A Department for Work and Pensions (DWP) consultation paper, Options for defined benefit schemes, published on 23 February 2024, has two main themes:
The Government says it wants to “ensure that employers and savers alike can take advantage of strong investment returns,” and proposes removing barriers to payment of surplus to both groups.
Currently, ongoing schemes can refund surplus to employers only if:
Where scheme rules are an obstacle, the Government is considering the introduction of either “a statutory power for schemes to amend their rules to allow for payments from surplus funding” or “a statutory power to make payments” – ie the latter would not need the rules explicitly to permit such a payment.
A lower funding hurdle is also under consideration, such that payments to employers could be made where the scheme would retain a meaningful surplus on a low dependency basis. (Under the new scheme funding regime, schemes will have an objective to be fully funded on a low dependency basis by the time they become significantly mature.) The required margin above full funding could be the same for all schemes, with a 105% funding level offered as an example, or it could vary according to the amount of investment risk. Covenant-related variants are also mentioned but are not the Government’s “preferred option”. Maintaining the current buyout-based threshold has not been ruled out.
Based on estimates for the DB universe in aggregate that The Pensions Regulator recently supplied to the Work and Pensions Committee, 105% of low dependency liabilities would have equalled around 96% of buyout liabilities at the end of December 2022 – though the relationship will vary between schemes.
The consultation paper does not discuss changing the requirement for trustees to be satisfied that payments of surplus to the employer are in members’ interests. However, plans to “simplify the process under which trustees can make one-off payments to members” (rather than adding uncertain future liabilities by enhancing pensions permanently) could make it easier for trustees and sponsoring employers to agree a surplus-sharing proposal. The consultation specifically asks about removing tax penalties from these one-off lump sums, which are currently unauthorised payments – a proposal from a WTW white paper Six changes to seize the DB pension surplus opportunity published last summer. It is also hoped that The Pensions Regulator could give trustees “confidence…to share the benefits of strong investment returns with employers and members where this is safe” via statements in a Code of Practice or regulatory guidance, and the Government says it wants to “remove behavioural barriers by bringing surplus extraction in line with trustee duties”.
The Government says that the measures summarised above could be sufficient but asks whether allowing schemes to pay a higher PPF levy in return for 100% of benefits being protected might also be necessary. Any such facility would be kept financially separate from the PPF’s core function. On this basis, the PPF estimates that it would have to charge at least 0.6% of buyout liabilities each year (eg £6 million per year for a £1 billion pound scheme).
Greater access to surplus will not be conditional on how the money is used; for example, there will not be a requirement for refunds to employers to be invested in the business or used to enhance workplace pension provision for current employees.
According to the consultation paper, schemes in surplus on a low dependency funding basis are estimated by The Pensions Regulator to have £225bn of surplus assets between them. This might be an overestimate and sums available for distribution would be smaller once a buffer is applied. Nonetheless, revenue raised through the tax on sums refunded to employers (which is being reduced from 35% to 25% from 6 April), or from income tax where surplus is shared with members, might not be trivial. By contrast, tax paid on surplus refunds to employers averaged only £12 million per year over the five years to March 2023.
A public consolidator is being established because the Government “considers that not all of the market (particularly smaller schemes and those less than fully funded) are likely to have a practical option” to transact with an insurer or commercial consolidator in the next few years. Leaving this perceived gap in the market unfilled is seen as undesirable because (and notwithstanding how the surplus access proposals might lead more schemes to run on) consolidation “can bring a range of benefits” including “the opportunity for increased investment in UK productive finance assets”. Although the Government envisages that the public consolidator would “primarily” target smaller and less well-funded schemes, it thinks this can be achieved with a “predominantly principles-based approach” and without “restrictive eligibility criteria”. Schemes wishing to enter may or may not need to demonstrate that they cannot join a commercial consolidator or secure insurance buyout. The public consolidator would be given a statutory objective to provide solutions for schemes that are unattractive to commercial providers.
While the Board of the PPF would manage the new public consolidator, it would be legally separate from the PPF’s compensation function. It would run on rather than act as a bridge to buyout. The consultation paper does not say what would happen to any surpluses generated, though this may depend partly on the funding model chosen (see below). Assets and liabilities would be pooled rather than sectionalised.
Benefits due to members of transferring schemes would be reshaped to fit one of “a small number of standardised benefit structures”. Although these benefits would be of equivalent actuarial value to scheme benefits, they could be worth more or less to individual members – for example, a higher initial pension combined with lower indexation could be better for a member who dies relatively soon and worse for one who reaches a very advanced age.
A scheme whose assets cannot cover the entry price could still transact if the sponsor agreed to make up the shortfall over time, with members’ benefits pared back in the event that the sponsor defaults. Schemes which are better resourced (after any payments to the employer under the new flexibilities, or exit payments received from the employer) could enhance benefits prior to entry.
The Government suggests that unfair competition could be avoided by requiring the PPF consolidator to meet the same funding standards as commercial consolidators, which would “influence” the entry price.
Unlike commercial consolidators, the PPF would not have third-party investors to provide capital. The Government has yet to decide between the two alternative sources of security that have been proposed: taxpayers underwriting the benefits or PPF reserves being used. However, the first approach appears to be the frontrunner: the consultation paper notes that taxpayer underwriting would “give more authority” for the Government to set investment strategy (as emphasised in the PPF’s submission arguing for an extension to its remit) and that other uses of PPF reserves are being considered (see below). An unqualified taxpayer guarantee would involve the PPF consolidator offering security that some trustees might prefer to insured buyout at a cheaper price. The consultation paper therefore says “it is likely that any government support would be limited and scaled to match the level of security that commercial consolidators provide”.
Earmarking some PPF reserves to the consolidator could potentially weaken the financial position of the PPF in respect of its current function. After acknowledging this drawback, the consultation paper says: “Government will be consulting in the coming months on levy changes, and PPF compensation levels.”
There have been calls for PPF compensation to be enhanced, given its strong funding position and the effect that recent high inflation has had on the purchasing power of compensation. The PPF has suggested that it might have charged a zero levy in 2024-25 if legislation allowed it to do this and then reintroduce levies later – something that the pensions minister has said he would like to “address”.
Unlike with scheme surpluses, there seems to be no suggestion currently that levy payers who contributed to PPF reserves might be in line for a refund.
The background to this debate is discussed in articles that WTW published last year discussing competing claims on PPF reserves, the PPF's argument for the raising £100m in 2024-25, and details of the PPF's levy proposals.
Responding to the consultation
The consultation period ends on 19 April 2024. Some of the questions raised by the consultation ask schemes how they might act if the proposed changes are introduced.
