The next phase of Mansion House reforms is upon us! On 23rd February the government published a consultation on proposals that will open up two new strategic options for DB schemes, each of which is very interesting for both trustees and sponsors.  

The government tells us they are “committed to a bold range of measures to drive these changes”. So we need to take note and think about what they might mean for our own DB schemes, member benefits, productive finance (meaning a positive impact on the UK economy and supporting the energy transition) and the gilt market. The two distinct proposals are:  

• Proposal 1: more flexibility for returning surpluses to members and sponsoring employers (including LCP’s own policy proposal)
• Proposal 2: the PPF becoming a public sector consolidator from 2026

Note that we also expect a Labour government (if elected) to be keen on pursuing these reforms (presumably with their own variants on the detail) given the public statements the Labour party have made about pension policy in recent months.

We will be responding to the consultation which runs until 19 April, and here are our initial thoughts in the meantime.

Proposal 1: More flexibility on using surpluses

With DB pension schemes never having been as well funded as they are now, we’ve been pushing for change in this area for nearly two years now and we’re delighted that our policy idea is being formally consulted on.   

The government is consulting on a series of proposals that are designed to give DB trustees greater confidence to more readily distribute surpluses to members and/or sponsoring employers. The hope is that the proposals will also lead to more schemes investing more in productive finance, and for longer – which might be expected to further enhance the benefits to all parties. Of course there will need to be appropriate protection for members’ pensions if any new flexibilities are introduced.

One of the options for such protection, and the one that LCP has been championing, is that the PPF could guarantee 100% of benefits for any schemes looking to access these flexibilities, in return for payment of a higher levy. The consultation refers to this as a “100% PPF underpin”.   

We believe that, if a meaningful change is to be made to the status quo, the 100% PPF underpin is critical to ensure that: a broad sweep of trustees are happy to distribute surplus; members’ pensions are protected; there is indeed a material impact on investment in productive finance (including supporting green and low-carbon transition); and there is protection for the gilt market.  These are objectives that government and many in the industry strongly believe in.  This is why:   

Without the 100% PPF underpin, you can arguably give trustees as much surplus distribution power and TPR guidance as you like, but as the consultation says: “Any extraction of surplus will reduce security for members”. And the stark reality is that there are no proposals being made by government that change trustee overriding fiduciary duties in any way. So, even if they have a new power, why should trustees use their power to reduce security for members, including paying discretionary pension increases to pensioners? The short answer is: most will (rightly) be very nervous of doing so (unless they have strong protection in some other form). This is why we have always believed that introducing a powerful new protection for members through the form of a 100% PPF underpin is vital to materially change the status quo.

And it’s not just about existing surpluses. It is also about investment strategies for future growth. Without the 100% PPF underpin (or broadly equivalent protection negotiated at a scheme level), from our experience trustees will not have the confidence to invest for moderate long-term growth even though this can be expected to benefit all stakeholders. The pull of fiduciary duties towards insurance solutions is just too strong unless downside risk to members’ benefits is strongly protected in other ways. At a UK policy level, from the options being consulted on, we believe that providing a 100% PPF underpin is the only way to achieve material investment in productive finance from the £1.4tr of DB assets. And it’s also the only way to protect the gilt market from big sell-offs as larger schemes otherwise move to insurers.

One of the points raised in the consultation is the potential high level of PPF levy needed to support this regime – the PPF have suggested at least 0.6% pa of scheme assets. We think this figure is much too prudent. Imagine if just twenty of the strongest schemes, with an average of £5bn of assets each, entered this new regime (we hope it would be many more). This would mean the PPF would collect £0.6bn of levy in year one. By year four the PPF would have c£2.5bn in a ringfenced pot for an emergency! The covenant and funding strength of these schemes would necessarily be strong (in fact, they would be funded at the level of prudence that PPF is willing to price consolidation at!). So even if the occasional sponsor went bust, it is unlikely that there would be much deficit (if any) for the PPF to make up at all. It seems to us that this level of levy will prove to be too prudent over time, and this will therefore lead to yet further (material) surpluses emerging at the PPF – arguably not the best use of PPF levy payers’ money.     

Proposal 2:  PPF as a consolidator  

We are supportive of exploring the potential for the PPF to become a consolidator of DB schemes with solvent employers (in addition to its current function relating to insolvent employers), but we’re cautious about the detail being proposed in this consultation.

Key questions remain unanswered. Eligibility could potentially be available for all schemes that are not 100% funded on a buyout basis and for any other schemes that can’t easily obtain quotations from insurers, and it is not clear how this will be assessed or policed. Entry prices for this new PPF consolidator could be materially attractive relative to the buyout market. The security of reserves can be expected to be less secure for members compared with those of an insurer.  And the proposal to standardise member benefits would add complexity to the process of transacting with the PPF. This is because all the benefit specification, data correction and GMP equalisation projects will have to be completed up-front, followed by actuarial equivalence calculations to determine the level of benefits in the standardised format. It should also be noted that there would necessarily be winners and losers among individual scheme members arising from benefit standardisation (which trustees have historically had concerns about in other contexts).   

In addition, trustees may have concerns that securing their members’ benefits with the PPF will not come with the same protections as purchasing a PRA-regulated, FSCS-underpinned insurance product.

But, if the proposal goes ahead as outlined, it could be very attractive for some employers. Compared with insurance, and potentially even to emerging superfund models, it could be a lower cost way to pass on pension risk and add value for shareholders.

We also suspect that other commercial consolidators (insurers and superfunds) will have significant concerns about the proposals, given that they appear to give the PPF a strong competitive advantage in the areas of: less prudent reserving and therefore pricing; the ability to standardise member benefits; and critically an easy way for schemes to swap their pension deficit for a fixed loan repayment schedule.

Finally, we also note with interest an apparent inconsistency. Under Proposal 1 above, the government is clear that the existing PPF must not be used to support the new option of a 100% PPF underpin (“funds from these functions should remain separate”). (Such support would materially reduce the initial level of levy needed because the 100% PPF underpin fund could borrow against the current PPF £10bn surplus if needed, and repay over time.) However, under Proposal 2, the government is open to using the current PPF to underwrite the risks for the PPF becoming a consolidator.   

In summary, this second proposal needs further thought (and adjustment) if it is going to meet its objectives including protecting member benefits and not undermining commercial consolidators.

Concluding thoughts

At LCP we are delighted that the government has published this important consultation and look forward to continuing the debate with policymakers and within the pension industry in the coming weeks and months.  We continue to call for change to the DB pension system to ensure DB pensions work for all concerned: members, trustees, sponsors, government and gilt markets, and the UK economy, including supporting the enormous low-carbon transition challenge we collectively face.  

There is of course lots of detail to work through and it is important that any changes do not introduce new risks and unintended consequences.  Our thoughts on how our own policy idea meets all these objectives, including some of the challenges that would need to be addressed, are set out in detail in our FAQs that you can find here.