Options for Defined Benefits schemes: a call for evidence


On 11 July 2023, the DWP issued a call for evidence on options for Defined Benefit schemes.

In this response

We welcome the opportunity to respond to this call for evidence. In addition to answering specific questions which are pertinent to our practice, or which we believe could give rise to difficulties in practice for our clients, we have provided some initial general comments.

General comments

As pensions lawyers our expertise lies, among other things, in understanding the legal complexities in the current DB pensions landscape.  Before delving into the detailed questions, we thought it would be helpful to explain some key legal points that feed into several areas of the call for evidence.

The call for evidence often refers to trustees and sponsors in the same question.  However, they each have different roles to play in respect of investment decisions for DB schemes.

Trustee investment duties

The power to make investment decisions rests with the trustees under both trust law and pensions legislation. Scheme assets must be invested in the “best interests of members and beneficiaries” but that doesn’t simply mean maximising investment returns at all costs or, conversely, making investments that are completely risk-free.

Trustees must exercise a power for the purpose for which it has been given. The purpose of the investment power in a DB scheme is, broadly speaking, to invest to generate returns in order to provide the specified level of benefits promised under the scheme.  So, while trustees need to ensure sufficient investment returns, it does not follow that they must maximise investment returns for each individual member.

Trustees also have a duty of care when investing trust assets, which is often called the “prudent person” test, requiring trustees to take such care as an “ordinary prudent” person would take if they were making an investment on behalf of someone they felt “morally bound to provide” for. Whilst the “prudent person” test does not go as far as to say any investment must be risk-free, trustees of DB schemes must take into account any potential risk in making any investment decisions.  The importance of risk management in DB schemes is emphasised in the Pensions Regulator’s (TPR’s) guidance, which goes into detail about how trustees should understand and mitigate investment risks.  Although there is no legal requirement to follow TPR’s guidance, it is considered good practice.

As such, under the law as it stands, there is currently no duty on trustees to consider the benefit to the wider UK economy and, indeed, doing so could be contrary to their duty to invest in the best interests of members, depending on what the trustees are investing in.

Employer’s role

As mentioned above, the power to make investment decisions rests with the trustees.  This means the role of the employer is limited when it comes to making investment decisions.

Trustees are responsible for setting investment principles governing investment decisions and recording those principles in the “statement of investment principles” or “SIP”.  However, they must consult with the sponsor when preparing the SIP. This has to be a proper consultation, but they do not need the consent of the employer before making investment decisions.  Indeed, trustees must not fetter their exercise of a discretionary power, including their investment power, so there cannot be any arrangement which would require the trustees to obtain the employer’s consent to any investment decisions.

Responses to specific consultation questions

Question 2: What changes might incentivise more trustees and sponsors of DB schemes to consider investing in productive assets while maintaining appropriate security of the benefits promised and meeting their other duties?


As mentioned in our general comments, trustees and sponsors have different roles to play in respect of investment decisions in DB schemes.  Given trustees’ investment duties and the needs to consider the potential risks of any investments, it is not straightforward to see what “incentive” could be offered to encourage them to invest in productive finance.  This is particularly the case in respect of closed mature schemes that have a shorter time to recover any losses.

There may be more scope in respect of large open DB schemes, that have a longer journey plan, with the longer-term nature of productive finance being more appropriate in the wider investment portfolio.  Introducing tax incentives on productive finance could be one option to help “tip the balance” for trustees when making investment decisions.


Some employers like trustees to invest in assets that generally produce higher returns.  However, as employers are ultimately the ones responsible for funding a DB scheme, they would also have in mind the risk of having to make good any funding shortfall if assets were to significantly decrease in value compared with the scheme liabilities.  As such, for a mature scheme that is well funded, the employer may also want to steer clear of racier or longer term investments, including productive finance.  In contrast, sponsors of open DB schemes may be more open to trustees making such investments, if the long term expected returns may reduce the need to pay as much into the scheme in the future.  Again, tax incentives could well help here.

Current and proposed regulatory funding regimes

The Pension Schemes Act 2021, and draft regulations under that Act, will introduce a new requirement for DB schemes to have a funding and investment strategy in place, including a journey plan towards low dependency as the scheme reaches maturity. Reflecting the messaging in its annual funding statements over the last few years, TPR’s draft DB funding code likewise expects schemes to be taking on less risk as they mature, rather than looking at more risky assets, such as productive finance.  Changes would be needed to the new funding approach to ensure it is consistent with any proposals in relation to productive finance.

