The Government has finally published its Green Paper: “Security and Sustainability in Defined Benefit Pension Schemes” setting out issues for consultation on the future regulation of defined benefit pension schemes. This follows a report on defined benefit schemes published in December 2016 by the House of Commons Work and Pensions Committee following its inquiry into defined benefit pension schemes.

The Government has finally published (on 20 February) its Green Paper: “Security and Sustainability in Defined Benefit Pension Schemes” (Cm 9412) setting out issues for consultation on the future regulation of defined benefit pension schemes. This follows a report on defined benefit schemes published in December 2016 by the House of Commons Work and Pensions Committee (see our Alert) following its inquiry into defined benefit pension schemes. [1]

In a welcome move, rather than simply accepting and implementing the (sometimes radical) Work and Pensions Committee’s recommendations, the Government is taking a more measured approach by:

  • recognising (throughout the Green Paper) the need for any regulatory changes to strike a “fair balance” between the interests of members and sponsoring employers;
  • considering available evidence;
  • highlighting the importance of ensuring that any regulatory changes do nothing to damage the competitiveness of UK business;
  • recognising that the Pensions Regulator already has “extensive powers” and limited resources (and additional resources would be needed for a more proactive regulatory approach); and
  • using the Green Paper to seek wider views on some of the recommendations made by the Work and Pensions Committee.

In particular, the Green Paper concludes that there are no significant structural problems with the existing regulatory and legislative framework, but instead considers a number of targeted areas where the system could be improved and addresses particular problems in a proportionate way. Some of the key issues are highlighted below.

Corporate activity

The Work and Pensions Committee recommended requiring compulsory Pensions Regulator clearance for some types of corporate activity, and also giving the Pensions Regulator the option to issue punitive fines in circumstances where it uses its “moral hazard” (“anti-avoidance”) powers. The proposed maximum level for any such fine would be double the actual amount required by the scheme (effectively tripling the overall exposure).

Although the Government is using the Green Paper to consult on whether compulsory clearance and increased penalties should be introduced, the Green Paper explicitly recognises that any framework for mandatory clearance and/or increased penalty regime should be narrowly defined to avoid damaging businesses that sponsor defined benefit schemes. The Government also wishes to avoid reducing the attractiveness of UK companies with defined benefit pension schemes to investors and any changes which could adversely affect the ability of distressed companies to restructure their operations.

The Green Paper comments:

“We have, however, considered the case for the Regulator to have a clearance regime in certain specified circumstances, although we note the very significant difficulties that would need to be overcome before such an approach could be considered. It would need to be very narrowly limited to avoid potentially significant disadvantages to business, and a high threshold would need to be set for the circumstances where seeking clearance would be required.

In looking at current information gathering powers, options for change include the creation of a duty, applicable to all parties responsible for a scheme, to co-operate with the Regulator, and providing the Regulator with a power to interview relevant parties supported by a sanction for non-compliance.”

Helpfully, the Green Paper also acknowledges that any regulatory changes in this area should “not in any way inhibit legitimate business activity” and that Government would need to “give very careful consideration to the potential impact on corporate transactions and the rescue culture, particularly the likely impact on employment”.

Adjusting benefits: indexation

Whilst the importance of the “pensions promise” is emphasised in the Green Paper, the Government is also consulting on whether there should be a statutory override to allow schemes to change the basis for calculating pension increases and revaluation away from the Retail Prices Index (RPI) to a Consumer Prices Index (CPI). The Government has previously made this change (by legislation in some cases) for state pension schemes, and those private sector schemes that apply statutory indexation can use CPI to calculate pension increases and revaluation following changes to legislation that took effect in 2011. Over time CPI has historically been less than RPI.

If introduced, this would be a significant additional flexibility for managing defined benefit liabilities for those schemes that are linked to RPI. The Government acknowledges that currently some schemes have rules which effectively prevent them from moving to CPI as a revaluation and indexation basis, and suggests that there may be a case for introducing an override to create a level playing field for all schemes.

Reducing benefits: stressed employers

The Government’s consistent view throughout the Green Paper is that defined benefit pension schemes are still affordable for most employers, and that it would not seek to propose legislation to allow reduction of benefits without compelling evidence from

consultation responses. One exception to this could be “stressed” employers.

The Green Paper considers whether stressed employers could be allowed additional flexibilities to enable them to continue their business, such as:

  • reducing benefits in certain circumstances; and
  • separating the business from the scheme,

by widening the criteria/circumstances when distressed employers can reach agreement with pension scheme trustees, the Pensions Regulator and the Pension Protection Fund (PPF) to compromise their pension liabilities to help facilitate the restructuring of such companies in the interests of all stakeholders.

The difficulty will be defining exactly what a “stressed” employer looks like and the circumstances that would allow these flexibilities to operate, as the Government is concerned that some employers could engineer their circumstances just to avoid their pension liabilities. The Government is therefore consulting on the appropriate metrics for defining a stressed employer to which any flexibilities would then apply.

Employers with significant resources

In contrast to the proposals to allow distressed employers to make use of additional flexibilities, the Government is exploring applying a more restrictive scheme funding regime to employers with significant resources and large scheme deficits in order to “encourage” such employers to pay off those scheme deficits more quickly.

One option proposed in the Green Paper is to limit extensions to deficit recovery plans for such employers or to set hard limits on the lengths of deficit recovery plans in certain circumstances.

However, one area which the Green Paper does not cover is whether it would be appropriate to have changes to both pensions and tax legislation to make it easier for employers to fund schemes to a higher level without running the risk of having trapped surplus (if it later emerges that the extra funding was not needed). Currently this can be achieved by using a charge or escrow structure, but the legislation is offputtingly complex.

There is also no specific mention in the Green Paper about restricting payment of dividends by employers. But the question is raised whether it should be required that the trustees be consulted “when the employer plans to pay dividends if the scheme is underfunded – and if so, at what level of funding?” If taken forward, any such requirement would need to deal with what “consultation” would involve and at what level in a group payment of a dividend triggered the requirement. The Government will also need to ensure that any requirement to consult does not make UK companies with defined benefit pension schemes less attractive to investors.

Other issues

The Government is also consulting on a number of other issues, including:

  • in relation to investment by schemes:
    • further research into the quality of decision making on investment by trustees; and
    • exploring whether there is scope to encourage some schemes to “make more optimal investment decisions and to mitigate any barriers to the greater use of alternative asset classes”;
  • reducing the period for agreeing a scheme valuation (after its effective date) from 15 months to 9 months and, potentially, adjusting the usual three year valuation cycle to be either shorter or longer, depending on the level of risk in the scheme;
  • allowing increased flexibility for small pension benefits to be taken as lump sums; and
  • removing barriers for the consolidation of smaller pension schemes.

What next?

The extent to which the Green Paper will result in a significant change to pensions law/regulation will depend on the responses to the consultation (which closes on Sunday 14 May 2017) and the Government’s reaction to those responses.

It is a positive sign that the Government is mindful of the wider impact on businesses of some of the more radical recommendations made by the House of Commons Work and Pensions Committee. Assuming the Government continues to be conscious of the balance that needs to be struck, any regulatory changes that do result from this Green Paper should hopefully improve the regulatory regime for the benefit of all stakeholders in defined benefit schemes.