Response to DWP Green Paper: Security and Sustainability in Defined Benefit Pension Schemes

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1 Response to DWP Green Paper: Security and Sustainability in Defined Benefit Pension Schemes Submission by Prospect May Latest revision of this document: This revision:

2 Introduction Prospect is an independent trade union representing more than 140,000 members in a wide variety of industries, including civil service, energy, defence, education, entertainment, communications and culture. Many of our members continue to enjoy ongoing access to occupational defined benefit pension schemes, although provision of these remains under threat. Many members are employed by employers who are sponsoring such schemes which have been closed to future accrual. In addition we have a significant number of retired members, the majority of whom are receiving an income from defined benefit pension schemes. We continue to believe that defined benefit pension schemes offer the most secure form of providing a predictable level of income in retirement members have repeatedly expressed great appreciation of such schemes, have made sacrifices in other aspects of remuneration to sustain them and have taken action to defend them when necessary. We are not oblivious to the difficulties that sustaining a defined benefit pension scheme can cause in a small minority of instances and some members have seen their employment changed or terminated as a result of DB funding levels, and associated PPF levies, which have threatened (or actually resulted in) employer insolvency. As a proactive trade union, Prospect is open to discussions with employers and policymakers on steps that will improve the sustainability of DB schemes and their sponsoring employer. We will enter into positive negotiations in instances where a genuine problem exists however it is important that a compelling case is made. Unfortunately we strongly suspect that many employers simply adopt a position not to favour DB provision, even where these are affordable. Our negotiations focus on ensuring the best pensions apply as widely across the workplace as possible, with members agreeing to accept a range of proposals, including benefit cuts, contribution increases and the accepted circumvention of statutory pensions protections. In our experience genuine negotiation is the best mechanism for delivering sensible workplace pension reform. Members with statutory protections provided through Energy Act or Protected Persons legislation remain of the view that such statutory provisions should continue to be honoured. Question 1 Are the current valuation measures the right ones for the purposes for which they are used? a) Are the flexibilities in setting the Statutory Funding Objective discount rate being used appropriately? If not, why, and in which way are they not being used appropriately? What evidence is there to support this view? How could sponsors and trustees be better encouraged to use them? We believe that an unfortunate herd mentality has been adopted amongst the actuarial profession and, by extension, amongst trustees that discount rates should always be devised by reference to the yield on government bonds; ignoring the ability to base these on anticipated future investment returns. In light of the low yields prevailing in government bonds, the unwarranted adherence to this measure has resulted in artificial Prospect submission on 12 May 2017 Page 2

3 deficits being created that could largely be avoided by focussing on the other measures listed in the Occupational Pension Schemes (Scheme Funding) Regulations We believe that there would be merits in exploring a more flexible funding regime being made available to DB schemes that remain open to a workforce. b) Should we consider shorter valuation cycles for high risk schemes, and longer cycles for those that present a lower risk? What should constitute a high or low risk? Or should a risk based reporting and monitoring regime be considered? Prospect believes that the current three year standard valuation cycle remains appropriate. c) Should the time available to complete valuations be reduced from 15 months? What would be an appropriate length of time to allow? We do not see any benefit in reducing the current time scales dramatically. d) Should other measures or valuation approaches, for example stochastic modelling, be mandated or encouraged? If so, which ones and for what purpose? How would the information provided to the Regulator to explain the agreed recovery plan differ from that at present? What would the costs be, and would they outweigh the benefits? No comment Question 2 Do members need to understand the funding position of their scheme, and if so what information would be helpful? a) Should schemes do more to keep their members informed about the funding position of their schemes? The current system of providing annual funding updates seems appropriate to Prospect. b) Do we need Government communications to provide information to the wider public and media about the degree of certainty and risk in the regime? What difference could this make? We think there is a case that trustees (or sponsors where relevant) should be required to explain any significant decisions taken (such as changing investment strategy, changing benefit structure or negotiations on funding commitments) and the potential impact on funding in the future. This could make members more aware of the rationale for any decisions and ensure that decision makers are accountable for these. As noted later in this response, Prospect has encountered a number of instances in which members have been given insufficient information about risk when they have been presented with decisions on transferring pensions from public sector into occupational DB arrangements. The risks that existed came to pass and members lost pension rights in a manner that would not have occurred had they left them in their public sector schemes. These risks were not explained at all to members. For this reason, we believe members need to be educated about worst case scenario risks, particularly when they are presented with any decision. 3