Capital backed investment structures

These structures can offer some of the benefits of consolidation without having to sever the link with the sponsor, allowing schemes to retain the benefit of the employer covenant and associated security for benefits. The market for these structures could develop alongside regulatory and tax incentives.

Building surplus

Question 3: How many DB schemes’ rules permit a return of surplus other than at wind up?

In our experience, older schemes often don’t contain a power to return surplus in an ongoing scheme.  However, OPRA (the predecessor to TPR) previously had a statutory power to grant a “modification order” (eg to modify a scheme’s rules to enable a return of surplus to the employer from an ongoing scheme) when the level of funding in a scheme had exceeded certain HMRC limits.  This was to assist trustees in satisfying an HMRC requirement to reduce or eliminate any surplus in the scheme, which fell away on 6 April 2006, when the new pensions tax regime came into force.

Newer schemes often have an express power to return surplus to an employer in an ongoing scheme.  However, scheme rules are all drafted differently so may have certain limitations built in, such as augmenting member benefits before making any return of surplus.

Introducing a power to return surplus in an ongoing scheme is complex, and many schemes have restrictions in the power of amendment which may prevent the power from being introduced.

Even for those schemes that contain a power to return surplus in an ongoing scheme, there are legislative conditions that currently need to be met, including that the trustees are satisfied that the return is in the interests of members.

Question 4: What should be the conditions, including level of surplus that a scheme should have, be before extended criteria for extracting surplus might apply?

Benefit to members

Many trustees would expect some upside to members before agreeing to any return of surplus.  However, the level and extent to which this would be appropriate would vary from scheme to scheme.  For example, if the scheme had generally been funded by employer contributions, with no or minimal member contributions, it could be thought that an upside to members would not be necessary. It would also depend on the benefit design – if all benefits are inflation protected, there may be no obvious benefit improvement to offer members.  However, for many schemes, some tranches of pension benefits have little or no inflation protection, so granting some inflation-linked increase could be seen as an important benefit improvement.

Level of funding

We would expect that any refund of surplus should not take scheme funding below an appropriate funding measure, for example, fully funding on a buy-out basis, with some margin or buffer above 100% funding.  However, this is an area where we will leave the commenting to the actuaries.

Open vs closed DB schemes

There are different considerations for open and closed schemes.  For instance, trustees of a closed DB scheme may be reluctant to allow a return of surplus to employers when the alternative would be being sufficiently funded to enter a buy-in or buy-out.  In contrast, trustees of a well-funded open DB scheme may be more willing to consider a return of surplus, if there were sufficient benefits for the scheme as a whole, eg the return was part of a wider support package from the employer to the scheme.

Question 5: Would enabling trustees and employers to extract surplus at a point before wind-up encourage more risk to be taken in DB investment strategies and enable greater investment in UK assets, including productive finance assets? What would the risks be?

As mentioned above, the trustees and employers have very different roles to play.  The key duty for trustees is to ensure members are paid the correct benefits at the correct time.  The benefit of extracting surplus out of the scheme would fall to the employer, not the trustees.  As such, it is difficult to see how extracting surplus would encourage trustees to take more risk, unless it were linked to some other benefit for scheme members.

As with any investment, there is a risk of investments in productive finance falling in value.  Given the longer-term nature of productive finance, this would be a particular issue for closed DB schemes, where they may not have sufficient time to recoup any losses.

There are also practical difficulties with investment in complex long-term funding solutions – they can make buy-ins and buy-outs with insurers more difficult, as insurers won’t take them on, so they have to be unwound, which can be a complex and expensive process.  There are similar difficulties in having illiquid assets if a scheme is forced to wind up under the PPF legislation.  If schemes are targeting transfer to a DB superfund, or a DB master trust, then the receiving fund or scheme would need to be able to take the assets in specie, or similar difficulties would arise in unwinding the investments.

Question 6: Would having greater PPF guarantees of benefits result in greater investment in productive finance? What would the risks be?

Trustees cannot take into account compensation available under the PPF when making investment decisions, so adjusting any compensation available under the PPF would not affect any such decisions.

