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A DOSE OF ECONOMIC REALITY – THE PENSIONS GREEN PAPER

27 February 2017 | London
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Last Monday, 20 February the Government published its long-awaited Green Paper, "Security and Sustainability in Defined Benefit Pension Schemes". It focuses on the "central challenge" for DB pension schemes, namely how best to provide a high degree of security in income in a world where nothing can be certain or guaranteed. The aim of the paper is to stimulate discussion about, and start the process of mapping-out the way forward with regards to, the various issues that afflicted private sector DB schemes in such a high-profile way during the course of 2016.

Background

Who in the pensions industry will forget 2016, a year which saw the legal and regulatory framework within which DB pension schemes operate called into question like never before. Central to this was the emerging concept of 'stressed' or 'distressed' schemes, suffering from major underfunding and sponsored by entities which – whilst not facing imminent insolvency – were the subject of serious doubts as to their ongoing ability to provide the requisite levels of financial support. Of equal concern in a different context was felt to be the speed and manner with which the Pensions Regulator would take action, when faced with corporate activity posing the threat of a materially-detrimental effect on DB schemes. Cases involving wellknown entities such as British Steel, Halcrow and BHS led to a gathering momentum which of course culminated, late last year, in recommendations by the Work & Pensions Select Committee for a radical overhaul of certain aspects of that overarching regime.

Green Paper

The Green Paper aims to progress some of those recommendations and seeks to explore the viability of others. It starts from the premise that we are fortunate to have a robust and flexible system of pension protection in the UK – a view not necessarily shared by commentators in the months prior to the Select Committee issuing its findings. It continues, however, that because of this widely-held view that aspects of the regime could be changed to deliver better outcomes (and/or increase confidence in pensions savings) and in line with Government's responsibility to ensure that the system remains fit for purpose, a properlyinformed discussion on the best way forward needs to take place.

The Green Paper begins by stating the Government's stronglyheld view that there is not a significant structural problem with the current regulatory and legislative framework. It indicates how there is little evidence to show that pensions are generally unaffordable for employers, or that funding deficits are driving them to insolvency – there is no evidence of an imminent crisis affecting the sustainability of DB pension schemes generally, it says. It suggests that, on the whole, the regulatory system applying to defined benefit pension schemes is satisfactory, and that the funding regime fairly balances the interests of employers and trustees/members. Perhaps the Government's overall stance can be best summed up by one quote from the Green Paper itself: "DB pensions are hard promises – they are debts like any others, and debts should be honoured where sponsoring employers are able to do so".

Against this backdrop the Green Paper goes on to consider four broad areas – funding and investment, pension scheme affordability, member protection and scheme consolidation – and whether there is scope for change. The approach taken clearly errs on the side of caution, recognising the "significant drawbacks" inherent in many of the changes being mooted; and those who were quietly hoping for a regulatory shake-up following last year's Select Committee report are sure to be disappointed. A number of the Select Committee's (undoubtedly well-intentioned) recommendations are felt by the Green Paper to be just not viable: more about these later. But that all said (and particularly where adequate safeguards can be found to minimise 'moral hazard' and the risk of abuse by unscrupulous employers) the Government does appear willing to listen, and to explore solutions to some of the more pressing issues that the industry is recognised to be facing. The industry's pleas that businesses are struggling to honour promises that were made in a very different environment have not entirely fallen on deaf ears.

Areas for potential change

Of the four broad areas considered by the Green Paper, those of 'affordability' and 'member protection' appear the most pertinent from a legal perspective whilst 'consolidation' appears the most intriguing.

Affordability

  • Easements for stressed schemes: Government's view is that no case has been made out for an industry-wide facility to reduce the level of benefits promised by DB schemes. The Green Paper also actively seeks to dispel assertions that the current system leads to outcomes that are essentially binary in nature (i.e. benefits paid from a scheme in full, or an employer failure as a result of which the scheme enters the PPF): statistics are said to illustrate how approximately 700 schemes have transferred to the PPF to date, a further 100 have secured benefits above PPF levels of compensation following an employer failure, and a final 40 have been rescued following sponsor insolvency.

    The Government does nonetheless recognise that there may be a case for less rigid arrangements to apply to stressed schemes and their sponsors. Examples would include:
    • a relaxation of the 'regulated apportionment arrangement' regime whereby sponsors can separate themselves from unaffordable schemes (for example by loosening the requirement that insolvency must be demonstrably likely within the next 12 months);
    • permitting such schemes to 'run on' without a sponsor, rather than falling into the PPF or going into wind-up;
    • broader powers for TPR to either wind a scheme up or to sever it from its sponsoring employer;
    • allowing benefit levels to be cut in certain, very limited circumstances (despite the "radical … and highly contentious" nature of such an idea); and
    • providing more intensive ongoing support from both the Pensions Regulator and the professional trustee community.

