Written by Steve Webb, partner, LCP
New regulations on Defined Benefit (DB) pension scheme funding, published for consultation by DWP in July, risk forcing all schemes into a ‘one-size-fits-all straitjacket’ according to consultants LCP, leading to potentially severe outcomes in some cases.
Under the regulations, all DB schemes will have to reach a state of ‘low-dependency’. This means that schemes have to plan to reach a funding level where no additional funding is expected to be needed from the employer, and then to lock in to that situation by means of a low-risk (and low-return) investment strategy. This goal has to be reached by the time they are ‘significantly mature’, which for a typical scheme means their members have mostly retired.
Analysis of LCP clients suggest that approaching 10% of UK schemes could already be regarded under the rules as ‘significantly mature’ and would have to move to a low-risk investment strategy (if not already there). But within a decade, LCP’s projections indicate that around half of schemes could be regarded as ‘significantly mature’.
There will be a measure of flexibility as to how schemes get to that state of low-dependency. In particular, prior to being significantly mature, and subject to having a strong enough employer to support them, schemes will be able to invest more freely. However, under the proposed regulations, every scheme will be expected – by law – to reach a very similar low risk end destination by the time it is mature, and there will be very little flexibility for schemes after that time.
The problem with this, according to LCP, is that it is a ‘one-size-fits-all’ solution which does not reflect the diversity of the DB pensions world and will be unsuitable in a number of cases.
Most importantly, some schemes have a relatively ‘weak’ employer who may not have the resources to top up scheme funding to the required level in time; full funding could have been achieved (without excessive cost to the employer) if the scheme was able to take an appropriate level of investment risk over a sustained period, but this option is now expected to be closed off by the new cut-off date for ‘low dependency’. If the new rules are implemented, in some cases the sponsoring employer will be asked for unaffordable levels of contributions to their pension scheme and would be at risk of insolvency.
Analysis of LCP clients suggests that up to 5% of schemes (c200 schemes and employers in the country, including some charities) could currently be in this position. This means that, if the regulations are implemented without amendment, trustees of those schemes will face a very challenging choice: either break the law by maintaining their current investment and funding risk in the scheme, or comply with the new law and likely force the sponsoring employer into insolvency.
Although these new rules are likely to impose a significant burden on a number of employers, with consequential knock-on impacts for jobs, the DWP ‘impact assessment’ offers no measure of the scale of these additional costs. DWP says that the impact of the new regime can only be assessed once TPR’s ‘funding code’ has been published. But TPR is only expecting to publish its code for consultation once the regulations have been settled, and TPR can only work within the framework of the law. This means there will be no official data on the impact of DWP’s measures in their own right, which LCP believe are likely to be significant.
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Commenting, Jonathan Camfield, partner at LCP said: “Until now we had been promised that the new funding regime would be flexible enough to take account of the circumstances of individual pension schemes and their sponsoring employers. But now it seems that DWP is determined to ultimately force all schemes into a one-size-fits-all straitjacket.
“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.
“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.
“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. We are concerned that DWP have chosen not to undertake an impact assessment of this significant shift in policy particularly at a time when economic growth is under threat.”