The much-trailed Green Paper on “Security and Sustainability in Defined Benefit Pension Schemes” was published by DWP on 20 February. Although wide-ranging in its scope, the 100-page paper is careful to emphasise that, at present, none of the suggestions discussed in it represent concrete policy proposals. As such, neither employers arguing for greater flexibility nor those (including the Work & Pensions Select Committee) pressing for greater protection of members can safely view the consultation as government endorsement of their case for change at this stage.

Background

The Green Paper has been prepared against the backdrop of a distinct polarisation of outlooks within the DB pensions arena. As the Paper notes, informal consultations undertaken in 2016 revealed a widespread view that “some schemes and employers are struggling, and that some changes may be beneficial”. However, there is no clear consensus as to what those changes should be.

On the one hand, a number of recent high-profile failures of sponsoring employers (including most notably BHS) have led to calls for better protection of member benefits, by a more proactive Pensions Regulator with increased powers to intervene at an earlier stage.

On the other side of the debate, many have argued that the funding requirements for legacy DB promises are increasingly unaffordable and unsustainable for employers, and risk driving otherwise viable businesses into the ground, with substantial collateral damage in the form of job losses and other adverse impacts on the economy. From this quarter, suggestions have been put forward which would allow some limited renegotiation of member benefits, or increase the scope for employers to be separated from their DB schemes to ward off insolvency.

The government’s starting-point: no change?

Against this background, it is unsurprising that the Green Paper is non-committal as regards the case for change. Indeed, to the extent that the paper contains any provisional conclusions at all, these all tend towards maintenance of the status quo, with at most some targeted tweaks to the current regime:

“our main conclusion is that there is not a significant structural problem with the regulatory and legislative framework”

“there is not strong evidence to demonstrate a systemic issue”

“we do not agree that across the board action is needed”

“we are not persuaded that there is a general ‘affordability’ problem for the majority of employers running a DB scheme”

These conclusions are put forward on the basis of a review of available evidence (in Part 3 of the paper) which, according to the DWP’s analysis, tends to suggest that “there is no evidence of an imminent crisis affecting the sustainability of DB pensions generally”.

Topics for discussion

Notwithstanding this somewhat lukewarm starting-point, the paper goes on to throw open for discussion a significant number of suggestions which have been put forward regarding ways in which the current framework could be improved.

The paper groups these issues into four broad policy areas:

1. Funding and investment. Under this heading, the paper addresses concerns that the current valuation and funding arrangements result in poor investment decisions, with schemes being too focussed on short-term deficit figures which are only a snapshot of the health of the scheme, rather than taking a longer-term view. The suggestion is also made that trustees do not have the necessary skills to make good investment decisions, and that members do not understand the risks that their DB pensions may not be paid in full.

Proposals for change which are canvassed in this part of the paper include:

  • mandatory use of professional trustees;
  • valuation cycles linked to risk, with more regular valuations for high-risk schemes;
  • a shorter timescale for completion of valuations;
  • the Pensions Regulator (TPR) taking a more central role in influencing or determining the level of risk a scheme should take.

2. Employer contributions and affordability. This section of the paper examines arguments that historical DB schemes represent an “unsustainable drag” on employers, and that it should be possible to make limited reductions or changes to member benefits to improve affordability and sustainability. The government’s opening position here appears fairly uncompromising: it believes that “DB pensions are hard promises”, which must be honoured where the employer can do so. Indeed, the suggestion is made that some employers could afford (and should be made) to pay higher levels of deficit recovery contributions or to have shorter recovery plans.

Any changes to improve affordability are therefore likely to be targeted solely at sponsors and schemes which are demonstrably struggling – though even here, the paper notes the difficulty of identifying such deserving cases in a manner which does not encourage ‘moral hazard’ by unscrupulous sponsors seeking to exploit any relaxation of the rules.

Possible changes put forward for consideration include:

  • relaxing the current rule that a regulated apportionment arrangement (separating a scheme from its sponsor) can only be entered into where insolvency is expected within 12 months;
  • expanding TPR’s powers to wind up schemes;
  • allowing struggling schemes to suspend indexation of pension benefits;
  • ending the current rules ‘lottery’ under which some, but not all, schemes are able to move from RPI to a different, and arguably more up-to-date, measure of inflation for indexation of benefits.

3. Member protection. The next part of the paper gathers together various arguments in favour of extending the powers provided to TPR and/or strengthening the position of trustees as regards sponsoring employers. The Work & Pensions Select Committee, in particular, has suggested that TPR requires greater powers to intervene in relation to corporate restructuring (such as the takeover of BHS), so that detriment to schemes can be avoided upfront. However, the paper is cautious about such proposals, noting the risk that such increased powers could inhibit legitimate business activity and increase the difficulty of achieving a corporate turnaround, which could in turn – and somewhat perversely – result in more schemes falling into the PPF.

Proposals discussed under this heading include:

  • enabling TPR to impose substantial penalties (in addition to requiring financial support for the scheme) where corporate activities are to the material detriment of schemes and no mitigation is provided;
  • mandatory clearance of certain limited corporate activities;
  • providing TPR with additional scheme funding powers, including the power to set explicit funding standards;
  • greater obligations on all parties to co-operate and engage with TPR;
  • requiring sponsoring employers to consult with trustees prior to paying dividends where the scheme is significantly underfunded.

4. Consolidation of schemes. The final policy area under consideration relates to the question of whether better member outcomes can be achieved by consolidation of smaller DB schemes, to enable such schemes to access economies of scale as regards investment and other services. Different models of consolidation are discussed, ranging from simple shared back-office functions which leave assets and liabilities separate, through to full consolidation of liabilities into some kind of ‘superfund’ consolidation vehicle (though the DWP is “not convinced” that any such vehicle should be government-run). In general, the paper favours the encouragement of voluntary consolidation, but considers that compulsion may be disproportionate.

A linked point considered under this heading is the position of multi-employer schemes, which are in themselves a form of aggregator vehicle. The paper confirms that the DWP is planning a further consultation on specific changes following its 2015 call for evidence regarding problems arising from the operation of the s.75 debt legislation in relation to non-associated multi-employer schemes.

Suggestions for changes to facilitate greater consolidation include:

  • making it easier to simplify and re-shape benefits (to enable full consolidation);
  • setting standards for DB consolidation vehicles;
  • requiring schemes to publish their administration and investment costs, and as part of that to explain what action they are taking to consolidate and reduce costs;
  • providing a legislative framework for ‘superfund’ consolidation vehicles targeted at stressed schemes.

The consultation period ends on 14 May 2017.

The amount of ground covered by the Green Paper is impressive, and the issues which it raises are potentially of material significance to employers, trustees and members, as well as to the wider pensions industry. As such, it is likely to generate considerable interest and debate, both during the consultation period and beyond.

However, it is difficult to detect from the contents of the paper any clear appetite for substantial change on the part of the government. In the main, the tone of the discussion, and the detailed consideration of the difficulties and downside risk involved in most of the possible proposals for change, indicate a provisional view on the part of the government that the current regime largely strikes the right balance, and that change may not be justified. In this respect, the approach can be contrasted with the strong message in the Work & Pensions Select Committee’s report in December 2016 that material changes are needed to address “wider flaws in DB schemes and their regulation”.

In particular, it seems unlikely that the paper will result in any radical increase in the ability of schemes to alter accrued benefits so as to improve employer affordability. Having witnessed the hostile media response to the mere suggestion in the Green Paper that member benefits might be reduced, the DWP will take some convincing that the actual introduction of such an option could ever be politically acceptable.