Third Report - Defined benefit pension schemes

We welcome that scheme funding has improved substantially since the mid- 2010s. However, the PPF and the ONS have produced different estimates of the extent to which the value of the assets in DB schemes reduced over 2022. The PPF acknowledges that its figures do not fully reflect the effects of market disruption during the LDI episode. It is important to have as accurate a picture of funding as possible. The Pensions Regulator and the Pension Protection Fund should continue to work with the Office for National Statistics to reach an understanding of the funding position of DB schemes and publish the results.

There is sufficient evidence of improvement in the funding position of DB schemes to justify a new policy approach. However, it is imperative that there is no return to a world of deficits. Policy changes therefore need careful thought so that they grasp the opportunities offered by improved funding levels, while being agile enough to respond to future challenges. One of the opportunities is to support DB schemes to remain an active feature of the pensions landscape, helping to deliver adequate retirement incomes. The Government should set out how it plans to promote retirement income adequacy in the future and the role it sees DB schemes, particularly open schemes, playing in this. (Paragraph 22) The scheme funding regime

Plans for the new DB funding regime were forged in a different era when the vast majority of DB schemes were in deficit and amidst concern that employers were seeking to evade their responsibility to underfunded schemes. Despite significant changes since then—improved funding levels and what these mean for future policy—the fundamental principles underpinning the new regime are unchanged: schemes are expected to target a position of low dependency at the point of significant maturity. While we welcome the changes made by DWP and TPR to allow more flexibility in the investment approach, it is unclear what the overall effect will be. Schemes have not yet seen the final version of TPR’s Funding Code. It is unfortunate that Parliament has been asked to vote on the Regulations before this was published and stakeholders have had the opportunity to evaluate and comment on the full picture. In future, DWP should commit to ensuring that Parliament has the material details it needs to make an informed judgement on the legislation it is being asked to vote on.

Open DB schemes help meet two important objectives: providing adequate incomes in retirement and investing in UK productive finance as they have greater capacity for this than closed schemes. Those responsible for running DB schemes have long expressed concerns that the Funding Code would force them to de-risk unnecessarily, increasing the costs to employers and resulting in their premature closure. While we welcome the additional flexibility in the revised Funding Regulations, it is essential Defined benefit pension schemes 55 that DWP and TPR work with open schemes to address the remaining concerns— particularly around the employer covenant horizon—and report back to us on how they have done so before the new Funding Code is laid before Parliament.

TPR’s approach to scheme funding has been driven by its objective to protect the PPF. We agree with those who told us that the objective now looks redundant, given the PPF has £12 billion in reserves. Two decades of regulatory policy caution have almost entirely destroyed the UK’s DB system. DWP and TPR need to act urgently to ensure they do not inadvertently finish off what few open schemes remain by further increasing the risk aversion, even while the risks of default have reduced substantially. Open and continuing schemes 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, the objective to protect the PPF should be replaced with a new objective to protect future, as well as past, service benefits. TPR should work with the pensions industry on what the change would mean in practice and what capabilities it will need to deliver on it effectively. (Paragraph 52) Scheme surplus

Many trustees and scheme sponsors will want to enter an arrangement to buy-out scheme benefits with an insurer and we welcome the security for scheme members this provides. However, not all will be able to do so, at least in the short-term. Well-funded schemes should also be supported to run on as there are potential advantages for scheme members, sponsoring employers and the economy. As part of its work to take account of financial stability considerations, TPR should monitor trends in demand for buy-out and its alternatives and work with financial regulators to understand the implications.

We note the further consultation launched in February on options to support DB schemes. Given that the aim of the funding regime is for schemes to be well-funded when they are significantly mature, some will be in surplus. We agree that if running a scheme on is to be an attractive option, it is important to explore ways in which such surplus could be used to the benefit of the sponsoring employer and scheme members, provided member benefits are protected. However, recent experience has demonstrated the volatility of scheme funding levels and we heard the ‘jury is out’ on the extent funding gains have been ‘locked in’. DWP is consulting on what a ‘safe’ funding level threshold would be. However, it acknowledges that other factors are relevant, such as investment risk and the strength of the sponsoring employer. These are among the issues on which the trustees would need to take a judgement, before deciding whether surplus extraction is ‘safe’ in line with their fiduciary duties, so strong governance will also be essential. 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.

We remain to be convinced that the PPF underpin would be an effective incentive to trustees to consider increasing their investment risk. DWP and TPR should consider whether there are changes to the funding regime that could give trustees confidence to take appropriate investment risk. (Paragraph 74) 56 Defined benefit pension schemes

Some pension scheme members are dependent on discretionary increases to ensure their pension payments keep up with the cost of living. Where these have not been awarded the effect has been, over time, to erode their standard of living. This can be particularly the case for those with rights built up before April 1997, when there was no general requirement to index-link pensions in payment. TPR should undertake research to find out: how many schemes have provision for discretionary increases on pre-1997 benefits within their rules; whether the discretion is for the trustee, sponsoring employer or both; the number of years in which they have paid discretionary increases on pre-1997 rights; and in the years they have not done so, the reasons for this.

