Defined benefit pension schemes - looking to the future

High Court implies public law limitations on a contractual discretion

The funding and future of defined benefit pension schemes is the subject of much discussion these days.  This has been prompted by various recent events, including (i) the news surrounding the collapse of BHS and the £363m “settlement” which Sir Philip Green agreed to pay to fund a rescue for the BHS Pension Schemes (ii) the investigation into the BHS collapse by the Select Committee chaired by Frank Field; and (iii) the Government’s recent consultation on changes it could allow to be made to the British Steel Pension Scheme in order to assist the sale of its sponsor, Tata Steel.

On 20 February the Department for Work and Pensions (“DWP”) published its much anticipated Green Paper on “Security and Sustainability in Defined Benefit Pension Schemes”.  The Green Paper recognises that there is a perceived crisis in the industry.  On the one hand there are concerns about the solvency of employers who may have to make “unaffordable” contributions to their defined benefit pension scheme and the impact those contributions have on an employer’s competitiveness.  On the other hand there is a concern that members of defined benefit pension schemes have a very valuable pension benefit promise, which is generally contingent on the sponsoring employer’s continued solvency.  In an underfunded pension scheme a sponsoring employer’s insolvency usually results in benefits being reduced, or compensation being payable from the Pension Protection Fund (“PPF”) which does not fully reflect the value of the pension benefit promise.  The insolvency of BHS and the entry of the two BHS pension funds into the PPF is a recent example of this.

The Green Paper considers the current defined benefit landscape and opens up a range of issues and options for informed debate on what, if anything, the Government can do.  This gives us a glimpse of possible future changes to the legislative framework in which defined benefit pension schemes operate.  Key areas of discussion include whether funding rules and statutory minima for member benefit protection (such as inflationary increases to pensions in payment) should be loosened for “struggling employers” and whether clearance for transactions should be mandatory in any circumstances.

Four key areas are covered in the Green Paper and these are detailed below.  In each area the DWP seeks views on various proposals and supporting evidence.

1. Funding and Investment

The issues discussed include:

  • Varying the frequency of the valuation cycle and/or reducing the time limit for completing a valuation;
  • Whether regulation is increasing the likelihood of overly risk-averse behaviours/decisions that result in sub-optimal investment strategy.

2. Employer contributions and affordability

The issues discussed include:

  • Whether and how struggling businesses could separate from their pension schemes in circumstances that fall short of insolvency or impending insolvency;
  • Whether member benefits could be reduced (in a variety of ways) for stressed employers, although the DWP described this as a “radical move and highly contentious as it undermines the nature of the hard promise of a pension as deferred pay”;
  • Whether legislation covering indexation of pensions should be altered, for example to allow all schemes to abandon RPI indexation in favour of using CPI, even if its hard-wired into their rules.

3. Member protection

The following issues relating to strengthening The Pensions Regulator’s powers were discussed, including:

  • Requiring employers to comply with a compulsory clearance procedure for corporate activities in certain circumstances, however the paper does recognise that this could potentially entail “significant detriment to legitimate business activity”.
  • Introducing substantial fines for the Pensions Regulator to levy on companies for corporate transactions which have a detrimental impact on schemes.
  • Giving the Pensions Regulator additional scheme funding powers and requiring it to take a more proactive approach, requiring additional resource, perhaps obtained through an increase to the scheme levy.

4 Consolidation of schemes

The issues discussed were the possibility of consolidating the many “small schemes” into larger schemes to gain from economies of scale and possibly provide an alternative to buying out member’s benefits.  Different approaches to consolidation were discussed (including compulsory consolidation although this was not favoured by the DWP) as well as ways of encouraging consolidation.

While many options have been laid out for discussion it will be interesting to see which, if any, gain traction.  The DWP appears to be largely happy with the status quo, stating that “it does not seem that there is an affordability problem across the board”. However employers will probably want to see, at the very least, legislation allowing them to increase pensions in line with CPI, rather than being stuck (in the majority of cases) with the now largely discredited RPI.

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