The Department for Works and Pensions has proposed measures it hopes would improve the quality of defined benefit schemes that pay members a fixed amount, including requiring them to have long-term funding plans
The Department for Work and Pensions (DWP) has put forward proposals that would allow defined benefit schemes (DB schemes) to cover around £1.7 trillion in assets.
Better protection for pension savers in defined benefit schemes is being considered in government consultation.
DB schemes, terminal salary or “career average” pension schemes, agree to pay members a certain income level when they retire based on their salary.
This differs from a defined contribution (DC) system, in which employees save into a pension fund whose returns are linked to returns in asset markets.
Consultation by the DWP, which submits its plans to the pensions regulator, is considered important given that almost 10 million people still live in such arrangements and around a million still actively contribute to these schemes.
As well as requiring systems to enforce clearer funding schedules, the proposals also suggest the changes would help trustees and employers plan their systems funding over the longer term, and thus help enshrine the best practices it said that they were evident in most schemes and would require trustees to report on their progress towards targets.
Pensions Secretary Guy Opperman said most DB systems are “well managed” but “best practice is not universal”.
“Our intent is to have better — and clearer — funding standards while retaining the strengths of a flexible, programme-specific approach,” he said.
“It’s not about one-size-fits-all solutions, nor about micromanagement systems,” he added. “Each scheme is treated on its merits.”
Executing DB programs has become increasingly difficult over the past decade, in part due to the sharp fall in bond yields.
Because bonds pay a fixed rate of return, they have historically been a popular asset for DB systems because their returns can be easily offset against the DB system’s liabilities.
But falling bond yields mean that this asset class, often seen as less risky than stocks, is less rewarding in terms of returns for DB systems.
When a DB system cannot cover what it owes its members, companies often have to find ways to fill the gap, often by having to contribute themselves, which is eating into their profits.
Over the past decade, the number of DB schemes has fallen from 7,297 to 5,522, according to data from The Pensions Regulator, as companies seek to close the schemes, or at least prevent new employees from joining them.
Research by auditing firm EY showed that listed companies with DB systems were responsible for more than two-fifths of the 583 profit warnings issued by UK listed companies in 2020, while 10 per cent of those companies issued their third consecutive warning, something EY said: “often.” a precursor to bankruptcy.
When British Airways closed both its defined benefit and defined contribution schemes to new contributions in 2018 and replaced them with a flexible benefits scheme, the company expected savings of £80m a year.
And when Philip Green’s Arcadia Group collapsed in November 2020, their three pension schemes had a combined deficit of £510m.
Many may call DB schemes “gilded” because they offer a set level of income in retirement, unlike DC schemes, but they can still fail.
The Pension Protection Fund (PPF), known as the Pension Lifeboat, manages £39 billion in assets for its 295,000 members – all people who were part of DB schemes linked to failed companies.
The PPF, now one of the UK’s largest pension funds, is funded in part by a compulsory levy on DB schemes, which helps it fund its spending as well as investments and the sale of assets it recovers from failing companies.
That doesn’t mean, however, that payments will remain at the same level that members of the DB scheme would have received if their employer hadn’t gone bust.
In its latest update, the PPF said that in its index of 5,215 DB schemes potentially eligible for lifeboat inclusion, the total surplus at the end of June 2022 was £267.9 billion, resulting in total assets of £1.598 billion .£ led.
There were 1,398 schemes in deficit but the deficit on those schemes had fallen to £25.3 billion in June from £28.2 billion at the end of May.
A DB scheme is always set up by an employer, with the amount paid out as a pension depending on how long a person has worked for the company and how much they have earned.
At retirement age, they pay out a secure, specific and usually inflation-linked income for life.