New DB regulations will force employers into a ‘one-size-fits-all-straightjackets’, which could leave some sponsors facing insolvency, according to consultants LCP.
It says introducing a cut-off date for schemes to reach funding targets could have a knock on affect on jobs and investment for some sponsors.
Under proposed new regulations all DB schemes will have to reach a state of ‘low dependency’, meaning schemes have to plan to reach a funding level where no additional top-ups are expected from the employer. They will then be required to lock in to that situation by means of a low-risk and low-return investment strategy.
The rules stipulate this goal has to be reached by the time they are ‘significantly mature’, which for a typical scheme means their members have mostly retired.
Analysis of LCP clients suggest that approaching 10 per cent of UK schemes could already be regarded under the rules as ‘significantly mature’ and would have to move to a low-risk investment strategy, if not already there. But within a decade, LCP’s projections indicate that around half of schemes could be regarded as ‘significantly mature’.
LCP says that there will be some flexibility as to how schemes get to this state of low-dependency, with schemes will be able to invest more freely, provided they have a strong enough employer to support them, during this period.
However, under the proposed regulations, every scheme will be expected – by law – to reach a very similar low-risk end destination by the time it is mature, and there will be very little flexibility for schemes after that time.
LCP says this creates a ‘one-size-fits-all’ solution which does not reflect the diversity of the DB pensions world and will be unsuitable in a number of cases.
It says, most importantly, some schemes have a relatively ‘weak’ employer who may not have the resources to top up scheme funding to the required level in time. It says in some of these cases full funding could have been achieved, without excessive cost to the employer, if the scheme was able to take an appropriate level of investment risk over a sustained period, but this option is now expected to be closed off by the new cut-off date for ‘low dependency’.
If the new rules are implemented, in some cases the sponsoring employer will be asked for unaffordable levels of contributions to their pension scheme and would be at risk of insolvency.
Analysis of LCP clients suggests that up to 5 per cent of schemes — around 200 schemes and employers in the country, including some charities —could find themselves in this position.
It says if these regulations are implemented without amendment, trustees will face a very challenging choice: either break the law by maintaining their current investment and funding risk in the scheme, or comply with the new law and likely force the sponsoring employer into insolvency.
It adds that these new rules are likely to impose a significant burden on a number of employers, with consequential knock-on impacts for jobs and the DWP ‘impact assessment’ offers no measure of the scale of these additional costs.
The DWP has previously said that the impact of the new regime can only be assessed once TPR’s ‘funding code’ has been published. But TPR is only expecting to publish its code for consultation once the regulations have been settled, and TPR can only work within the framework of the law.
LCP says this means there will be no official data on the impact of DWP’s measures in their own right, which LCP believe are likely to be significant.
LCP partner Jonathan Camfield says: “Until now we had been promised that the new funding regime would be flexible enough to take account of the circumstances of individual pension schemes and their sponsoring employers.
“But now it seems that DWP is determined to force all schemes into a one-size-fits-all straitjacket. Being able to invest for long term growth and take an appropriate level of investment risk is a key part of the strategy for many pension schemes, and is critical to mutual survival of the scheme and the employer in some cases. But this long term flexibility is being dramatically reduced by these new regulations.
“The very real risk is that some employers will face insolvency if they are forced to plug shortfalls in pension scheme funding at pace and with minimal reliance on scheme investment returns. Other employers could also find themselves being forced to pump in more cash than is needed – money that could be spent investing in their business or paying better wages to their staff to help them through current cost of living pressures.
“We are concerned that DWP have chosen not to undertake an impact assessment of this significant shift in policy particularly at a time when economic growth is under threat.”
The DWP said these regulations should not mean schemes have to undertake inappropriate derisking.
In the forward to this consultation, the DWP stated: “Those schemes that are maturing will be required to manage their risks carefully, taking proper account of the extent to which those risks remain supportable as they move towards run-off, or securing members’ benefits.
“But these draft regulations also take account of open schemes which are not maturing and have adequate ongoing sponsor support. It is not our intention that such schemes should have to undertake inappropriate de-risking of their investment approaches. The intention is to have better, and clearer, funding standards, but not to move away from the strengths of a flexible scheme specific approach.”