Harriet Fletcher

Penny Cogher

I’ve been pointed to a very good article on pension increases by Irwin Mitchell’s Penny Cogher and Harriet Fletcher on discretionary increases. The article was written this January and I suspect that in the meantime, the presumption of “buy-out” or “buy-in” and indeed of schemes being in an end-game, has softened. Many schemes are considering the prospect of running on their defined benefit schemes , either to improve the DC contribution or to unlock productive finance for the sponsor and its shareholders.

That does not reduce the power of the article’s closing paragraph which is one of the clearest statements of the need for change in pension trust law in recent times. I quote it in full

While it is good to have all benefits secured through annuities, it may be that there should be a change in the law here. There is no rationale for not giving pre-6 April 1997 benefits pension increases for non GMP benefits, and this should be a requirement before surplus is refunded to an employer. The PPF’s rules should also be changed. The PPF’s excess in funding has partly arisen on the back on not providing pre-6 April 1997 increases for non GMP benefits even where the scheme rules require these increases, and the scheme was funded for them.

But please do not scroll to the end of the Irwin Mitchell article to see these paragraphs again in isolation, read them in the context of the development of a train of thought.

If the long or short-term aim of the trustees is to seek to buy-out or buy-in the scheme’s benefits, is it not their fiduciary duty to ensure that not only does the employer rid itself of unwanted risk , but that – primarily – the interests of members are best served.

To date, I have heard much talk of achieving the lowest price for buy-out , but less of achieving the maximum pension for those who are bought out or find their scheme benefits secured by an annuity on the road to buy-out. Once the deed is done, there is no turning back, there are no discretionary increases from an annuity.

The concept of “shared outcomes”, where guaranteed benefits are supplemented by a share of profits achieved by a scheme above the required run-rate, is nothing new. It is the principal on which “with-profits” policies have run in insurance-land and it was part of the contract of the “shared-cost” model of DB.

We forget, so long it was that most private-sector employees received DB accrual, that employees felt they had an economic interest in the running of the scheme. They contributed a proportion of the cost of running the scheme and they were promised discretionary increases, not by some mis-writing of the trust deed and rules, but because a pension scheme was seen as a shared enterprise.

It is also true that in the days before the PPF and the Financial Assistance Scheme, members of pension schemes had 100% of their benefits “at risk”. These pre PPF members actually shared considerably more risk than is appreciated today (something that should be pondered by those who consider CDC flawed for having no guarantees).

Employees had an economic interest in the upside and had a very real interest in the covenant of their pension scheme because there was no safety net. The arrival of the PPF coincided with the end of that model, the closure of DB schemes – first for new entrants and then for future accrual.

But while the schemes sought to lock-down their liabilities, they could not lock-down the markets which continued to see positive returns on growth assets. Those schemes that did not load up on gilts through borrowing, have benefited from the end of the suppression of interest rates in 2022 and are now healthily in surplus. Even when a scheme lost heavily from LDI , there was still sufficient pick-up in notional funding levels from the collapse in the valuation of liabilities to render many of them solvent.

Ironically , the period of national austerity following the accession of Osborne to the Treasury throne, was also a period of pension austerity. Schemes, that had interest rates not been supressed would have been considered solvent, were deemed in deficit and sponsors required to make up 100% of the funding shortfall. The concept of shared risk had been abandoned and with it the concept of  discretionary payments (at least in the employer’s eyes).

The architects of the shared-cost, shared-risk, shared-outcomes model of DB schemes prior to the introduction of the concept of “guarantees”  (including guaranteed minimum pension) had long since gone. A new breed of employers arrived in the early 21st century who regarded the pension scheme as a debt on the company’s balance sheet and not a part of the company’s reward strategy. The pension scheme was so far removed from the company’s growth strategy as to be considered a drag on productivity.

Which is why, philosophically, the captains of industry who are currently turning down the recommendations of trustees of firms like BP, Shell, Exxon , Hewlett Packard and many others , to pay full cost of living increases, are so hardened. Many envy the DB pensioners for having a benefit they did not enjoy. Most, even if they have DB accrual, have no pre 1997 accrual, the promises of discretionary benefits were not made on their watch and were not made for them. All they have known is the pension schemes as a menace rather than a benefit.

Articles such as the one cited, give us some historic perspective on the nature of the promises that are not being kept, even though schemes can keep those promises without imperilling the scheme or sponsor. The dark days of pension austerity are now behind us, as is the chilling impact of the LDI crisis. Schemes are coming out of the bomb shelter and seeing blue sky above them. It is time to recognise that the concept of DB pensions is not so economically disastrous as thought and that , indeed, our great pension schemes still have the legs to pay pensions that don’t wither on the vine. Let me repeat that final paragraph of Penny and Harriet’s article

While it is good to have all benefits secured through annuities, it may be that there should be a change in the law here. There is no rationale for not giving pre-6 April 1997 benefits pension increases for non GMP benefits, and this should be a requirement before surplus is refunded to an employer. The PPF’s rules should also be changed. The PPF’s excess in funding has partly arisen on the back on not providing pre-6 April 1997 increases for non GMP benefits even where the scheme rules require these increases, and the scheme was funded for them.