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The funding levels of the majority of defined benefit (DB) schemes have improved. Although there are questions about the extent to which the value of assets fell over 2022 which we think need to be resolved, the change compared to the mid-2010s when the majority were in substantial deficit, is clear. This raises new questions and gives rise to new opportunities and challenges, for example, relating to how DB scheme funding is regulated, how to treat any surplus in pension and compensation schemes and how to ensure scheme members feel their interests are represented in these decisions.
One area of focus during our inquiry was the development of a new DB funding regime, which the Department for Work and Pensions (DWP) and The Pensions Regulator (TPR) propose to introduce for scheme valuations from 22 September 2024. The intention is to require schemes to aim for a position of low dependency on the sponsoring employer by the time they are significantly mature, with investments that are highly resilient to risk. One of the questions we set ourselves at the outset of our inquiry was whether the proposed new arrangements would enable open schemes to thrive. Although they represent a small minority of DB schemes, they are important in providing adequate incomes in retirement and, because they are able to take a longer view, they have greater capacity than closed schemes to invest in the economy. We continued to hear concerns from open schemes that the new funding regime would require them to de-risk inappropriately, potentially leading to their premature closure. Although DWP introduced additional flexibility in the Regulations laid before Parliament in February, it is essential that TPR works with open schemes to ensure that the remaining concerns are addressed in the final version of the Funding Code.
TPR’s approach to regulating scheme funding has been driven by its objective to protect the Pension Protection Fund (PPF). It has prioritised protecting benefits that have been built up, encouraging a de-risking approach which has increased the cost of DB schemes for employers. Given the improved funding position of schemes, and the fact that the PPF now has £12 billion in reserves, this objective is no longer needed. Open and continuing schemes now need confidence that the additional flexibilities that have been promised will be reflected in the actual approach regulators take in future. To signal the change in approach needed for this, TPR’s objective to protect the PPF should be replaced with a new objective to protect future, as well as past, service benefits.
Many schemes are much closer than they expected to being able to enter a buy-out arrangement with an insurer to secure scheme benefits. Buy-out arrangements are now at record levels and many will want to continue on this road. It is important that trustees and employers are able to see running the scheme on as an attractive and meaningful alternative. This has potential advantages for: scheme members (of, for example, allowing them to continue to receive discretionary increases); the sponsoring employer (able to see a well-funded scheme as an asset); for the UK economy (enabling trustees to take a longer-term view and increase their investment in return-seeking assets); and financial stability (as more schemes would be working towards different long-term objectives).
DWP is consulting on proposals to allow surplus to be extracted in a wider range of circumstances (it is currently only allowed in schemes funded to buy-out level). This is an important consideration if we want to encourage well-funded schemes to run on. However, these proposals must not put member benefits at risk. Schemes can take steps to improve the security of member benefits. Recent experience has illustrated the volatility in scheme funding levels and the jury is out on whether schemes have locked in their gains. We note the current consultation on the level of funding a scheme would need to have for surplus extraction to be an option. However, strong governance will also be essential. We recommend that DWP should conduct an assessment of the regulatory and governance framework that would be needed to ensure member benefits are safe and take steps to mitigate the risks before proceeding.
Improvements in scheme funding have given new prominence to the question of how to treat any surplus in the best interests of scheme beneficiaries. Decisions can be for trustees, the employer, or both, in accordance with scheme rules. We heard from scheme members concerned that their interests would be overlooked in this process. We recommend that DWP and TPR explore ways to ensure that scheme members’ reasonable expectations for benefit enhancement are met, particularly where there has been a history of discretionary increases. Discretionary increases are particularly important for some scheme members with rights built up before 1997, where their scheme rules do not provide a right to indexation. In some cases, scheme members told us they had not had an increase for some years, resulting in a substantial erosion of their living standards. We recommend that TPR undertake research to understand the extent of the problem.
While many trustee boards work well, we know that TPR has long had concerns about governance standards in some schemes, particularly smaller ones. It hopes that consolidation will help to address this by reducing the number of small schemes. However, this is not a foregone conclusion: pension Superfunds have faced significant challenges in getting off the ground in the absence of a statutory regulatory framework; and although DWP is consulting on proposals for a public consolidator, the model raises significant questions which are still to be answered. DWP and TPR therefore need to invest in driving high standards of governance across pension schemes. We recommend that DWP legislate to make accreditation mandatory for professional trustees; explore ways to ensure lay trustees have the time and resources to become accredited; and set out plans for ensuring every trustee board has at least one accredited member, lay or professional, and a timetable for achieving that. It must also ensure that the new trustee register is used to ensure trustees complete TPR’s Trustee toolkit.
The PPF is now fairly confident that it is secure and able to meet future claims from its existing funds, with £12 billion in reserves. This is a significant achievement which we applaud. It means there is the opportunity to consider how both levy payers and scheme members can benefit from this. DWP should legislate to give the PPF more flexibility to reduce its levy to zero, knowing it can increase it again if needed. It should also legislate to improve PPF compensation levels. We heard that for PPF members, the priority was indexation of pre-1997 benefits, which have had a disproportionate impact on women and older scheme members. This should be the first step, before other improvements are considered. The same must apply, funded by the taxpayer, to Financial Assistance Scheme (FAS) members, who tend to have more of their service before 1997.