The Government has published its White Paper, Protecting Defined Benefit Pensions. The Government intends to give more powers to the Pensions Regulator – as a response to the high profile BHS case – and strengthen the Regulator’s position on Scheme funding. The Government will also be consulting further on measures to allow defined benefit schemes to consolidate. However, none of these changes will be quick: a Bill is unlikely to be introduced before the 2019-2020 Parliamentary Session.
The Government has concluded that there is no systemic problem in the regulatory and legislative framework that governs defined benefit pension schemes. However there are examples of sponsoring employers misusing the flexibility in scheme funding, so the Government is proposing changes which support the Pensions Regulator's ambition to be clearer, quicker and tougher.
Protecting private pensions - A stronger Pensions Regulator
The most headline grabbing changes in the White Paper are proposals to give the Regulator an express power to penalise the targets of a contribution notice by issuing fines and a new criminal offence “to punish wilful or grossly reckless behaviour of directors (and any connected persons) in relation to a Defined Benefit pension scheme”.
The Government has ruled out making clearance for certain transactions involving defined benefit schemes mandatory, but is asking the Regulator to review its guidance. There is also going to be a review of the notifiable events framework - which requires trustees and employers to inform the Regulator of certain events which might indicate a potential claim on the PPF – to ensure it covers all relevant transactions and whether the timing needs clarifying so that the Regulator is informed earlier.
A new requirement for a "declaration of impact" will be placed on sponsoring employers or parent companies, prior to "relevant business transactions" taking place (such as the sale or takeover of a sponsoring employer). This will be issued, in consultation with trustees, meaning that they would need to be fully informed in advance. In practice this may mean that employers will have to effectively articulate their rationale for why they are not applying for Pensions Regulator clearance on the transaction.
The Regulator's information gathering powers are being increased: the ability to compel a person to attend an interview with the Pensions Regulator; civil penalties for a failure to respond to section 72 notices for information as an alternative to the existing criminal sanction and an extension of the Regulator's existing inspection powers. As a result of these proposals, the Government has decided against legislating for a “duty to co-operate” at this stage, but will give this matter further consideration as part of the wider discussions on a more proactive Regulator.
Improving the way the system works - scheme funding
This is perhaps the most significant area for change for defined benefit schemes.
The Government does not believe that the evidence supports a general affordability problem across Defined Benefit schemes as a whole. However, there is no clear definition for terms such as "prudent" and "appropriate". The Government's view is that "It is … critical that trustees, in collaboration with the sponsoring employer, should set appropriate long-term objectives for the scheme, and then take those objectives into account when setting the statutory funding objective." Accordingly, the Regulator will consult on clarified funding standards through a revised Defined Benefit Funding Code of Practice, focusing on how prudence and appropriateness can be defined to better balance employer commitments with risks to members and the PPF. Because of this revision to the Funding Code the Government has decided to retain the current 15 month completion time period for completing the valuation.
The importance of the Code will be strengthened by a change in the legislation "to require trustees and sponsoring employers to comply with some or all of the clearer funding standards." The Regulator will be able to enforce these standards or take action in the event of non-compliance (e.g. through sanctions or fines) and improved funding powers putting beyond doubt that it is the responsibility of scheme trustees and sponsoring employers to demonstrate compliance with funding standards or the Code.
Defined benefit schemes will also be required to appoint a Chair (if they have not already) who will report on their key scheme funding decisions in a Statement from the Chair. The Statement is expected to set out the scheme’s long-term financial destination and a description of the scheme’s strategic plan for reaching the statutory funding objective. The Statement will also show the key risks to meeting the funding objective (covenant, actuarial, investment and governance) and how trustees have chosen to mitigate and manage them. Unlike the Chair's statement for a DC scheme, this will not be an annual requirement, but instead will form part of the triennial actuarial valuation.
The Government is also going to work with the Regulator to consider what more could be done to promote greater transparency of costs and charges and how best to support trustees to ensure Summary Funding Statements are clear and informative to members.