4 Question 3 Is there any evidence to support the view that current investment choices may be sub-optimal? If yes, what are the main drivers of these behaviours and how could they be changed? a) Do trustees/funds have adequate and sufficient investment options on offer in the market? Is there anything Government could do to address any issues? b) Do members need to understand the investment decisions that are being made? If yes, are there any specific decisions that need articulating? c) Would it be appropriate for the Regulator to take a lead in influencing or determining an acceptable overall level of risk for a scheme in a more open and transparent way? d) Would asset pooling or scheme consolidation help schemes to access better investment opportunities? e) Is regulation (including liability measurement requirements) incentivising overly riskaverse behaviours/decisions that result in sub-optimal investment strategies? If yes, which regulations and how do they impact on these decisions? f) Are you aware of evidence of herding or poor advice from the intermediaries and advisors? The investment universe is dynamic with a number of new opportunities becoming available. Trustees / investment managers need to look at the universe regularly. The regulator could benchmark the maximum risk a scheme could consider as appropriate. There are an increasing number of pooled vehicles which gives access to bigger investment universe for the smaller schemes, and which would be hoped to drive better value products. However, scheme consolidation should be voluntary but a template ought to be available for schemes considering it. We do not believe that infrastructure investment (whilst important for the UK) should be mandated in any way on trustees. Similarly it would be wholly inappropriate for the Government to have any power of veto on investments as has been proposed for funded public sector schemes. g) Are measures needed to improve trustee decision making: skills such as enhanced training, more Regulator guidance, or the professionalisation of trustees? Whilst we support enhanced training opportunities and improved guidance; we are concerned about the potential impact of professionalisation. We are aware that professional, independent trustees have become more prevalent across the DB sphere, and worry that this can dilute the impact of Member Nominated Trustees. Professionalisation should not be at the expense of ensuring that a proportion (ideally 50%) of trustees is representative of the members of the scheme. Question 4 Is there a case for making special arrangements for schemes and sponsors in certain circumstances such as a different regime for employers who can afford to pay more, and/or new or enhanced flexibilities for stressed sponsors and schemes? a) Do you have any evidence that Deficit Repair Contributions are currently unaffordable? 4

5 Not generally, although a couple of instances (referred to in answer 5.j below) have seen employers made insolvent due to pensions deficits, and pensions diminished through transfer to the PPF. b) Should we consider measures to encourage employers who have significant resources as well as significant DB deficits to repair those deficits more quickly? Yes where trustees and employee representatives believe that this should be a priority. If so, in what circumstances, and what might those measures be? c) If measures are needed for stressed sponsors and schemes, how could stressed be defined? Should a general metric be used, or should this be decided on a case by case basis? Given that any proposed measures would presumably serve to weaken the promise made to scheme members, it seems only fair that the best metric on whether or not a scheme or sponsor is stressed, is whether members of the pension scheme are collectively convinced that it is stressed and that any proposed measures are a proportionate means to alleviating any such stress. That requires no other metric than for the sponsoring employer to make available full information to members and their representatives outlining the scale of any financial problems that exist. d) Are there any circumstances where stressed employers should be able to separate from their schemes without having to demonstrate that they are likely to become insolvent in the near future? We cannot see any scenario where such a route should be permitted, other than where the members of a scheme collectively agree to it. e) How would it be possible to avoid the moral hazard of employers manipulating such a system in order to off load their DB liabilities? Would some sort of quid pro quo be appropriate to ensure the scheme is not disadvantaged relative to other creditors of the employer/stakeholders? What could this look like? As above, moral hazard would be avoided through full disclosure to scheme members and through the presentation of a compelling case to scheme members that any proposal is absolutely necessary. f) Are there any circumstances where employers should be able to renegotiate DB pensions and reduce accrued benefits? If so, in what circumstances? g) Is there any evidence to suggest that there is an affordability crisis that would warrant permitting schemes to reduce indexation to the statutory minimum? h) Should the Government consider a statutory over-ride to allow schemes to move to a different index, provided that protection against inflation is maintained? Should this also be for revaluation as well as indexation? i) Should the Government consider allowing schemes to suspend indexation in some circumstances? If so, in what circumstances? j) How would you prevent a sponsoring employer from only funding a scheme to a lower level in order to take advantage of such an easement? We respond to questions (f) to (j) collectively as our message on each is consistent. The law currently allows the renegotiation and reduction of accrued rights, where these have been agreed by members on an individual basis. We believe that the principle of 5

