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New pension funding rules could thwart Chancellor’s pro-growth agenda

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On 7th September, new Chancellor Kwasi Kwarteng told business leaders:

“The Prime Minister and I are committed to taking decisive action to help the British people now, while pursuing an unashamedly pro-growth agenda.  We need to be decisive and do things differently. That means relentlessly focusing on how we unlock business investment and grow the size of the British economy…”

(Source: Chancellor Kwasi Kwarteng sets out economic priorities in first meeting with market leaders - GOV.UK (www.gov.uk)).

However, pensions experts at consultants LCP have identified a multi-billion pound hit to business buried in new regulations on pension scheme funding being brought forward for consultation by the DWP.  

LCP estimate that if these new rules are implemented as planned they could lead to an ‘unnecessary’ cost to business and scheme members of up to £30 billion, and could also lead to up to 200 employers being forced to the brink of insolvency.   LCP are calling on the government to think again about what it describes as these ‘rigid’ new rules on pension scheme funding.

Under the Pension Schemes Act 2021, a new regime for funding traditional ‘Defined Benefit’ (DB) pension schemes is to be introduced.  This has been planned for several years and is in large part a reaction to cases such as Carillion where the employer went bust leaving a shortfall in the pension scheme.   The Pensions Regulator is already in the middle of reviewing its ‘funding code’, whilst DWP is re-writing the legislation around pension scheme funding. 

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.

Whilst the regulations are being introduced with the best of intentions, namely to make sure that workers get the pensions they have been promised, they do this in a particularly heavy-handed and inflexible way. 

LCP believe that if these proposed regulations are not changed, employers which stand behind DB pension schemes will be forced to pay unnecessary extra amounts into their pension scheme, whilst others who cannot meet the new demands may be forced out of business altogether. This could also 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 in the new regulations 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 which can afford to do so, this extra funding for the pension scheme is 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 increasing financial difficulties and ultimately may be forced into insolvency.

The paper provides two case studies of LCP clients where these new rules would have potentially adverse effects:

  • A scheme with a credible long-term plan to deal with its pension scheme deficit but which would be forced to accelerate payments substantially under the new rules;  the required contribution rate could be unaffordable and could drive this not-for-profit employer out of business;
  • A scheme sponsored by an employer with 5,000 employees which is already ‘significantly mature’ but needs to go on taking modest investment risk to clear its deficit; under new rules there would apparently need to be a sudden and large cash injection to meet the new requirements.  At best this could wipe out the firm’s investment plans, threatening its long-term future, and at worst it could force the company to close.

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% of the pensions of those under retirement age and may offer less generous inflation protection going forward than the original scheme would have provided.  Putting too much pressure on sponsoring employers could therefore be bad news not just for businesses and their owners but also for their past and present employees who may end up with less valuable pension benefits.

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.  Such 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.

Commenting, Jonathan Camfield, partner at LCP said:

“Whilst everyone shares the goal of making sure that 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”.

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Note to editors:

The full paper can be found here