This is how the DWP introduces the question of surplus funding in its consultation on options for defined benefit schemes.
Incentives for employers to invest for surplus are currently quite weak. Employers have little to gain from any surplus, their access to which is strictly limited, and they are entirely responsible for any deficit that might emerge if investment does not perform well. Any deficit would have to be filled by additional employer contributions and would have to be reported on the company Balance Sheet. This could affect the company’s market capitalisation, and the company’s ability to borrow and attract the investment needed to grow.
Nor are surpluses helping Trustees
There are similar issues with incentives for trustees. There are many varied drivers that lead trustees to decide how much risk to take with pension scheme investments. Scheme trustees are concerned with ensuring members get the benefits they have been promised and will want to limit risk that could threaten members’ interests; they may therefore prefer contributions from the employer to relying on uncertain investment returns. There is little incentive to invest to drive funding to a higher level than is needed to meet the pension promises.
For businesses which are running both a DB and defined contribution (DC) fund, there is currently limited ability to transfer surpluses to help bolster DC funds whilst protecting the member benefits for the DB funds.
The Government is calling for the views of the private sector on how surpluses should be dealt with , starting their questions by asking ” How many DB schemes’ rules permit a return of surplus other than at wind up?”
My answers are in bold.
The Pensions Regulator and Pension Protection Fund have detailed analysis. They will have better intelligence on this than the private sector as they aggregate data from all schemes
According to an analysis of FTSE 350 companies by Barnett Waddingham, the actuarial consultancy, their schemes have £50 billion of assets in excess of 105 per cent of the funding levels regarded by The Pension Regulator as enough to leave a scheme self-sustaining if the sponsor were to fail
What should be the conditions, including level of surplus that a scheme should have, be before extended criteria for extracting surplus might apply?
At present, the rules allow it only after a scheme is in wind-up after securing all promised benefits, for example by handing all liabilities to an insurance company through a so-called buyout. There is also a penal rate of tax at 35 per cent on any money paid out.
So Trustees are not incentivized to run-on a pension. Once a scheme is ready to buy-out , it is logical for the trustees and employers to wind up the pension scheme after outsourcing the payment of the promised pensions to a third party
This is driving sponsoring employers and Trustees to seek buy-out as a quick and easy way out of a no-win situation.
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?
Where a scheme has announced it will not continue to accrue future pensions, the liabilities of the scheme are finite and the trustees primary purpose is to meet the pensions promised in full. It is not to speculate with the fund behind these promises to deliver employers a surplus.
There are situations where a scheme may be used to increase contributions to related schemes (for instance a DC plan insider the same trust as the DB plan) but this is uncommon.
It’s legitimate for trustees to look to improve DC benefits from DB assets but this can only happen where there is clear daylight in funding and then only with the regulator’s permission.
Similarly the restoration of contentious benefits lost (such as on some pre-97 accrual) can only occur where doing so will not put at risk the core benefits not under contention.
Finally, where scheme allows discretionary increases to be made, these can only be made where doing so could not put reasonably in doubt , the payment of the core benefits promised in scheme rules.
Gaming a pension fund so heads the employer gets a surplus and tails the PPF gets the deficit is speculation and should play no part in DB funding.
Would having greater PPF guarantees of benefits result in greater investment in productive finance? What would the risks be?
Improving the guaranteed benefits of the PPF to mirror the benefits of the “scheme rules” of the DB scheme falling into it, would require an extra obligation on the PPF that would need funding. A proposal from LCP is that schemes looking to stay open or improve existing member benefits (including DC) could do so without “gaming” by paying a super-levy. This is a good idea, providing the trustees paying the levy consider their scheme well run.
This would allow such trustees to invest for growth and move some of the fund into productive assets. Here the risk to members would be minimal (amounting to the opportunity cost of the super-levy not being invested).
As with any investment for growth, there is a risk that such an investment might fail, but a good scheme would seek to mitigate such risk through the choice of asset/fund managers
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?
We don’t see any reason for changing the tax position on pension scheme surpluses. The tax-system should not incentivise employers taking surpluses.
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?
Yes (see above), though we understand that this can only be done if the DC members are in the same (hybrid) trust as the DB members. We shouldn’t allow money to be extracted by the employer for onward payment into another workplace scheme. There is considerable risk that the money would not get paid across or paid across at a much diminished rate (relative to the surplus).
Could options to allow easier access to scheme surpluses lead to misuse of scheme funds?
They could. Pension liberation schemes , from Maxwell to ARC have sort to release money due to pensions by foul means
I have produced other blogs in answer to this open consultation and call for evidence