By David Brooks, Technical Director, Broadstone
It is clear the Government is not convinced that there are fundamental problems with the DB system but has clearly been concerned by various issues that have occurred, most likely around BHS and Carillion.
Quick summary
By way of a quick summary the White Paper canters through most of the major issues concerning the Defined Benefit framework.
• The Pensions Regulator is to be given more powers to punish errant directors who avoid their legal and moral duties to support DB schemes linked to their business. We may not see the nuclear deterrent as wished for by Frank Field but it is notable that the new punishment regime could apply from the date of the White Paper. The Regulator will also be getting more powers to collect information from those it wishes to investigate.
• The CPI/RPI would seem to be put to bed with the government unable to countenance a reduction in member benefits by allowing schemes to switch from RPI to CPI.
Anyone watching recent headlines around the DB pensions space should not be surprised by much of what is included in the White Paper. The Government needs a strong and proactive Regulator and concluded that boosting their interventionist powers was the way forward.
Scheme Funding – MFR-lite?
The Government has asked the Pensions Regulator to issue a new Code of Practice reviewing the definition of “prudence” and “appropriate” crucial to setting the actuarial valuation assumptions.
This new code will be crucial for the future direction of DB funding. If too prescriptive the definitions will funnel schemes to a similar funding strategy and, therefore, effectively remove the flexibilities available to schemes. It is an interesting development, as the Regulator has a difficult balance to achieve. I would be surprised if a return to an MFR-lite regime occurs at this stage in the story of
DB schemes. We should recall that the Government does not think there is a major problem in the ongoing affordability of schemes.
The issues now are the big stories of bad behaviour and inappropriate decisions.
A move to a fully prescriptive regime will be more likely when private sector DB becomes purely a legacy issue. In 15-20 years’ time there could be merit in this, as schemes reach their end games, but at this time a degree of flexibility in the system seems to provide more assistance to Trustees than harm.
It is notable that the discussions around the setting of discount rates present in the Green Paper have gone to be replaced by an emphasis on good governance and clear accountable decision making. It is without doubt going to result in a doubling down on the Regulator’s current drive for schemes to actively discuss and document their processes around Integrated Risk Management, contingency planning and long-term strategy plans.
Scheme Consolidation – A messier market
Perhaps the most interesting area is the Government’s pledge to consult on the legislative framework to allow for the establishment of a private-sector commercial DB scheme consolidator. This was followed up, almost immediately, with the announcement that the first Super Fund will be established with funding from Edi Truell and run by ex PPF CEO Alan Rubenstein. This is a major development and likely to be a disruptive element in the market place.
The fact that it would appear the Super Fund remains eligible for PPF coverage is significant and likely to result in interest in how the scheme should be run and funded from both the PPF and TPR. It is likely that schemes unable to meet a funding test will be unable to enter such a fund; as the PPF would be mindful of drift into a large consolidator that could fail resulting in a large aggregated call on them. There are also likely to be concerns from an established insurance market already structured in a way that permits buy-out into secure (without PPF coverage) schemes.
We need to be mindful of the employer’s obligations, but underpinning this is that any future consolidation can be run in a way that does not future member benefits at risk.
Any future legislation/consultation in this space will be very interesting to all involved in the management of DB pension schemes.
Where are we going?
It would seem the future is potentially complicated with the likelihood of a slightly more prescriptive funding regime, with any deviation from a central direction of travel only applicable to those with rock solid or very weak (stressed) employers, as the regulator looks to provide clearer guidance on the assumptions that Trustees use.
I would expect the Regulator to flip the burden of proof so that schemes will be required to justify why they are deviating from an expected position rather than the Regulator having to challenge decisions made by the Trustees.
Finance Directors up and down the country will be keenly interested in the Super Fund consolidator as a method to write a cheque (and smaller than buy-out) to remove their DB funding obligations. With the protection of the PPF remaining this may make the decision much easier for Trustees.
Some may have thought that the DB sector was heading for a long slow (universe like) death as schemes carried on with their employer not failing (heading to the PPF) and not being able to be bought-out. The stability of a unified funding method with the possibility of targeting Super Fund buy-out means that for many schemes the end seems a much closer bang than a long slow whimper.
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