Investment for UK Growth : The Public Policy Opportunity

This article has been written by William McGrath , Founder of C-Suite.

All stakeholders can benefit from better use of £1.4 trillion of resources behind Defined Benefit pension schemes.

Security and Growth : Astute incentivisation : No mandation

Add UK to Solvency UK for life insurers: Run On 4 Goode exercising discretion to maintain real pension value.

At present too much money is invested offshore by life insurers and reinsurers. DB investment allocation is ultra and unnecessarily cautious.

The benefits of Solvency UK and of having overfunded DB schemes need directing to protect benefits and to grow the economy. DB scheme trustees can be well Informed Decision makers with better data and coordinated regulators to support them. Government can see tangible benefits resulting from the public policy shifts made in recent years. Investment and growth are achieved.

Objectives

Build on important policy work of PRA in devising Solvency UK and TPR / FRC in broadening run-on options.
Ensure Pro UK asset allocation. Use financial incentives so that UK gilt and UK productive asset allocations cover at least [60%] of assets invested through life insurers and DB schemes. [10%] of all assets are to be in UK productive classes.
Restore the objective of DB schemes promising to protect real not only inflation capped value of pensions.
Allow surplus returns to sponsors – with incentives to invest in UK.
Share surpluses between scheme and members on a phased basis to protect against residual downside risk and provide fair treatment of members of all ages.

Policy Proposals

DB schemes with Pro UK asset allocation. Self-certify annually:

Downside risk reduced. Scheme will not be subject to 10% reduction for deferred members if scheme joins PPF.
Discretion use encouraged as package between sponsor and trustees. Sponsor receives surplus payment from scheme net of tax per DWP HMRC proposals. Sum deducted (the Deduction) is amount paid to HMRC. This is notified by trustees to sponsor. The Deduction is treated for corporate tax purposes by HMRC as a prepayment and reduction in tax payable. The Deduction is limited to the amount the sponsor’s UK tax group has paid in the year for DC or CDC pension contributions. (Consideration can be given to broadening the Deduction to cover cash paid on the UK capital expenditure in the year.)
The Deduction is available on the basis that no more than 3% of the scheme’s assets have been paid out in surpluses in the year to the sponsor and the members.

Life insurers with Pro UK asset allocation. Self certify annually:

Pay [0.75%] of asset value as an annual levy on assets other than Pro UK assets. Could set a straight % for the year. Charge is to pay for PRA supervision of global asset allocations and for FSCS cover.
Apply Solvency UK as compliant provider. If non compliant, life insurer revert to Solvency II losing lower capital cost benefits.
Phased approach possible: Apply levy to new business with transition phase for existing business as life insurers raise UK allocations.
Added incentive for members with life insurer buy-ins. With “value sharing” arrangements sums paid to members can be deducted from the tax payable in UK.

NB Since 2016 policy has helped life insurers grow rapidly. Solvency UK has reduced operating costs of life insurers further. PRA has sought to ensure pricing discipline is maintained. Life Insurer Stress Tests show capital ratios have reached new highs. PRA and FSCS back up are central to life insurer marketing and are currently provided free.

Why the Policy Proposals Work

Government: Realigning DB resources with the UK growth agenda will have a strongly positive impact financially and in attitude terms. The UK financial services sector will see a new wave of resources becoming available. Companies looking for resources for growth will see there will be more buyers and more takers of debt instruments. New projects will be stimulated.

The tax offset provided for sponsors is on pension surplus tax. HMRC is not currently assuming it will receive much tax from surpluses. As the offset comes with Pro UK investment and with packages to pay surpluses to members (mostly UK tax payers) there will be a net “tax take” increase.

The overhang on the gilts market from life insurers taking on DB schemes and selling down UK gilt positions goes. “Crowding out” is less of a concern. The current onus on issuance at the shorter end is reduced. Interest cost pressure falls. The life insurers’ current enthusiasm for the use of leveraged gilt to increase returns will be on the PRA watch list at present.

Trustees / members: DB scheme trustees making informed decisions to exercise fiduciary duty will consider “risk – benefits” to answer “relevant questions”. Maths shows the risk of less for members may not reduce from swapping a sponsor ring-fenced scheme for a life insurer. The benefit of discretionary payments is material. The gap in value is low and falling and the likelihood of PPF working well makes the PPF / FSCS safety net comparison newly important.

Scheme members when aware surpluses are available and can be distributed are likely to take an informed interest.

Sponsors will have access to surpluses and to tax credits covering the cost of current DC / CDC pension provision will reassess pensions “Get Rid ASAP” strategies. Cash returned from a scheme – perhaps stating with a one-off adjustment payment and a long tail may be attractive. A Board agenda item is appropriate.

Life insurers and Reinsurers: Have had exceptionally benign regulatory framework since 2016 and should accept the need to move to a more UK sustainable, balanced position. Scope for tax credits with value sharing arrangements under buy-ins can be a new business dream.

Regulators: Benefits of coordination realised. Avoid PRA / TPR arbitrage. FRC to have meaningful role in scrutiny. Information upgrades from FRC and IFoA / CMI on longevity. FCA to protect members on buy-in to buy out move. Secondary objective of growth supported.

Summary: Likely Outcomes

The £120 billion gilt overhang from pension risk transfers addressed. [Schemes will have more attractive options available than traditional buyouts and will have possibilities properly explained].
FSCS levy generates income on assets that are not Pro UK.
Recognition a 10% increase in UK productive asset allocation over time is likely to change expectations on current markets and on how they develop.
Sponsors can balance up front surplus return and long term receipts. Accounting will be a major driver.
Members expect the real value of pensions at least to be maintained, via discretionary payments. A 15% inflation catch up “one-off” (Roy Goode) payment would cover the early 2020’s. A 10% discretionary annual payment thereafter are likely (+/- 0.5% of the scheme’s assets).
Immense goodwill generated.
Cost of UK employment (and UK capex) for groups with legacy DB schemes reduced. Corporate Wealth Fund.
No net costs of incentives on HMRC. Scope for 25% tax receipts on payments by schemes in place.
Add UK to Solvency UK: Fair on insurers: Pro UK investment strategies expand. PRA reasserts itself. Value share becomes a feature in all stakeholders’ interests.

360⁰ Review shows all stakeholders benefit and can accept the balancing of interests.

Economic Growth Wins.