On 20 February 2017, the Department for Work & Pensions (DWP) released its Green Paper entitled "Security and Sustainability in Defined Benefit Pension Schemes".
The Green Paper explores the current issues facing Defined Benefit (DB) pension schemes and seeks views from members, trustees, employers and other pension professionals on the ways in which confidence might be restored in a system which, although it has worked well for decades, has suffered in recent times due (at least in part) to the negative impact of some high profile cases. In this article, we look at those aspects of the Green Paper which will be of most concern to trustees. A further article considering the proposals from an employer perspective can be found here.
- The evidence does not point to there being a crisis in the DB pensions sector. The system is working broadly as intended but there are widespread perceptions that the DB pensions sector is in crisis. This is not supported by the evidence.
- Confidence needs to be restored. Rather than there being a crisis in the DB pensions sector itself, it is more a crisis of confidence in the sector.
- Support, engagement and empowerment. The Green Paper explores the ways in which this could be achieved, whether by better supporting trustees, improved engagement with members or increased regulatory and trustee powers.
Better supporting trustees
The Green Paper acknowledges that trustees are really the 'first line of defence' for scheme members and have a fiduciary duty to act in the best interests of all scheme members.
Although the DWP is seeking views and evidence on whether some trustee boards are acting in the most appropriate way when it comes to funding and investment decisions (it questions, for example, whether trustee boards are adopting overly conservative investment strategies, and if they are, whether this is because there is a lack of understanding or because of other factors), it does not go so far as to suggest that trustee boards should only be made up of professional trustees nor that existing trustees need more training (while acknowledging that this is being looked at by the Pensions Regulator in its work on 21st Century Trusteeship).
This approach is to be welcomed. In this team's experience, having a well-chaired, diverse trustee board is the optimal situation. Trustees receive professional advice in relation to their funding and investment strategies and there may well be good reason why trustee boards have adopted conservative investment strategies - employers have a role to play in this too and may well be influencing the shift towards more conservatism.
The Green Paper does suggest that there may be an argument for more intensive support from the Pensions Regulator for stressed schemes/sponsors. This would include more guidance for trustees of stressed schemes to assist trustees in understanding the actions schemes should take and, if appropriate, replacing existing trustees if it deemed that greater expertise was needed. Trustees faced with a stressed sponsor may well feel the weight of their responsibilities more acutely and, in our view, extra support in these circumstances could help ease that burden.
Improved engagement with members
The statistics suggest that there are over 11 million people in DB pension schemes in the UK, each expecting an average pension of Ł7,000 per annum. While those involved in pensions know and understand the risks only too well, despite recent high profile cases, the recent Pensions and Lifetime Savings Association (PLSA) Task Force found that 71% of respondents to their survey thought that they were guaranteed to get the income they had been promised from a DB pension and less than half of those with a DB pension had considered whether a deficit might affect their scheme.
The Green paper explores two key themes around improved member engagement:
- more information to help members understand the requirements for scheme funding and more information about the current funding position of their scheme; and
- better communication of the degree of certainty and risk inherent in the DB pensions regime.
The DWP invites views on whether it is trustees or the Government that should be tasked with raising awareness of these issues.
Improving the understanding of members about, and their engagement in, DB pensions must be a positive step. It might well be that the Government is best placed to undertake this kind of communication exercise with schemes able to supplement that information should they so choose (as, perhaps, is the case currently with pension scams). That way, all members of all DB scheme are assured of receiving at least the same basic information.
Increased powers for the pensions regulator and trustees
Much of the Green Paper focuses on options for increased regulatory involvement in the DB pensions arena. For trustees, the more interesting discussion is probably around increased powers for them.
The options put forward for comment include:
- requiring the employer to engage constructively with the trustees;
- requiring the employer to provide information that the trustees might reasonably require in order to be able to carry out their functions;
- employer and trustees to publish a joint statement of objectives for the pension scheme (perhaps within a range of acceptable objectives set by Government);
- a requirement for the employers of severely underfunded schemes to enter into formal consultation with trustees when the sponsor is considering making dividend payments.
In this team's experience, many trustee boards already engage extremely well with sponsoring employers, and arguably more so since the introduction of the Pensions Regulator's guidance on integrated risk management.
There is already a requirement for employers to provide trustees with the information they or their professional advisers reasonably require to perform their respective duties (Regulation 6(1) of the Occupational Pension Schemes (Scheme Administration) Regulations 1996, but if an employer fails to provide that information, trustees have very little power to enforce it. This needs to be addressed. More assistance to trustees where the employer is reluctant to engage is therefore to be welcomed but it must be accompanied by some form of recourse or sanction where employers fail in their duties.
Any obligation for formal consultation with trustees before the payment of a dividend where a scheme is severely underfunded must be treated with caution. Many UK pension schemes are sponsored by UK subsidiaries of larger overseas corporate groups - any attempt to increase the regulation of those subsidiaries (especially in relation to matters which they will consider to be legitimate business decisions) might have a longer term negative impact on UK plc which would be highly undesirable from a UK DB pensions perspective.
Indexation and revaluation
There is little appetite in the Green Paper for giving schemes or employers the power to abandon indexation/revaluation or to have a blanket power to change indexation/revaluation measures or caps but the DWP is keen to explore the idea of conditional indexation of pensions in payment such that indexation of pensions in payment could be suspended for a time where a scheme is stressed.
It will be interesting to see how the industry responds to the question of whether trustees and employers should have some sort of overriding ability to amend the revaluation measure and/or cap. In some schemes, "inflation protection" was historically written into scheme rules as RPI, perhaps with a 5% cap. Of course, every set of scheme rules is different and many employers and trustees have already spent a lot of time and money trying to ascertain whether a change can and should be made. If the position were clarified by the Government, perhaps that money could be better spent in the scheme to protect members' benefits (as is stated to be the overriding objective of the Green Paper).
In the absence of any significant shift in the Government's stance on this issue, with appropriate safeguards (to guard against manipulation of the figures), conditional indexation could be a good answer for stressed schemes which would otherwise survive.
There are many difficult questions raised by the Green Paper against the background of the sometimes competing interests of those involved in DB pensions. It will be interesting to see how the industry responds and where, ultimately, the Government lands. We have already provided comments to the Work and Pensions Select Committee in response to its call for evidence, and we will also be providing comments on the Green Paper.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.