6 member consent should be retained in any instance of a promise being diluted be it a reduction in accrued benefits, including any change in indexation (temporary or permanent). However we are of the view that defined benefit pension schemes are collective in nature. Also, given that pensions are defined as deferred pay, and given that pay can be subject of collective bargaining provisions, we can see an argument that collective consent could be sufficient to achieve any legitimate variation in accrued rights. This would ensure that members retain the power to accept or reject any change; and would ensure that a convincing case has to be made. The constituency for any such ballot would have to include all pension scheme members, and would undoubtedly have to involve trade unions. As such it is likely that an employer who continues to offer such a scheme to their workforce could be more successful in making a compelling case than one who only supports deferred and pensioner members. This would ensure the attractiveness of keeping such schemes open as well as the sustainability of both scheme and employer. We believe that any moral hazard that would encourage funding to a lower level would be avoided through full disclosure of information to members and their representatives. If parties who would be called upon to authorise any change are not convinced that they have been provided with full information, or on the basis of information provided are not convinced that a case has been made; they would be unlikely to accept any change. k) Should Government consider allowing or requiring longer, deferred or back loaded recovery plans? If so, in what circumstances? Should other changes be considered, such as the valuation method of Technical Provisions? We believe there is scope for the Regulator to promote greater flexibility in both of the aspects mentioned. We do not believe that a legislative change is needed to deliver this just a change in the regulatory approach that will ensure discount rates can be approached more flexibly and that recovery plans can be made more flexible depending on the needs and long term prospects of a sponsor. l) Should it be easier to take small pots as a lump sum through trivial commutation? We do not believe any change is needed to the current regime, although recognise that limits should be reviewed on a regular basis. Question 5 Do members need further protection, and should this be delivered by a stronger and more proactive Regulator, and/or trustees with enhances powers? a) Would greater clarity over the requirements for scheme funding be helpful to members and to sponsors? If so, would this be better set out in detail in legislation or through increased guidance and standards from the Regulator? The requirements for scheme funding seem clear enough. Where more clarity is needed is how trustees can fully appreciate the competing demands placed on sponsors and whether the pension fund is getting a good deal. Greater transparency for trustees, members and representative trade unions is needed to ensure a full appreciation of the financial calls on a sponsor. 6