Similarly, when TPR is assessing whether an employer might have acted in a way that materially affected the likelihood of accrued scheme benefits being received, which is an element of the criminal offence under section 58B of the Pensions Act 2004, any PPF compensation must be disregarded.

Question 7: What tax changes might be needed to make paying a surplus to the sponsoring employer attractive to employers and scheme trustees, whilst ensuring returned surpluses are taxed appropriately?

It is important to remember the distinction between the role of the trustee and the employer again here – see question 5 above as to why returns of surplus are not an incentive for trustees.

The current tax charge on returns of surplus to an employer is generally 35%, although there are certain exceptions (eg if the employer is a charity).  As employers benefit from tax relief on contributions into a registered pension scheme, we would expect that paying the surplus even with the tax charge is attractive in any event.  However, a lower tax rate would no doubt be more attractive – aligning it with current corporation rate levels could be one option.  Of course, with any relaxation of tax legislation, there would need to be appropriate checks and balances in place to minimise the risk of abuse.

Question 8: In cases where an employer sponsors a DB scheme and contributes to a DC pensions scheme, would it be appropriate for additional surplus generated by the DB scheme to be used to provide additional contributions over and above statutory minimum contributions for auto enrolment for DC members?

There are legal difficulties in using a surplus in a DB scheme to provide contributions into a separate DC scheme, including restrictions in schemes’ rules as well as current tax legislation.  We think there would need to be an overriding statutory trustee power to make this option workable.

However, we are already aware of schemes that use a surplus in a DB section of a hybrid section to fund the contributions (both the statutory minimum contributions as well as any additional contributions) to the DC section of the same scheme.  This approach has been supported in case law and seems to work well in practice.

Question 9: Could options to allow easier access to scheme surpluses lead to misuse of scheme funds?

Yes, they could – there will need to be appropriate protections in place to minimise the risk of misuse.


Question 11: To what extent are existing private sector buy-out/consolidator markets providing sufficient access to schemes that are below scale but fully funded?

Schemes that are below scale but fully funded on a buy-out basis can access private sector buy-outs.  Although there is only limited capacity in the insurance market for these deals, it generally works well.

The consolidator / superfund market hasn’t taken off yet – there is only one TPR-approved superfund and no completed transactions to date.  Note that TPR would not expect a scheme that is fully funded on a buy-out basis to transfer to a superfund – superfunds are for schemes that are less well funded.

Question 12: What are the potential risks and benefits of establishing a public consolidator to operate alongside commercial consolidators?

Potential risks include:

  • Underwriting risk. Any consolidator / superfund needs someone to ultimately underwrite the risk.  In the case of a public consolidator, we would expect this would fall to the government and then, ultimately, the taxpayer.
  • Adverse impact on commercial consolidators. Where there is a government-backed consolidator, this could adversely impact the commercial consolidator market, as trustees would view the government-backed consolidator as offering better security of benefits.

Potential benefits include:

  • Opportunities for smaller schemes. For those schemes that are not attractive to the commercial market, eg smaller schemes, a public consolidator could open up consolidators as an option which would not otherwise be available.
  • Expanding productive finance investment. A public consolidator could help achieve the policy aim of investment in productive finance if the legislation setting up the consolidator required the consolidator to invest in a certain way.  Having said that, that approach could increase the risk of calling on the taxpayer in the event of a deficit (see question 14 below).

Question 14: Could a public consolidator result in wider investment in “UK productive finance” and benefit the UK economy?

It would depend how the consolidator is set up.  The government could require investment into UK productive finance.  If the consolidator was able to invest in riskier assets more generally, the consolidator would not necessarily choose to invest in the UK.

Question 15: What are the options for underwriting the risk of a public consolidator?

The main option for underwriting risk in a public consolidator would be for it to be government-backed, ie ultimately funded by the taxpayer.

An alternative option could be for levies to be imposed on DB schemes, but we struggle to see how practical or appropriate that would be when not all DB schemes would be targeting transfer to a public consolidator (and they are already paying levies to fund the PPF).

Question 16: To what extent can we learn from international experience of consolidation and how risk is underwritten?

When drawing from international experience, it is important to compare like with like.  We are aware of several commentors drawing on the investment successes of the Canada Pension Plan (“the CPP”). The CPP was established in 1965 and is not a private pension plan like occupational DB schemes in the UK, instead it is the “second pillar” of Canada’s retirement income system, enabled by legislation.  All employed Canadians 18 years old or older are required to contribute a percentage of their salary to the CPP and the benefits it provides are subject to a cap (which was CAD 1,154.58 a month in 2019).

