23 July 2020
A major new report from consultants LCP has highlighted serious concerns about proposed changes to the way Defined Benefit pension schemes are regulated. The report warns that the new regime threatens to be too rigid and to have potentially damaging effects on schemes and employers.
In March 2020 the Pensions Regulator (TPR) published a consultation on a new framework for regulating DB pensions. TPR envisages a dual track regulatory framework that provides pension scheme trustees a choice between two approaches to meet TPR’s new requirements on funding and investment:
- A ‘Fast Track’ approach, expected to be chosen by a majority of schemes, using standardised assumptions about things like investment returns, which could allow relatively swift TPR sign-off of pension scheme valuations;
- A ‘Bespoke’ approach for trustees and sponsors who take the view that their scheme has distinctive characteristics which means that a standardised approach would not be appropriate.
It is expected that this new approach would be backed up by powers in the new Pension Schemes Bill which would enable TPR to impose an approach – centred around the Fast Track framework – if it was not happy with what the scheme was proposing.
The report’s central concern is that the Bespoke approach does not go far enough in recognising the diverse nature of DB schemes, and unhelpfully still uses the ‘Fast Track’ approach as a benchmark even in cases where schemes clearly face unique issues and where doing so could lead to worse outcomes for members.
A particular issue arises around TPR proposals which would push schemes towards more conservative (lower risk) investment approaches. In some cases, this makes sense. However, in other cases this could increase the cost to employers whilst at the same time worsening the security of member benefits. The report uses an ‘integrated risk management’ model which takes account not just of investment risk but also of the risk of a company becoming insolvent. The model shows that in some cases pushing too hard for extra employer contributions or requiring excessive caution on investment could undermine the financial security of the employer and lessen the security of member benefits overall.
The report also highlights a number of areas where the proposed regulatory framework may not be a good fit for particular schemes. These include:
- The expectation that investment returns are benchmarked against the return on gilts (a ‘gilts plus’ approach), rather than reflecting the actual investment mix of the scheme;
- The lack of a special framework for open schemes – an issue on which the government suffered a recent defeat in the House of Lords – leading to increased pressure to close;
- The requirement to reduce reliance on the strength of the employer over an unrealistically short period;
- The risk that excessive pressure on employers to increase contributions could have an adverse effect on other stakeholders, including members of workplace DC arrangements which may be less well funded as a result;
Commenting, LCP partner Jon Forsyth said:
“The DB pension universe is incredibly diverse, and there is a real risk that these new requirements could force too many schemes into a one-size-fits-all mould. Whilst it is understandable that TPR wants to press trustees to reduce risk and employers to fill pension deficits as quickly as possible, our modelling suggests that if this is over-done then in some cases it could actually reduce member security. The idea of a ‘Bespoke’ funding regime is a good one in principle, but if it is too rigidly benchmarked against a standardised ‘Fast Track’ approach then it will not be flexible enough to reflect the diversity of DB schemes. It is important that anyone who has concerns about the proposals responds to the current consultation so that the final version of the new regime appropriately reflects the diversity of UK DB schemes”.