Improving the way the system works – consolidation
The most discursive part of the White Paper is the section on consolidation of defined benefit schemes. Consolidation could offer a more affordable way of risk transfer than securing benefits with an insurance company. However, the Government cautions that "it is important that this is done in a safe way, with clear parameters for vehicles to operate within and to provide members with reassurance that funds are meeting a set of clearly defined standards".
The Government will be consulting on consolidation later in 2018, but is currently not proposing that commercial consolidators should be required to fund schemes at the level required of insurance companies offering buy-out arrangements. However, funding requirements would be likely to be at a higher level than is typical of schemes with a continued attachment to their employer.
The Government has set out some of its initial thinking and notes that "there is a delicate balance to be struck" between such factors as the on-going relationship with the sponsoring employer (ie does it cease to have any further pension liability on transfer to the consolidator?), the long-term funding objective for the consolidator and the amount of capital buffer that is required and whether it is appropriate for a consolidator to be underwritten by the PPF.
The Government has currently ruled out legislative changes to allow trustees to simplify members’ benefits without consent, potentially overriding scheme provisions. Although the Government acknowledges there is evidence that benefit simplification could be advantageous to schemes hoping to consolidate, it is not yet convinced that a change in legislation is justified.
British Steel Pension Scheme and CPI/RPI
The Government has concluded that the outcome for the British Steel Pension Scheme was "very positive … considering the difficult circumstances". But it has acknowledged that members faced a difficult choice whether to transfer to the new British Steel Scheme, remain in the existing scheme which would go into the PPF or transfer out altogether. This was not helped by the inappropriate advice that some members were receiving and which the Work & Pension Select Committee has been investigating. The Government has ruled out giving trustees powers to deem consent when faced with such a restructuring option, but accepts that there "are lessons to be learned" and will be seeking to better understand the circumstances and motivations of members during the time when they were asked to consider transferring.
The Government has also ruled out introducing a "a power for employers or trustees to change scheme rules so that schemes can apply inflation increases using CPI instead of RPI." The rationale is that the Government is not prepared to accept a reduction in employer liabilities, which might simply benefit shareholders. However, it was acknowledged that RPI is no longer an official national statistic and the Government will be continuing to monitor developments in the use of inflation indices - so the door appears open for this to be considered at a later stage.
Clyde & Co comment
The powers to fine, and bring criminal charges, against directors have gathered the most attention – although it is hard to see how much of a deterrent they will be given that contribution notices can impose significant personal liability already.
Of more significance are the changes to scheme funding. It is perhaps the first step back towards the approach the Regulator initially took in 2005 – and then abandoned - that recovery plans should generally not exceed 10 years or be back-end loaded; but it is to be hoped that the Regulator is not so prescriptive as to effectively reintroduce a minimum funding requirement by the back door. The Regulator's influence is also being enhanced by the change in status of the Code – a trend which can also be seen in the recent changes to the Employer Debt Regulations.
The declaration of impact has not garnered much attention, yet it could prove to be a significant change. It would force employers (or their prospective owners) to enter discussions with trustees – which does not always happen - and will be a statement which the Regulator will undoubtedly refer back to if the actual impact turns out to be materially different. However, as with all of the White Paper, the devil will be in the detail of the circumstances when this will apply and what precisely needs to be included in the declaration.
Scheme consolidation has been an idea which has been around 10 years or so. The PPF and the Pensions Regulator were concerned that it would lead to liabilities being transferred without the security of the insurance regime and so would be a one way bet against the PPF. The Pensions & Lifetime Savings Associations work has given this new impetus, but similar concerns must surely remain and it is perhaps possible to detect that the Government is somewhat lukewarm on the idea.
The decision not to allow schemes to switch to CPI will mean that the current complex position will continue. Whether schemes can switch will remain a lottery depending on the precise wording of the scheme rules. Introducing a power to switch – subject to trustee agreement and backed with a Regulator Code of Practice - might have adequately addressed the Government's concerns.