Productive finance consultation on DB investment raises questions around role of 'consolidator'

One of the more controversial Mansion House consultations - how defined benefit (DB) pensions can invest in more illiquid and longer-term assets  - has ended with concerns over any such remit's regulation and benefits.

Although many industry experts backed DB-endgame flexibilities, others expressed concerns about the role of a public consolidator.

The call for evidence by the Department for Work and Pensions (DWP) Options for defined benefit schemes had sought input on how DB pension schemes, and the PPF, could support increased greater productive UK investment in the UK. 

The consultation was issued on the back of the Chancellor’s Mansion House reforms, which were announced on 10 July, and follows a government push to get pension funds to invest in more private equity and 'productive finance' – such as start-ups.

Supporting UK growth

This week, industry bodies published their responses.  The Association of Consulting Actuaries (ACA) expressed support for schemes being given encouragement to invest more in productive assets, provided there is an upside for both scheme members and scheme sponsors – as well as supporting UK growth prospects and wider society. 

Steven Taylor, chair of the ACA, said: “Viewed as a whole, the Mansion House package could help improve outcomes for the next generation of pension savers.  

“We are supportive of more flexibility on the use of DB surplus. It may be possible to design a statutory over-ride allowing refunds of surplus to take place where scheme funding is above a given threshold, perhaps in combination with discretionary benefits to members, or with more flexibility for schemes which remain open to future service. 

“We also support a reduction in the tax rate on refunds of surplus and more flexibility for employers to use DB surplus to meet contributions for current employees’ pensions, be those DB, DC or CDC. This additional flexibility could encourage more investment in productive assets.”

PPF as productive finance 'consolidator'

The Pension Protection Fund (PPF) is being mooted as a potential consolidator. It argued that the current framework does not support DB schemes to substantially increase their allocations to productive finance assets. 

In its response to the call for evidence the PFF said fundamental changes to the objectives for DB investments are needed and adjustments to incentives will not secure a substantial increase in DB allocations to productive finance.

However, this can be achieved through consolidation and removing the link with the employer covenant. It said that a consolidator – aiming to invest for growth over the medium to long term allied with scale and professional asset management –  - will lead to greater allocations in productive finance while providing security for members. 

Kate Jones, PPF chair, said: “With almost £1.5 trillion in invested assets, DB schemes could play a major role driving greater productive investment in the UK economy whilst securing good member outcomes. However, this is unlikely to happen under the current framework – a step change will be needed in the DB market to deliver this.”

The PPF said it has 18-year experience consolidating over 1,000 DB schemes and said it is well placed to take on an additional and separate function as a public sector consolidator should this be the government’s preferred solution. 

Oliver Morley, chief executive officer at PPF, said: “Running a public sector consolidator would be a natural evolution of the PPF’s existing capabilities. Through our investment approach the PPF already provides a blueprint for how the government’s objectives can be delivered at scale. We’re a major buyer of UK gilts, invest heavily in productive assets and, by investing for growth over the long term, we’ve delivered greater security for our members.”

Investing a scheme surplus

Pensions consultancy Broadstone said the proposed creation of a public sector consolidator could open up de-risking opportunities for smaller schemes.

It argued higher levels of consolidation would naturally lead to fewer schemes which would each manage a larger asset base. This in turn should result in better access to investment options , including productive finance, that might not be available to smaller schemes or cost effective for them to consider due to minimum investment levels or fees. 

If consolidation is aimed at smaller schemes, it would help fill the current gap whereby smaller schemes struggle to access the insurance market because they are less financially attractive – even when they are fully-funded and prepared for buy-out.

David Brooks, head of policy at leading independent consultancy Broadstone, said: “A public consolidator can be designed specifically to meet the needs of the government so its purpose is evident. It could provide security to employers and members via a flexible investment strategy to encourage investment in ‘productive finance’ and with economies of scale to reduce cost.”

He added: “Given congestion in the insurance market following the improvement in funding positions, it would also help ‘fill the gap’ with smaller schemes currently struggling to attract the attention of insurers but with the ultimate backstop of buy-out over time.”

ABI warning

The Association of British Insurers (ABI) warned the Government it needed to ‘exercise extreme caution’ with fundamental changes to the DB pension system. The ABI has stressed that the central purpose of DB pension schemes - to pay the benefits promised to members - should not be undermined.

Only over the last five years has the conversation around DB pensions shifted from tackling deficits to dealing with surpluses. It added that is there are fluctuations in asset values, this could reverse again, so caution must be taken. 

It added that any move to allow employers to use the surplus of a DB pension scheme should only be considered if member benefits have already been secured. Otherwise, this risks creating commercial benefits for employers, while generating further risks for scheme members. It argued that this is precisely what the regulatory system has been created to prevent over the last twenty years.

Yvonne Braun, director of policy, long-term savings at ABI, said: “We welcome the focus on addressing some of the ongoing challenges in pension policy and are keen to work with Government to tackle these. However, it should exercise extreme caution when exploring options for DB schemes, including the ability to extract surplus, and introducing a public consolidator. Introducing these market-shifting proposals may bring significant risks for highly uncertain rewards. 

“Changes must not be rushed. Proposals must be thoroughly considered, for the long-term, and ensure that savers’ needs are at the heart of all pensions policy decisions.” 

Pensions cart before the horse

The consultation was criticised by Patrick Bloomfield, partner and senior actuary at Hymans Robertson, who said concentrating on boosting DB investment in UK productive finance assets is akin to ‘putting the cart before the horse’.

He said: “The focus on boosting DB investment in UK productive finance assets has a sense of putting the cart before the horse. What we need are policies that create a DB renaissance, to align DB schemes with wider social interests, by extending time horizons and increasing risk appetites. This would lead to the investment in productive assets and higher savings rates that the Government desires.

"A rebirth of DB would be best achieved by updating DB’s statutory objectives to balance security of accrued rights with current and future pension provision. This would pave the way for meaningful and lasting DB investment in UK productive finance, rather than a faddish policy flash-in-the pan.”

He added there is a role for a voluntary DB public consolidator and argued that it would be more effective if it stimulated the DB consolidation market, rather than becoming a monopoly consolidator with taxpayer backing.