New defined benefit funding rules may lead to “potentially severe outcomes”, consultancy LCP has warned, while Mercer has predicted that the regulations would “accelerate pension liability buyouts and the demise of DB schemes”.
In July, the Department for Work and Pensions published its consultation into DB funding following the introduction of the Pension Schemes Act 2021, which set out the framework for the government’s proposals on this topic. The consultation closes on October 17.
A scheme in a state of low dependency is deemed to be sufficiently invested in a “low dependency investment strategy” and not require further employer contributions.
Trustees and managers will be required to set out the investment strategy’s asset mix at a high level, detailing exposure across different asset classes such as equities and bonds, but not information on actual scheme investments.
Long-term flexibility is being dramatically reduced by these new regulations
Jonathan Camfield, LCP
A funding position based on the low dependency principle will satisfy the investment strategy requirement and see an asset-liability ratio of one to one.
Will the market meet heightened demand?
Mercer warned that the draft proposals would force the sale of £500bn of return-seeking assets, the majority being required before 2040.
It said this is the approximate value of return-seeking assets held by DB pension schemes in the UK. The Pensions Regulator’s 2021 purple book recorded around £1.7tn of pension scheme assets, of which about 30 per cent were investments that seem unlikely to be permitted under the draft regulations after schemes reach significant maturity.
Around £200bn of liabilities could be added to the balance sheets of employers with DB schemes over the next 10-15 years, the consultancy added.
This forecast is based on Mercer’s approximate estimate of the difference between the cost of pension scheme liabilities already accounted for on balance sheets, compared with the cost of securing benefits with an insurer, together with the expectation that the new regulations could cause or bring forward the date that trustees and sponsors are forced to transfer pension scheme liabilities to an insurer for a large number of schemes.
“What isn’t clear yet is whether this accelerated demand could be met by current market participants,” said Mercer chief actuary Charles Cowling.
LCP partner Jonathan Camfield, meanwhile, cautioned that the new rules risk forcing schemes into a “one-size-fits-all straitjacket”.
Analysis of LCP’s client base suggests almost a 10th of schemes could be considered “significantly mature”, but within a decade this could reach around half of schemes.
Camfield said: “Being able to invest for long-term growth and take an appropriate level of investment risk is a key part of the strategy for many pension schemes, and is critical to mutual survival of the scheme and the employer in some cases.
“But this long-term flexibility is being dramatically reduced by these new regulations.”
Some employers may face unaffordable contributions
In an interview with the Financial Times, TPR chair Sarah Smart admitted that some employers faced needing to plug funding shortfalls ahead of schedule.
“There will be some schemes for which there is a lengthy (deficit) recovery plan, where if we went in tomorrow and said ‘where is your evidence for the length of your recovery plan’, I suspect that they would not be able to provide that,” she told the FT.
LCP’s analysis suggests that up to 5 per cent of schemes could see their sponsoring employers asked to foot unaffordable levels of contributions and face insolvency.
“The very real risk is that some employers will face insolvency if they are forced to plug shortfalls in pension scheme funding at pace and with minimal reliance on scheme investment returns,” Camfield said.
“Other employers could also find themselves being forced to pump in more cash than is needed — money that could be spent investing in their business or paying better wages to their staff to help them through current cost of living pressures.”
New proposals set DB schemes on path to ‘low dependency’
Defined benefit pension schemes will need to be funded in such a way that they are in a state of “low dependency” on their sponsoring employer by the time they are significantly mature, under new government proposals.
A DWP spokesperson pointed to the consultation’s foreword by pensions minister Guy Opperman, which stated: “Those schemes that are maturing will be required to manage their risks carefully, taking proper account of the extent to which those risks remain supportable as they move towards run-off, or securing members’ benefits.
"But these draft regulations also take account of open schemes which are not maturing and have adequate ongoing sponsor support.
“It is not our intention that such schemes should have to undertake inappropriate derisking of their investment approaches. The intention is to have better and clearer funding standards, but not to move away from the strengths of a flexible scheme-specific approach.”
