DWP publishes white paper on protecting defined benefit pension schemes

In February 2017, the Department for Work and Pensions (DWP) published a green paper: “Security and Sustainability in Defined Benefit Pension Schemes”. We reported that the green paper sought views in four key areas to see whether more could be done to help private sector defined benefit (DB) schemes to operate more efficiently.

The green paper consultation closed last May and, after some delay, the DWP has published a summary of the consultation responses and a white paper: “Protecting Defined Benefit Pension Schemes”.

The white paper sets out a number of measures that the government intends to take forward and says there will be a “phased approach to delivery”. Work has already started in some areas. For example, the government is working with the Pensions Regulator on ways to increase trustee and employer awareness of scheme consolidation options and to help members to understand their scheme’s funding position and the different funding measures. However, most of the changes will need more thought and primary legislation. The white paper says that the DWP and the Pensions Regulator will consult in 2018 and 2019, but that where primary legislation is needed this is “unlikely to be before the 2019-20 parliamentary session at the earliest”.

So what proposals does the white paper contain?

New powers for the Pensions Regulator

The white paper confirms that the government intends to legislate to:

• give the Pensions Regulator a new power to impose a punitive fine against anyone who deliberately puts a pension scheme at risk. This would allow the Pensions Regulator to fine anyone who is the target of a contribution notice (including individual company directors) and would apply to any act or omission after the date of the Paper (19 March 2018);
• create a new criminal offence to “punish wilful or grossly reckless behaviour of directors (and any connected persons)” in relation to a DB scheme;
• extend the scope of the Pensions Regulator’s powers to gather information, inspect records and electronic devices, and / or require someone to attend for interview (but this will stop short of the ‘duty to co-operate’ with the Pensions Regulator discussed in the green paper); and
• allow the Pensions Regulator to impose fines in other cases (for example, a fixed and escalating fine when a notice requiring production of documents or information has not been complied with).

In terms of corporate changes and transactions, the green paper raised the idea of a mandatory clearance regime. The government has decided against this. However, it does intend to:

• “consider whether the whole [clearance] framework can be made more effective, for example by reviewing the role of trustees and whistleblowing activity and asking the Regulator to review their clearance guidance to ensure it is clear and captures all appropriate transactions”;
• require sponsoring employers or parent companies to make a “statement of intent, in consultation with trustees, prior to relevant business transactions [e.g. the sale or take over of an employer] taking place, that they have appropriately considered the impacts to any Defined Benefit scheme affected”, which will “enable trustees to better engage with the Regulator if the scheme is subsequently put at risk as a result of the transaction”;
• consider whether the ‘notifiable events’ regime should be widened to include more events  and/or whether events should be reported earlier to give the Pensions Regulator more time to intervene if it needs to; and
• review the Pensions Regulator’s powers to impose a contribution notice or financial support direction, to see if legislation is needed to strengthen them.

Scheme funding

The white paper says the government believes that “all schemes and employers will benefit from clearer scheme funding standards”. For example, the Scheme Funding legislation says that a scheme’s technical provisions must be set ‘prudently’, and its recovery plan be set ‘appropriately’. However, ‘prudently’ and ‘appropriately’ are not defined, which can make it difficult to establish whether trustees have complied with their duties. There is also concern that, when they complete their valuations, some schemes are focussing too heavily on the funding objective for the next three years and not giving enough thought to the long-term, and that some are not considering whether their funding objective will withstand key risks (for example, the risk of poor investment performance).

