Pensions are now center-stage in Britain’s economic debate. The assets within our DC and DB pension systems are openly discussed by politicians , the think-tanks and in the press.

The immediate future of UK pensions has been opened to debate

There has been a polarisation over the past few weeks which exposes a fundamental divide in thinking about funded pensions in the UK.

On the one side of the divide are those who consider that a pension is a promise that should be backed by risk free assets and divorced from wider social and climactic issues. This view – which put the trustees fiduciary duty as being the payment of the promise in full, would have pensions take fewer risks by financing existing payments rather than investing for future generations.

On the other side of the divide are people who still think of inter-generational solidarity where investment into the future growth of Britain is made by those with wealth – either backing their pension or directly invested in their pension pot. Here the emphasis is on generating the economic conditions for future payments to become affordable.

I  could characterise the first view as “lockdown” and the second as “build back”.

VFM Framework and DB Funding Code – the regulatory focus

There are two key areas of pensions policy which provide a focus for the debate.

For DC pensions, there is a nexus of issues around consolidation, a relaxation of cost and charges and the investment of funds – to get better returns for members by investing in higher return strategies; that at least is what the VFM framework is supposed to be about.

Those in the “lock-down” camp want to improve member outcomes by sticking with tried and tested investment strategies, by driving down costs and focussing on getting more money into pensions from employers, savers and from tax-relief.  This position is well expressed by Nico Aspinall in his latest podcast (minute 50 onwards).

For DB pensions, the focus is on the future of the DB funding code and whether the goals of self-sufficiency and buy-out – the instruments of lockdown – prevail. Those who consider we have made enough pension promises support the strictures  of the proposed DB funding code, arguing that it ensures that existing promises get paid without recourse to the Pension Protection Fund. The DB funding code assumes that DB pensions, at least in the private sector are in terminal decline.

Revitalising Corporate DB pensions with the help of the PPF

Until very recently, Government policy was that corporate DB pensions were a thing of the past. This was the view argued by Government when the Pension Schemes Act was debated in 2020. DC pensions were assumed to be the fertile ground for growth investment and Australia was used as an example of Government nudging consolidation which created the scale for a more productive investment of assets to take place.

But over the past two months , the Government has moved from the DB lockdown camp to a view that not just DC workplace pensions but DB schemes can be converted to the “build back” agenda.  A number of Treasury leaks suggest that Ministers and senior officials are considering converting the Pension Protection Fund into a pension consolidator with an investment brief to invest in productive capital. First the Mayor of the City of London and then the Tony Blair Institute have proposed the creation of superfunds capable of receiving money from DC pots and DB pension schemes.

This is understandably receiving short shrift from organisations which put the fiduciary duty and the sanctity of the pension promise as the main priority. For organisations such as the PLSA, this is the politicisation of pensions and a threat to a well established pension industry dependent on diversity , rather than consolidation.

Further options for DB trustees on the horizon

DB pension schemes appear to be in rude health despite being shorn of some £500bn of their asset base in 2022. The depletion of assets is more than compensated for by a reduction in the cost of funding for liabilities. This reduction is primarily down to the adoption of higher discount rates which reduce the present values of liabilities.

And this rude health gives their trustees and employers options. One option is to sell-out to insurers who are eyeing up the market and cherry-picking the best managed and funded pension schemes to enhance their bulk annuity operations. For trustees, this involves preparing a scheme for buy-out by investing as an insurer will invest – in low risk bonds and gilts

Another option is to wait and keep the pension scheme in a holding position awaiting buy-out at a later stage, and  the orderly run off of liabilities through the payment of pensions in the meantime. This involves maintaining a very cautious investment strategy – not dissimilar to those preparing for buy-out.  This is a strategy targeting sel-suffeciency – hoping to make no further cash calls on the sponsor

But a third option is now being talked about, where with the support of Government, schemes might take a much more aggressive attitude to investment. The pension consultancy LCP are suggesting that the Pension Protection Fund encourages this to happen by offering itself as a fallback, if such an investment strategy goes wrong.

The Government may be considering changing the rules to allow the PPF to provide this fallback or it may encourage trustees to consolidate their scheme directly into the PPF, where the scheme cannot negotiate terms with an insurer. This was an option for the PPF when it was originally being designed, an option that was rejected because it was seen to open the floodgates to demand from under-funded schemes.

These new options which are appearing on the horizon, are only rumoured and they are likely to be fiercely opposed by those who want pensions to lockdown and use existing options.

DC schemes and  DB schemes may converge

The proposals to create substantial asset pools to build back Britain, was originally proposed by Rishi Sunak and Boris Johnson as Britain was coming out of the pandemic. Progress has been slower than hoped, partly because the Pensions Regulator’s guidance to DB schemes did not encourage such investment and partly because a combination of competition and charges regulation forced DC schemes to remain in listed markets (even when growing through consolidation).

But the warm reception given to Nicholas Lyons’ proposals by both the Chancellor and Shadow Chancellor, and the publication of the even more ambitious proposals of the Tony Blair Institute, include talk of both DB and DC schemes using the same pools. It is very unlikely that the Government will go so far as to mandate schemes to invest in these proposed superfunds, more likely that they will be incentivised to do so by support from a reformed PPF and the interventions on value for money, the consumer duty and the creation of better post retirement options for workplace pensions.

Taken together, a more aggressively invested DB pension sector and a DC sector managed for value rather than for lowest cost, could lead to a convergence of the two. This could be around a third type of scheme – CDC – or it could be through more aggressive DB and DC consolidators – superfunds and the PPF.

Where the debate moves next

Over the next few days, this debate is likely to gather momentum as LCP lay out their proposals to a wider audience (you can watch this webinar now – simply by registering retrospectively).

The following week is the PLSA investment conference where this debate is likely to be the central discussion.