DWP proposes statutory override to allow surplus extraction
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The government is proposing a statutory override to scheme rules on surplus distribution, in a new consultation on options for defined benefit pension schemes seeks views on surplus extraction and a public sector DB consolidator. The consultation closes on 19 April.
The Department for Work and Pensions published a new consultation on DB options on Friday, proposing to make surplus extraction easier to encourage schemes to invest in productive assets. It ahas, however, reassured the industry that surplus extraction will not be conditional on use of funds for specific purposes.
The DWP said because respondents to a call for evidence last year cited scheme rules as the main barrier for accessing surplus freely, “we are considering introducing a statutory override to ensure that all schemes can choose to share surplus subject to the appropriate funding levels”.
Pensions minister Paul Maynard – who is under investigation by the compliance officer at IPSA over alleged spending breaches – said: “We are in a welcome position with DB pension schemes enjoying high levels of funding, and we want to make this money work harder for savers and the wider economy. I welcome industry views on our plans to reform the pensions market.”
What should be the minimum funding level after surplus extraction?
An override could either take the form of a new statutory power for schemes to amend their rules to allow for payments from surplus funding, or a statutory power to make payments could be introduced, the DWP said. This could potentially include powers to make one-off payments to beneficiaries, with the government offering to make changes to tax rules to avoid the risk of an unauthorised payment charge.
The government stresses that “any surplus extraction should still leave the scheme over 100% funded on a prudent basis”. The consultation adds that “the level of investment risk and the strength of the sponsoring employer will also have a significant bearing on what level of surplus is ‘safe’ to extract”.
It proposes different ways to define the required residual funding levels:
low dependency plus a fixed margin, e.g. 105%;
funding above the low dependency funding basis plus a variable margin based on investment risk, for example above 100% + y% of the low dependency basis;
A covenant requirement in combination with a funding requirement; or
a buyout funding level threshold with a statutory override so that trustees can exercise this option even if not codified in the scheme rules.
To help trustees with considerations around taking out surplus, the DWP suggests TPR support in the form either of an additional module to the DB funding code, a separate code on surplus extraction, or TPR guidance.
As well as asking for views on these proposals, the government wants to hear about an industry idea whereby schemes could obtain a 100% underpin from the Pension Protection Fund by paying a ‘super-levy’, although it warns this might need to be relatively high to cover potential costs.
The PPF is also in focus as government wants it to run a public sector consolidator, to be set up by 2026, and is asking if schemes have faced challenges in achieving buyout and about market impact, which has been a concern for buyout providers and commercial consolidators.
The Pensions Regulator has welcomed the consultation. A spokesperson for TPR said: “As part of our role to protect savers and enhance the pensions system, we support DWP’s consultation into the options for defined benefit schemes, specifically in terms of the safeguards needed in areas such as surplus extraction. We welcome a robust debate about establishing a public consolidator, again to provide a safe alternative model for DB schemes considering their options.”
Mixed reaction to surplus proposals
Some in the industry are showing relief that the government’s push for easing surplus extraction comes with conditions around funding levels, while others warn that government appears overly ready to view current high funding ratios as permanent.
“The central purpose of DB pension schemes - to pay the benefits promised to members - should not be undermined,” said Hetty Hughes, manager of long-term savings at the Association of British Insurers.
“Only over the last five years has the conversation around DB pensions shifted from tackling deficits to dealing with surpluses. If we see fluctuations in asset values, this could reverse again,” she added.
At the other end of the spectrum, Iain McLellan, head of research and development at consultancy Isio, said the consultation “could help unlock the huge value potential stored in UK DB pension schemes”.
Others are hoping the reforms could make DB schemes more attractive again. Laura McLaren, head of DB actuarial consulting at Hymans Robertson, welcomed the proposed link to scheme funding levels before money can be released, and not making extraction conditional on use of funds for particular purposes.
She added: “Surplus extraction will be more effective where it is part of a larger reframing of the statutory objective for DB, to bring about a DB renaissance and secure future pension provision."
A ‘renaissance’ of DB might not be expected by many, but in the US, IBM has reportedly reopened its DB scheme to new joiners.
While the DWP proposals aim to make extracting surplus easier, they do not address the disputes that often arise over how surplus should be distributed, as illustrated by a recent spat between BP and some of its DB pensioners.
Last month, economic secretary to the Treasury Bim Afolami told MPs that the DB consultation would contain proposals about surplus where its recipient is unclear, but this does not appear to have been included.
And while the consultation claims that its overarching aim is to introduce reforms "that jointly benefit scheme members, sponsoring employers and the wider economy”, it only talks about one-off benefits to members, based on the feedback of “some stakeholders” that increasing future liabilities should be avoided.
Public sector consolidator divides pensions world
On a new public sector consolidator, the ABI urged “extreme caution”.
Director of long-term savings Yvonne Braun said: “While the intention for a public consolidator is to target only defined benefit schemes that are unattractive to commercial providers, great care would still be needed to avoid a market-shifting intervention, moral hazard for employers and risk of detriment to scheme members.”
Simon Kew, who heads up market engagement at consultancy Broadstone, said: “The outlined plans for establishing a public sector consolidator by 2026 could open up opportunities for some schemes – particularly at the smaller end of the market – albeit we are expecting new entrants in the market this year to provide further supply for unprecedented de-risking demand.”
The interim chief executive of the PPF, Katherine Easter, welcomed the consultation.
“Given the £1.4tn scale of the DB sector, we believe the public consolidator can work alongside existing commercial providers, supporting a healthy market by providing an attractive option for schemes unable to access existing solutions on reasonable terms,” Easter said.
“We plan to engage with stakeholders both on the detailed design of the public consolidator and further viable approaches which use the PPF’s skills and capabilities.”