The existence of adequate safeguards to prevent abuse would need to be a given for any such potential changes to be progressed; as would a precise definition of the very concept of 'stressed scheme' to which such easements could potentially apply.

  • Indexation: The Government continues to appear vexed by this most unwanted hot potato. On the one hand the Green Paper volunteers that allowing all schemes to move from RPI- to CPI-based indexation "would have [a] significant impact on members' benefits". And on the other it recognises the concept of the 'scheme rules lottery' that dictates what a particular scheme must provide, and actively posits the suggestion of a statutory override to allow just such a switch to be made. As for stressed schemes, a more targeted approach is again proposed – potentially including additional flexibilities such as the temporary suspension of indexation in appropriate circumstances (so-called "conditional indexation"), or the ability to remove all but statutory minimum indexation from a scheme's governing provisions.

Member protection

  • Heightened regulatory oversight: The Government does not appear keen on suggestions for a mandatory clearance regime, other than in "narrowly limited" circumstances requiring a "high threshold" to be satisfied for clearance to be mandated. Very careful consideration would need to be given to the potential impact on corporate activity and the competitiveness of the UK economy generally, along with the (counter-intuitive) possibility of an increased risk to members of pension schemes falling into the PPF.

    Punitive fines for those engaging in activity found to have a detrimental impact on the pension creditor (another suggestion of the Select Committee, its so-called "nuclear deterrent") appears to find more favour. But better information flow between parties to corporate activity and the Pensions Regulator, along with the power for the Regulator to compel parties to engage with it (with strict and possibly criminal sanctions for non-compliance), are the firmest proposals for helping the Regulator to take a more proactive approach to its regulatory duties. Increased resources (or perhaps the introduction of 'hard charging' for certain services provided by the Regulator), and the bestowing of more power into the hands of pension trustees themselves, also number amongst the suggestions on which discussion is invited.

Consolidation

The final area addressed by the Green Paper is that of consolidation, something with which the Select Committee found clear favour to the extent that it even proposed the creation of a statutory aggregator fund under the auspices of the PPF, as part of a wider initiative of 'compulsory consolidation' for smaller schemes. Whilst noting a number of potential advantages (and inviting industry comment), the Government is also very keen to draw out the various challenges to the implementation of any consolidation initiative. These are said to include:

  • a high level of up-front costs, particularly relating to quality of scheme records;
  • the vested interests of trustees and scheme advisers, ranging from day-to-day operational matters via funding and investment strategy to sensitive matters such as discretionary benefits;
  • sponsors' reticence to share too much detail about their business and commercial strategy;
  • nuanced differences between the underlying characteristics of scheme investments; and
  • the difficulties of scheme benefit structures being subtly different but different nonetheless;

along with, in cases of 'full consolidation', significant questions around cross-subsidy and the sharing of liabilities across participating schemes and their sponsors – challenges which, according to the Green Paper, would be a "fundamental issue" and "should not be underestimated".

Various difficulties are also foreseen with the notion of a statutory aggregator fund to facilitate the consolidation of smaller schemes, for example to address potential failure in the buyout market (as manifested in such schemes' lesser ability to obtain favourable terms for buyout, even if healthily funded). The question of 'who bears the risk' was felt to be particularly pertinent, with each option – the employer, members, and the PPF – having notably significant downsides. How to assess scheme failure, and how to fund the PPF via a suitable levy against such a risk, could also result in a significant change in the PPF's role which would effectively become the underwriting of the consolidation vehicle's investment risk.

The Green Paper's 'piece' on consolidation concludes with the message that Government believes there to be a strong case for voluntary consolidation but is not convinced that compulsion would be a proportionate response. It also indicates further Government interest in the question of how the 'employer debt' regime applies to non-associated multi-employer schemes (and appears to promise that, building on 2015's Call For Evidence, separate consultation will take place on a "new option" for managing employer debt in such circumstances). The issues surrounding orphan liabilities in these schemes – such as have been hitting the headlines recently in connection with the Plumbing Industry Pension Scheme – are also recognised, and a request made for further evidence to allow a proper assessment of the scale of the issue to be undertaken.

Where next for DB pensions?

The Green Paper is in summary very 'green' and, whilst well-intentioned, clearly recognises the difficult balancing act that it is having to perform between supporting the existing regulatory regime and finding scope for change in suitable circumstances. To the extent that any of the proposals put forward find favour, the Green Paper can only be the first of a great many steps towards dealing with the issues exposed within the pensions industry during the course of 2016. At a headline level the outcomes it seeks are to be applauded, but whether any of them will be sufficiently viable (and/or capable of sufficient definition) to make it to the statute books clearly remains to be seen.

The consultation period closes on 14 May.

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