7 Members can be well protected through the system of including Member Nominated Trustees who are truly reflective of a scheme s membership. The selection process for MNTs should be more transparent and positions need to be dedicated to representatives of scheme members. The appointment of non-representative MNTs should not be allowed. Where there insufficient candidates for MNT positions, temporary inclusion of independent trustees could be considered; however the preference should always be for member representative trustees. b) Is it possible to design a system of compulsory proactive clearance by the Regulator of certain corporate transactions, without significant detriment to legitimate business activity? If so how? What are the risks of giving the Regulator the power to do this? It is unlikely that such a system could be specific enough in describing the types of transactions that are relevant to be manageable. Instead trustees and trade unions should have access to sufficient corporate information to enable an informed decision to be made on whether such any transaction should be approved or not. The Regulator should have powers to ensure such information can be made available in a timely manner. Timing is crucial in all of this as Prospect members have experience of corporate transactions, such as entering pre-pack administration, being undertaken at such speed, and in such secrecy, that no-one (trustees, union, Regulator) had an opportunity to scrutinise or intervene. c) Should the Regulator be able to impose punitive fines for corporate transactions that are detrimental to schemes? If so, in what circumstances? Yes. This should be available in cases where the covenant available to trustees and members has been weakened through any transaction which did not receive approval from trustees and Regulator. The scope of levying such fines should be able to follow the value of any business that has been separated. d) What safeguards could ensure that any additional powers given to the Regulator do not impact on the competitiveness of the UK business or the attractiveness of the UK market? e) Should the Regulator have new information gathering powers? f) Should civil penalties be available for non-compliance? As noted above the Regulator should have powers to request, and be given, full corporate information, where this is identified for the purposes of approving corporate activity. Civil penalties should be available for non-compliance. In addition bodies carrying out covenant reviews on behalf of trustees should have rights to full disclosure of corporate information. g) Should levy payers be asked to fund additional resources for the Regulator? h) Should trustees be given extra powers such as powers to demand timely information from sponsors, to strengthen their position? If so, what extra powers might be helpful? As noted above full corporate information is needed to ensure trustees are in a wellinformed position. Trustees should be afforded sufficient information and time to be able to consult with members and trade unions appropriately. i) Should trustees be consulted when the employer plans to pay dividends if the scheme is underfunded and if so, at what level of funding? 7

8 Trustees of any scheme that is effectively a creditor in respect of past device deficits should be consulted on dividend payments should be consulted, and trustees should be able to consider this in conjunction with the sponsor covenant. Dividends are unlikely to be blocked through such consultation, but it is important that a creditor opinion is considered by the sponsoring employer. j) Is action needed to ensure that members are aware of the value of and risks to their DB pensions? We believe that most members appreciate the value of such schemes. Many remain baffled by the risks that exist, particularly in respect of increased costs driven by depressed gilt markets, which provide a wholly artificial measure to the value of their pension, their longevity, future pension increases or, in the majority of cases the levels of investment returns achieved in their pension fund. Prospect members in two areas are latterly aware, all too keenly, of the risks posed by DB scheme funding. Members at ADAS and AEA Technology, previously organisations in the public sector and who underwent privatisation in the 1990s, were given options to transfer civil service pensions into new privately funded pension schemes. Information provided to members from relevant Government Departments, the Government Actuary s Department and from their new pension schemes went to lengths to outline the benefits of a transfer; but did not adequately compare the risk of insolvency and how their pensions would be much less secure in a private sector arrangement compared to those retained in the Civil Service. Members of these schemes have seen their pensions now moved into the Pensions Protection Fund, with associated caps and restrictions to indexation resulting in reductions to retirement income of thousands of pounds. Members remain aggrieved that these risks were never outlined to them and Prospect remains of the view that, as appropriate advice was not presented at the time of transfer, these members should be allowed to retain equivalent benefits in the Civil Service Pension arrangements (or equivalent compensation granted). As a result of this, Prospect is of the view that much more work is needed to ensure that members are educated about the potential downside risks that can exist, particularly for members who are presented with decisions about their pension provision. Question 6 Should Government act to encourage, incentivise, or in some circumstances mandate the consolidation of smaller schemes into vehicles with greater scale and better governance in order to reduce the risk to members in future from the running down of closed, especially smaller, DB schemes? Prospect recognises that consolidation of DB pension schemes can take a number of forms many of which seem acceptable from the point of view of delivering greater efficiency and a better member service. However from the outset, we would express our strong opposition to any proposals that allow a sponsor to sever all links with a pension scheme on any basis that provides for a covenant that is weaker than that which would be provided through an insurance company buyout. Other mechanisms to consolidate administration, investment and governance functions are recognised as having the potential to achieve improved scale and governance (although this could come at the expense of diluting the voice and decision capabilities of a sponsoring employer and 8

