Can regulation revive DB schemes?

Though in decline in the private sector, DB schemes remain of critical importance with 9.6 million people relying on them for their retirement income. Ultimately it is a positive that the government is considering the future of DB. 

On the surface, if a scheme’s success means meeting benefit promises for members, then yes, the current regulatory regime has indeed been a success. Funding levels have been improved and investment risk reduced. 

However, DB schemes have become less attractive to sponsors due to increased costs and risks. So, if success is based on increasing membership and the number of open DB schemes, then the current regulatory regime is not aligned with this objective. What could the future look like?

While there are some regulatory changes that could be made to encourage schemes to stay open or incentivise sponsors to re-open previous schemes or open new schemes, there are other possibilities that could change the direction of the market. 

While there are some regulatory changes that could be made to encourage schemes to stay open or incentivise sponsors to re-open previous schemes or open new schemes, there are other possibilities that could change the direction of the market

Iain McLellan, Isio

Buyout could become more accessible  

There has been a lack of capacity in the buyout market for smaller schemes, with only a few insurers writing business at this end of the market and only during lulls in larger deals. The restriction is due to limited specialist resources rather than capital availability, so only schemes that are certain to afford buy-out are likely to be considered.

To improve the certainty of affordability for all deal sizes, an introduction of deferred premiums would be beneficial. These regulations could be changed to allow deals to be structured so that trustees, backed by sponsors, could take loans with the buy-in insurer, secured on the buy-in policy purchased, thereby enabling attractive rates due to the security of collateral.

Remove compliance burdens through consolidation 

The size of a DB scheme should not determine the quality of member experience and outcome. However, it is evident that larger DB schemes have the scale to deliver better governance compared to minimal compliance.

As compliance burdens continue to increase with additional regulation and focus on improving quality, with associated costs falling disproportionately on smaller schemes, we believe that making consolidation easier for sponsors and trustees should be encouraged. One way to achieve this would be to simplify the superfund gateway tests. Regardless of any changes, we also advocate for improving knowledge among trustees and sponsors about the various consolidation options available. 

A move towards multi-employer CDC arrangements

Improvements in DB funding levels may accelerate the transfer to insurance, resulting in relatively lower levels of investment risk and enabling some schemes to remain open for longer. The divergence between public sector, mainly DB, and private sector, mainly defined contribution (DC) pension provision is expected to continue.

While private sector DB pension provision is projected to decline, we support the development of multi-employer collective defined contribution (CDC) arrangements, which could provide cost better outcomes for members compared to DC schemes with equivalent contribution rates.

An inflection point for DB

To conclude, there are changes that could be made to existing regulations that could help combat the reduction in active membership, like reducing the cost of funding open DB schemes. The new funding code could carve out genuinely open schemes or allow longer covenant reliability periods. There are also options to reduce the requirements on future DB benefits, such as removing the need for a minimum level of pension increases.  

However, more significant regulatory changes would be needed to incentivise sponsors to reopen or introduce DB schemes. It may be more realistic to aim for regulatory changes that support multi-employer CDC schemes as a means of achieving a new measure of success for the UK’s pension system that delivers value for stakeholders and good outcomes for members.

Iain McLellan is head of research and development at Isio