New DB regulation, due to come into force next year, could force employers to pay higher sums into these schemes, potentially driving some out of business altogether, according to analysis from LCP.
The pension consultancy says these proposed rules could hamper the government’s stated ‘growth agenda’ by causing a “multi-billion pound hit” to UK businesses. It adds that although these rules are designed to protect member benefits, some could end up with smaller pensions if more schemes end up being wound up.
LCP is now calling for the government to re-think what it describes as ‘rigid’ rules on pension scheme funding. Its analysis are in response to the Department of Work and Pension’s consultation on these new regulations.
Under the Pension Schemes Act 2021, a new regime for funding traditional DB schemes is to be introduced. This has been planned for a number of years, and is in part a reaction to cases such as Carillion where the employer went bust leaving a shortfall in the pension scheme. As part of this process The Pensions Regulator is already in the middle of reviewing its ‘funding code’, whilst DWP is re-writing the legislation around pension scheme funding.
However in July 2022, DWP published a consultation document and draft regulations on pension scheme funding which it is expected would come into force by late 2023.
LCP says that while these proposals have been made “with the best of intentions” if regulations are not changed, many sponsoring employers will be forced to pay unnecessary additional sums into their pension scheme, with those who cannot meet the new demands potentially forced out of business.
LCP says this could result in benefit cuts for some scheme members, which would be a perverse outcome given the goal of the new funding rules is to increase security of such benefits.
The heart of the issue is the requirement for schemes to be funded on a ‘low dependency’ basis by the time they are ‘significantly mature’. Although these terms are defined in a highly technical way, the basic idea is that a scheme is ‘significantly mature’ when the majority of its members are pensioners, and has ‘low dependency’ on the employer if its funds are highly likely to generate the returns needed to meet all pension promises, with very little risk of having to call on the sponsoring employer for a top-up. This level of certainty is achieved by reaching a low-risk, low-return investment strategy by the date that the scheme reaches maturity.
The problem with this binding legal requirement is that a significant number of pension schemes had planned to meet their funding targets by investing for growth for a longer period (ie past the date of ‘significant maturity’).
If they are forced to move to a low-risk / low-return investment strategy at an earlier date they will have to put more money in sooner. For businesses this extra funding may be considered “simply wasted expenditure” compared with their previous plans, and gives them less money to invest in their business. For businesses (including charities) who cannot find the additional money to meet the legally binding increase in pension contributions, they will find themselves in an increasingly difficult financial position.
In its response to the DWP LCP provides two case studies of clients where these new rules would have potentially adverse effects.
Where employers go bust at a time when a pension scheme is underfunded, members will receive some protection through the Pension Protection Fund. However, the PPF only covers 90 per cent of the pensions of those under retirement age, and may offer less generous inflation protection going forward than the original scheme would have provided.
LCP’s research also highlights the volatility which the new funding rules could create for employers. Under the new regime, schemes will have to target a ‘low dependency’ funding level by a date when they are ‘significantly mature’. But this date itself could vary substantially over short periods of time as it varies according to market conditions. The report highlights one scheme whose deadline date for reaching low dependency would have moved by four years during the course of 2022 had this regime been in force. This volatility could lead to significant shifts in the investment strategy of schemes forced on them at short notice by over-rigid rules.
LCP are calling on the government to re-think these plans, and to allow greater flexibility for schemes and employers which are serious about meeting their pension promises but need to be allowed more time to reach the desired target level of scheme funding.
LCP partner, Jonathan Camfield says: “Whilst everyone shares the goal of making sure company pension promises are kept, these proposed regulations do so in an unnecessarily rigid way. The result will be an unnecessary hike in the amount of money employers are expected to put into pension schemes, to the detriment of their ability to invest in their own future. And for some employers, these increased demands could be the final straw which pushes them into insolvency.
“At a time when there is so much focus on economic growth and boosting business investment, this does not look like joined up government. DWP needs to re-write these rules to strike a better balance between security for pension scheme members and avoiding unnecessary burdens on the employers who stand behind them”.
Responding to the claims a DWP spokesperson says: “Our intention is to have better – and clearer – funding standards, whilst retaining the strengths of a flexible, scheme-specific approach. It is neither ‘one size fits all’, nor about micro-managing schemes. Every scheme will be treated on its merits.
“Millions of people rely on defined benefit schemes. Our new measures will help ensure they are protected for the long-term.”