DB pension trustees – what’s my goal again?

If you’re a trustee of a DB pension scheme then the Chancellor’s Mansion House speech in July may have left you scratching your head.  How can the government’s “drive to promote economic growth”, and the role of pension schemes in that, be reconciled with your existing duties towards your members? You may also be wondering what all this means for the endgame of your scheme. Should you be targeting buy-out, or will running your scheme with a view to utilising surplus and supporting UK growth be a viable option in the future?

Can trustees align their duties with the government’s agenda?

The DWP has launched a call for evidence on how DB schemes could use their assets more flexibly, while maintaining appropriate security of members’ benefits and not undermining trustees’ duties to their members. In summary, the DWP is looking to explore:

  • access to and the use of surpluses in DB schemes
  • the potential benefits and drawbacks of a public sector consolidator, and
  • the role of the PPF as the public sector consolidator.

DB trustees could be forgiven for thinking that driving economic growth is not their responsibility (or for that matter, the responsibility of their sponsoring employer). The key question for the government is whether a balance be struck between keeping members’ benefits secure and its goal of promoting economic growth?

The next question is how can DB trustees promote economic growth? That is what the government will be exploring. It is conceivable that this might involve trustees running their DB schemes on rather than buying-out and winding-up.

It is probably fair to say that buy-out is currently the favoured target for most DB schemes. There are many good reasons for this. The main one is probably the stronger regulatory regime that sits behind insurance companies (and the corresponding capital requirements). In addition, there is also the benefit of FSCS protection for your members which means that they will (in theory at least) get 100% of their benefits if the chosen insurer goes bust.

Is running on a viable alternative option?

On the basis that trustees would be deciding to continue relying on their sponsoring employer’s covenant rather than that of an insurer, any decision to run on rather than buy-out would need to be supported by (very) robust covenant advice. If the funding position deteriorates then it is the employer who will be picking up the tab!  A strong investment strategy focused on the objective of paying pensions when they fall due (rather than buy-out) will also be needed.

Trustees will also need to consider the ongoing adviser and administration costs that will be incurred and how these are going to be paid for.

On the employer side, the major downside of running a DB scheme on is that they carry 100% of the funding risk. There could also be accounting consequences for the sponsor to consider.

Under the current legislation, the bar is set very high for trustees considering returning surplus to an employer from an ongoing scheme (and this is before we even consider the tax consequences of refunding surplus or any specific restrictions in scheme rules). If employers can’t easily extract surplus, then this is likely to make them wary of the risk of overfunding and trapped surplus which might translate to an aversion to risky growth assets. Accordingly, it is difficult to see how the goal of promoting economic growth will fit with the current legislation in this area. The government has recognised this, with the call for evidence raising a variety of questions on the use and return of surplus.

What if trustees decide to keep the scheme running but it doesn’t go as planned?

All of this talk of schemes supporting economic growth assumes that DB surpluses are here to stay. What happens if trustees decide to run on and things don’t go as planned? Ultimately this will result in them having to ask the sponsor for more money. But what if the sponsor can’t/won’t pay?

Trustees should also be mindful that a decision to run on arguably means that deferred members are carrying more of the downside risk than pensioners. If a scheme is run on and deferred members don’t receive their full benefits as a result, then the trustees could potentially be accused of intergenerational unfairness.

Other options?

The government seems set on making the most of using DB schemes to support UK economic growth. As noted above, some other options that it is exploring include:

  • supporting the development of superfunds for schemes with no realistic prospect of buying out on the insurance market;
  • the potential benefits of a public sector consolidator which could allow the government to ensure investment objectives are met and promote long-term investment timeframes that would support
  • investment in UK productive finance; and
  • extending the PPF’s remit to include acting as a consolidator or provider of aggregated services for schemes are not attractive to commercial consolidators.

Taking another tack, if surpluses are here to stay, might we see DB schemes reopening to new members and future accrual? Probably not on a pure DB basis given the experience of the past 30 years but we might perhaps see more employers considering other options such as CDC as an alternative.

As things stand, we are still at the call for evidence stage and there are no firm proposals from government. Accordingly, any changes to legislation are probably a long way off. However, Trustees should still be mindful of the government’s wider agenda to improve opportunity for investment in alternative assets including in high growth businesses when considering their endgame.

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