheme valuations and the existing timeframe of fifteen months to complete a valuation. It had previously been suggested that this period could be shortened to twelve months, with more frequent valuations. The White Paper also does not include further member disclosure requirements in relation to scheme funding, which had been trailed in the Green Paper.
Consolidation of schemes
A consultation has been promised later this year on the methods available to consolidate small defined benefit pension schemes, in a stated attempt to achieve better governance, lower costs and better investment returns.
The consultation will focus on what are perceived as more affordable options to buyouts, including the use of existing master trusts and legislating to create commercial consolidator vehicles.
The latter would involve a private company setting up a defined benefit scheme and accepting bulk transfers from schemes in return for premiums payable by the sponsoring employer of each transferring scheme. External investors would provide capital to support the covenant, but would expect a return on their investment.
A delicate balance will need to be struck here between the inherent tension of delivering a profit for the backer of the consolidator vehicle and protecting members' interests. This, coupled with concern expressed in some quarters that the new consolidation vehicles may be subject to less stringent capital requirements than an insurer which is buying out benefits, may mean that the concept does not gain much traction in practice.
RPI / CPI override: a missed opportunity?
The Green Paper previously invited comments on a number of options for helping sponsoring employers shoulder the burden of scheme deficits. Amongst these was the possibility of introducing a statutory modification power which would allow schemes to switch to CPI in place of RPI for revaluation and indexation purposes (irrespective of the terms of the scheme rules).
The White Paper concluded that the Government was not minded at this stage to introduce such a statutory modification power, but would monitor the position. In practice, this means that the trustees and employers considering a switch from RPI to CPI will be left at the mercy of the precise wording used in their scheme rules and how such wording may have been interpreted by evolving case law.
Most of the proposals put forward by the White Paper appear sensible and well thought out. Although further detail is required, where necessary we expect that sponsoring employers and trustees will adjust their behaviours to align with the principles underpinning the proposals.
The key message from the Government is that the current system is working well for the majority of defined benefit schemes, but a tougher and more timely approach is needed for the minority of employers and trustees whose decisions have a detrimental impact on their defined benefit pension schemes.