To try to address this:

• the Pensions Regulator is going to consult on a revised Defined Benefit Code of Practice, which will include more guidance on “how prudence and appropriateness can be defined to better balance employer commitments with risks to members and the PPF”;
• this consultation will also consider what help trustees might need to take a long-term view when they set their funding objective, and to test the resilience of their funding objective to key risks;
• the government intends to legislate to require  “trustees and sponsoring employers to comply with some or all of the clearer funding standards” and to give the Regulator power to “enforce them or take action in the event of non-compliance”. The enforcement powers might be “sanctions or fines … and improved funding powers putting beyond doubt that it is the responsibility of scheme trustees and sponsoring employers to demonstrate compliance with funding standards or any statutory Code”; and
• the government intends to change the law to require the trustees of DB schemes to appoint a chair, who must then prepare a Chair’s statement containing prescribed information about their “key scheme funding decisions”. The trustees will need to send a Chair’s statement to the Pensions Regulator with each triennial valuation and the prescribed information will include: how the scheme’s funding objective is being set in line with a long-term funding objective; what the key risks to meeting the scheme’s funding objective are; and how the Trustees have chosen to manage and mitigate those risks. There will, however, be no change to the current timescale for completing valuations, which will remain at 15 months.

Consolidation of schemes

The government recognises that DB schemes have access to some options which can help to reduce administrative and investment costs, make it easier to access improved investment strategies and improve governance. These include, for example, asset pooling, DB Master Trusts and (for schemes able to afford it) buy-out. However, the government also recognises that there is no ‘one size fits all’ answer and that it might be helpful for schemes to have access to other options. As a result, it is going to look at changing the law to support new ‘commercial consolidation’ vehicles. The white paper explains that under this model “a private company would set up a new Defined Benefit pension scheme and take over the responsibility for meeting the liabilities of other pension schemes in exchange for a one-off payment or structured payments by the previous sponsoring employer. The company then acts as the ‘sponsor’ with a new board of trustees responsible for scheme governance. The covenant is provided by additional capital supplied by external investors who expect a return for their investment”.

The government recognises that a change of this kind would represent a “major shift” in the DB sector, which has always operated on the basis that an employer will stand behind a scheme until benefits are bought out. However, the paper sets out some initial thoughts on a legislative and regulatory framework that could balance the interests of members, investors and the PPF, and confirms that the government will consult in detail later this year. It also says that the government will work with the Pensions Regulator to see how its Trustee Toolkit could be updated to increase trustee and employer awareness of consolidation options, and that it might include a section on consolidation in the new DB Chair’s statement (above).

Other changes

Finally, the white paper confirms that the government:

• does not intend to introduce any ‘RPI / CPI override’ to allow schemes whose rules link pensions increases or revaluation to RPI, to change the index to CPI. The government will, however, continue to “monitor developments in the use of inflation indicies across Government, in pensions, and more widely”;
• does not intend to make any more changes to the employer debt legislation. One of the key remaining problem areas is ‘orphan liabilities’ but there is no easy solution and the government hopes that its proposals relating to scheme  consolidation (above), together with the new ‘Deferred Debt Arrangement’ and other changes being made to the employer debt legislation on 6 April, will help to provide a way forward; and
• will continue to look at whether it would be possible to make changes to the Regulated Apportionment Arrangement process to make it easier for employers to use in cases where a RAA (which is intended to provide a way forward on pensions liabilities for employers who are facing insolvency) would be in the best interests of the employer and scheme.

Osborne Clarke comment

Recent high profile events have increased the focus on the funding and overall treatment of DB pension schemes. The proposals to increase the Pensions Regulator’s powers would give the Regulator more ‘teeth’ and could act as a deterrent to poor treatment of DB schemes by employers. Similarly, the scheme funding and scheme consolidation proposals could, respectively, help trustees and employers to achieve stronger funding outcomes and provide a helpful option for smaller schemes who are facing increasing costs and governance standards but cannot afford to buy out. However, with some of the proposals there are difficult balances to strike, and it will be interesting to see whether, and in what form, they proceed.

In terms of timing, the white paper confirms that there will be very little in terms of immediate change. However, it does represent a very clear statement of intent. In view of this, we suggest that trustees and employers look at the proposals in the white paper now, and start to consider how the changes could affect their scheme, including potential impact on scheme funding discussions and proposals for corporate change involving DB schemes.