Improvements in scheme funding have given new prominence to the question of how to treat any surplus in the best interests of scheme beneficiaries. For example, there may be discretion after benefits have been secured on buy-out to enhance benefits before returning any remaining surplus to the employer. There may be options allowing scheme members and employers to benefit from surplus in a continuing scheme. Decisions can be for trustees, the employer, or both, in accordance with scheme rules. We heard from scheme members concerns that their interests would be overlooked in this process. DWP and TPR should explore ways to ensure that scheme members’ reasonable expectations for benefit enhancement are met, particularly where there has been a history of discretionary increases. (Paragraph 89) Governance

We welcome confirmation from TPR and Ministers that the interests of pension savers are paramount and that investment decisions are for trustees in line with their fiduciary duties to act in the best interest of scheme beneficiaries. The Government should continue to work with the industry to create an environment that supports investment in the UK economy.

The use of sole trustees is increasing. While they can bring knowledge and expertise, there is the potential for conflicts of interest. We are concerned that employers often have a unilateral power to appoint sole trustees in the place of the existing trustee board, including member nominated trustees. DWP should introduce measures to improve the accountability of sole trustees and to enable scheme members to be involved in their appointment.

Despite strong support from TPR and trustee bodies for accreditation as a way to improve governance standards, they can only encourage it. DWP should set a date by which it intends to make accreditation mandatory for professional trustees.

Member-nominated trustees play a vital role in representing the interests of scheme members and providing a link to the workforce. As part of its planned engagement with stakeholders, DWP should explore ways to support lay trustees with the time and costs needed to become accredited and report the results. It should set out plans for ensuring every trustee board has at least one accredited member, lay or professional and a timetable for achieving that. (Paragraph 109) Defined benefit pension schemes 57

We welcome the introduction of a trustee register as a way to improve TPR oversight of trustees and to communicate directly with them. We also welcome TPR’s decision to update the Trustee toolkit. We recommend that TPR should use the register to report annually on the number of trustees who have completed the toolkit.

TPR sees consolidation, including through Superfunds, as one of the main ways to improve governance, providing advantages of scale in terms of investment and governance. The Government committed to legislating for this in Mansion House as did DWP’s 2023 response to the consultation on pension Superfunds but there was no Bill in the King’s Speech at the start of this parliamentary session. It will be challenging for Superfunds to get off the ground without legislation. The Government should consult on the detailed proposals of the Superfunds legislative framework to protect member benefits and then introduce primary legislation for pension Superfunds as soon as possible.

There may be a good case for a public consolidator. However, there are complex issues to address, particularly in relation to who would underwrite the risk, the impact on member benefits and how its introduction would be justified. In response to this report, the Government should explain whether the core aim of a public consolidator is to rescue stressed schemes likely to enter the PPF in any case, or is it for small schemes who may face challenges accessing the buy-out market.

Given the improvements in scheme funding, trustees must ensure they secure benefits for members, be that through consolidation, buy-out or letting schemes run on. TPR should be proactive in encouraging trustees to assess the potential costs and benefits of different options rather than assuming this assessment is taking place. TPR should consider requiring schemes to set out why they have pursued a particular approach and why it is in the best interests of scheme members. (Paragraph 131) Pension Protection Fund and Financial Assistance Scheme

The Government should find an early legislative opportunity to give the PPF more flexibility in how it sets the levy, allowing it to reduce it to zero and then increase it again if necessary.

We applaud the fact that the PPF is now reasonably confident that it has the funds it needs to meet potential claims on it. This is a significant achievement. There is now an opportunity to consider how the £12 billion in PPF reserves can be used to the benefit of PPF levy payers and scheme members. For scheme members, the priority is indexation on pre-1997 rights. DWP should bring forward its promised consultation on levy changes and PPF compensation levels without delay.

Non-indexation of pre-1997 benefits has had a significant impact on PPF members and disproportionately on older members and women, reducing the value of their compensation in real terms. Given the £12 billion in PPF reserves, the potential impact on levy payers is no justification for continuing this policy. We welcome the fact that the Government will be consulting on levy changes and PPF compensation levels. It should legislate to provide indexation on compensation in respect of pre-1997 rights where scheme rules provided for that. It should work with the PPF to consider 58 Defined benefit pension schemes other changes to compensation—such as raising the cap on indexation of post-1997 benefits above 2.5%—as part of its forthcoming consultation on levy changes and PPF compensation levels.

Financial Assistance Scheme (FAS) members are likely to have more of their service before 1997, so are particularly likely to be affected by non-indexation of pre-1997 benefits. Any improvements for PPF members should also apply to FAS members. Given the age of many FAS members, the Government should legislate as a matter of urgency to provide indexation on FAS compensation for pre-1997 rights, where their schemes provided for this, funded by the taxpayer. The Government should review the Financial Assistance Scheme, including looking at the case for removing other discrepancies in FAS compensation, compared to the PPF, such as the continued application of the compensation cap and lack of interest on arrears.

We support the recommendation of the Public Accounts Committee that the Government should “ensure that members’ complaints about the AEAT pension case can be independently reviewed, for example by a relevant ombudsman.” We agree with the Pensions Minister that it is important for a sense of justice and fairness that people should have an adequate means of redress. The Government should report back to us by the summer recess on how it intends to ensure an adequate means of redress for AEAT pension scheme members. (Paragraph 165) Defined benefit pension schemes 59