A wide-ranging government green paper is exploring a number of possible changes to improve the sustainability of defined benefit schemes, but although experts welcomed the variety of issues discussed, some noted a lack of urgency.
With around 11m members in DB funds, the focus on improving the security of final salary schemes has continued to increase over the last few years.
The Department for Work and Pensions’ green paper, 'Security and Sustainability in Defined Benefit Pension Schemes', which was published on Monday, said the government is not persuaded that there is a general affordability problem for the majority of employers running a DB fund.
I think there’s a fair bet we’re going to see a beefed-up Pensions Regulator coming out of all of this
Tom McPhail
“Consequently, we do not agree that across the board action is needed to transfer more risk to members, or indeed to reduce members’ benefits in order to relieve financial pressure on employers,” states the document.
Spotlight on stressed employers
However, it calls for industry insights on whether indexation should be suspended in some circumstances, until certain financially distressed employers have recovered.
Although there is a "moral hazard issue" of introducing conditional indexation, the paper notes that it could mean that "stressed schemes and their employers are supported in their endeavour to address deficits in hard times".
The possibility of additional scheme funding powers for the Pensions Regulator, which has been discussed in recent months, has also found its way into the paper.
While a blanket requirement on parties to obtain clearance from the regulator ahead of any planned corporate activity is deemed disproportionate in the paper, the DWP has considered the case for the regulator “to have a clearance regime in certain specified circumstances”.
Other issues explored include consolidation and the fact that current valuation and funding arrangements influence schemes to make “overly cautious” investment decisions.
Greater urgency needed
Sir Steve Webb, director of policy at provider Royal London, criticised the paper for a lack of urgency.
“It’s almost as if… they’ve just started on day one of the discussion,” he said, noting that these issues have been discussed for some time in other areas of the industry, including the Work and Pensions Select Committee and the Pensions and Lifetime Savings Association.
Sir Steve also conveyed his concern regarding the suspension of annual pension increases for struggling employers.
He noted that “unscrupulous employers” may “err on the side of underfunding, knowing that if things get tight you’ve got this sort of safety valve”.
Tom Selby, senior analyst at platform provider AJ Bell, dubbed the paper “the greenest of green papers from the DWP”.
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He continued: “Ministers have clearly decided they are not ready to pick a fight with the trade unions just yet, but that battle will surely come if accrued rights are to be watered down in any way. Even switching from [the retail price index] to [consumer price index], a seemingly innocuous change, would save schemes £90bn – a saving that would come at the cost of members.”
On the topic of RPI and CPI, Alex Waite, partner at consultancy LCP, said he was disappointed. “The DWP have failed to note that RPI is a very poor measure of inflation,” he said.
Industry divided over CPIH
The Office for National Statistics has said it will make the consumer price index including owner-occupiers’ housing costs its preferred measure for gauging inflation next year, so should the government follow suit for pension indexation and revaluation?
Waite added: “Unfortunately, a legal lottery and inertia in the pensions industry combine to mean that only a limited number of pension schemes have so far switched away from the outdated measure, RPI, which has been used for decades.”
Balanced and measured
Tom McPhail, head of retirement policy at Hargreaves Lansdown, praised the DWP for taking a measured view.
“Clearly they’re trying to strike a balance between the competing demands of employees’ pension rights, their continued employment, shareholder interests and the wider economy,” he said.
Some of the most interesting areas, said McPhail, relate to the modification of existing rights.
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“I think there’s a fair bet we’re going to see a beefed-up Pensions Regulator coming out of the end of all of this," he said. "Given the tone of their questions, everything seems to point towards a more substantial role for the pensions regulator in future."
What about consolidation?
The green paper also seeks views on consolidation of DB schemes to create economies of scale.
Nick Griggs, partner at consultancy Barnett Waddingham, said that “if facilities were available to simplify and standardise schemes… that would seem sensible.”
However, going down that consolidation route may mean trustees and employers give up “a lot of that flexibility that they currently benefit from”.