9 associated members); however a superfund which has no links to a sponsor and thereby no recourse to future calls on funding seems to offer a poor deal to members. a) Is there anything in the existing legislative or regulatory system preventing schemes for consolidating? How might such barriers be overcome? b) What other barriers are there which are preventing schemes from consolidating? How might they be overcome? We believe that a framework exists for the consolidation of administration, advice and governance functions. We understand anecdotally that the position on pooling assets can be somewhat more difficult and that some attention will be needed in this respect. As noted above the position whereby a sponsor can abandon a scheme should not be facilitated through any regulatory or legislative means. c) Should Government define a simplified benefit model to encourage consolidation? d) Should rules be changed to allow the reshaping of benefits without member consent? In what circumstances? Should there be prescribed restrictions to the types or limits of such reshaping? We understand that reshaping is permitted in instances when it has been actuarially certified that reshaped benefits are of broadly equivalent value to original benefits. We cannot see any reason as to why this should be subject to any change. If a proposal was made to ensure that benefits are reshaped in a way that would provide a lower actuarial value, then this will need to be ratified by members. e) Are costs and charges too high in DB schemes? f) Should schemes be required to be more transparent about their costs or justify why they do not consolidate? In what circumstances? In respect of charges associated with investments, including consultancy fees, we believe that the market is particularly uncompetitive and opaque. We support measures being taken in that industry to require full disclosure of costs and reporting of this by pension schemes. g) Is there a case for mandatory consolidation? In what circumstances? We would not support this, as we continue to believe that a well constituted trustee board, acting in the best interests of scheme members, will be able to take an informed view on the appropriateness of consolidation. However where it can be demonstrated that a trustee board is dysfunctional, does not have the support of its members or fails to act in line with their fiduciary duty, there is scope for the Regulator to have powers that would involve consulting with members about consolidation. h) Should the Government encourage the use of consolidation vehicles, including DB master trusts? We do not believe that it is the role of Government to act in this manner; however if there was to be any development in the regulatory sphere, we would expect the Pensions Regulator to take steps to advise trustees and sponsors of these. If so how might it do so? i) Are further changes needed to the employer debt regime in multi-employer schemes to encourage further consolidation? 9

10 It is recognised that the provision triggering employer debt when benefits cease accruing reflects a disparity with a single employer scheme; in which no such debt is triggered following benefit closure. However as an organisation which campaigns for the retention and widening of access to defined benefit accrual, we would not support any mechanisms which will make it even more favourable for employers seeking to end access to these schemes. j) Is there a case for consolidation as a cheaper, but more efficient form of buy-out, with the employer and trustees discharged? If so, what should be the requirements for a scheme to enter such a consolidator, especially the level of funding; and (b), should the residual risk be borne by the member, or by the PPF? k) Should Government encourage creation of consolidation vehicles for stressed schemes? As noted above, we cannot support any mechanisms which severs any link with a sponsor, unless this provides the level of benefit security current seen through buyout with an insurance company. We are aware of proposals made separate from this Green Paper, which would seek to sever such ties and which would result in superfunds which would have powers to vary accrued rights, with uncertainty on access to the Pension Protection Fund. In the expectation that such superfunds would provide members with less security than an insured benefit, we do not believe that any mandatory move into such vehicles should be supported. l) Should employer debt legislation for multi-employer schemes require full buy-out and for the actuary to assess liabilities for an employer debt by estimating the cost of purchasing annuities? m) How else could historic orphan liabilities be met if they were not shared between employers? n) Are new measures needed to help those trustees of an association or employers who could be held individually liable for an employer debt? Prospect believes that there should be improved means of recourse through complex corporate structures to repairing any deficits for a scheme which has seen a principal sponsor fail. If parent or interdependent companies exist that have a demonstrable financial interdependence with the principal sponsor, then a mechanism should exist which allows for them to contribute towards deficit repair. 10