The CPP Fund is now managed by the CPP Investment Board, established by legislation in 1997, with a statutory objective to “invest its assets with a view to achieving a maximum rate of return, without undue risk of loss, having regard to the factors that may affect the funding of the Canada Pension Plan”.  The CPP Fund has assets of more than half a trillion Canadian dollars.

The CPP is a partially funded plan that is financed using a “steady-state funding” methodology. This involves a steady‑state contribution rate that is the “lowest rate sufficient to ensure the long‑term financial sustainability of the base Plan without recourse to further rate increases”.  This means that the funding of the CPP is heavily reliant on future contributions.  Given all employed Canadians are required to contribute to the CPP, this seems a reasonable funding basis.  If the assets were valued on a “closed group approach” (ie assuming no future contributions or future accrual) then the CPP would have a huge unfunded liability of over CAD 800 billion in 2018.

Whilst it would not be appropriate to draw direct comparisons between the CPP and the UK pensions industry, in particular in respect of the funding approach, there are useful insights to take away when thinking about a public consolidator.  For example, considering an appropriate statutory objective for the consolidator.

Pension Protection Fund as a consolidator

Question 17: What are the potential risks and benefits of the PPF acting as a consolidator for some schemes?

Potential risks include:

  • Potential cross-subsidy with PPF compensation. Would there be clear segregation of assets between the compensation and consolidator sections? We would expect so, to avoid cross-subsidy by schemes paying the PPF levy.
  • Administrative complexities. When a scheme enters a buy-out, there is a huge amount of work to make sure the right benefits will be paid.  Less work is needed when a scheme goes into the PPF, as the PPF compensation is standardised to an extent.  There are a huge number of different benefit structures in the DB landscape, even within a single scheme, due to benefit design changes and mergers of other pension schemes over the years.  It would be a huge undertaking for the PPF to successfully administer so many different benefit structures so there could be resourcing constraints.  An alternative could be for benefits to be “reshaped” on entry to the PPF consolidator, to ensure a degree of uniformity.
  • Funding burden on taxpayer / DB schemes? How would the ultimate risk be underwritten – would it be picked up by the taxpayer or by levies? As with question 15 above, we struggle to see a “fair” way to impose levies on DB schemes to fund the PPF to act as a consolidator.

Potential benefits include:

  • Economies of scale. PPF already has scale, which is of benefit when entering a new market, eg DC master trust market.
  • Expanding productive finance investment. As with question 12 above, legislation setting up the PPF as a consolidator could require the PPF to invest in a certain way.

Thought would also be needed as to the entry criteria.  Would it be the same as for commercial consolidators or set at a different level (eg restricted to smaller schemes that aren’t attractive to commercial consolidators)?

Question 19: How could a PPF consolidator be designed so as to complement and not compete with other consolidation models, including the existing bulk purchase annuity market?

Discussed above in question 12 in relation to public consolidators more generally.

There could also be a focus on distressed employers.  For instance, schemes that are funded above PPF levels but have insolvent employers could transfer to the PPF but then have top-up benefits provided by the PPF consolidator, rather than transferring to insurers, as is currently the case.

Question 20: What options might be considered for the structure and entry requirements of a PPF-run public consolidator, for example:

  • are there options that could allow schemes in deficit to join the consolidator? In keeping with other consolidators, we would expect that schemes that are well funded but not fully funded on a buy-out basis would be in scope for transferring to the PPF consolidator. In terms of deficits on other funding bases, we could see this could potentially, but thought would be needed as to how any deficit would be “made good”.
  • what principles should there be to govern the relationship between the consolidator and the Pension Protection Fund? There would need to be clear separation of assets to ensure no cross- subsidy between the PPF compensation scheme funded by the PPF levy, and the PPF consolidator.
  • should entry be limited to schemes of particular size and / or should the overall size of the consolidator be capped? We suggest further research is undertaken to understand how a public consolidator would fit alongside the commercial consolidators and whether any limits or caps are needed to ensure they work well together.
  • how could the fund be structured and run to ensure wider investment in UK productive finance? As mentioned above, the legislation establishing the PPF as a public consolidator could require the PPF to invest in a certain way.