Better together – the next generation of pension schemes

Many employers now have several pension schemes of varying vintages, carrying financial risk for them and for their employees and former employees. Rationalising these schemes has often been in the “too tricky” box, due to cost and/or time investment, with risk and cost implications for employers, including in corporate transactions.

Some new options are in the active planning stages, for both defined benefit (“DB”) and defined contribution (“DC”) pension schemes.

In the DB arena superfunds are coming, and in the DC world, master trusts and collective defined contribution schemes or CDCs.

Superfunds – a solution for some schemes

Superfunds for defined benefits are in development, to offer a staging option on the way to securing scheme benefits. On transfer of assets and liabilities to such a fund, the covenant supporting the superfund would be substituted for the employer covenant. Due diligence on covenant, protections, funding and various other aspects will be required. Clearance by the Pensions Regulator will be a feature.

The Pensions Regulator has introduced guidance, and the DWP will bring forward legislation to put an authorisation and governance framework in place. A consultation on consolidation of defined benefit pension schemes was launched on 7 December 2018. 

Master trust or not?

Master trusts are not new, but a new set of duties will apply for schemes authorised as master trusts after 31 March 2019 under the Pension Schemes Act 2017.

Master trusts are defined in the Act. Schemes that meet the criteria must apply for authorisation by 31 March 2019 or will have to wind up. It is critical that existing schemes identified as master trusts and meeting the criteria specified for master trusts apply for authorisation by 31 March 2019.

Industry-wide schemes, and other schemes which are not public sector schemes and have two or more unconnected employers, are caught by the statutory definition, so action is required before 31 March 2019.

CDCs – version 2

A Government consultation on reviving and adjusting its defined ambition framework, introduced by the Pension Schemes Act 2015 but not activated, closed in January. The catalyst is the approach from Royal Mail and the Communication Workers Union, who plan to put in place a CDC pension scheme. The aim is to mitigate some of the risks faced by employers and members and to deliver good outcomes, set within a regulatory framework as favoured by the Work & Pensions Select Committee. The requirements of the Equality Act 2010 will also have to be addressed. The outcome of the consultation and proposed legislation is awaited.

Risks identified in current individual DC arrangements include members having to make complex financial choices and decisions on outcomes critical for their income in retirement, both during their working lives and at retirement, and bearing investment volatility, longevity and inflation risks.

It is proposed that contributions are pooled together in a fund and then invested, aiming to deliver an identified level of benefit in retirement so members would not have to make decisions on investments. Longevity, investment volatility and inflation risks would be shared in the pooled fund. Any mitigation of these risks is a positive step for members.

A key point is that employers will still not guarantee a level of benefit for members, so scheme rules will have to include mechanisms to adjust contributions and reduce pensions in payment if the assets are not performing in line with funding requirements. Such steps would, of course, be concerning for members, so rules for many CDC schemes would be likely to include a framework for building up and operating capital buffers. This will bring its own challenges.

Changing world

It is encouraging to see such development and innovation, but there is some way to go and no one complete solution. It is critical that employers and members are clear on the type of pension provisions that make up their portfolios and the options available so risks, requirements and options can all be worked through to increase the likelihood of good financial outcomes, and minimise legacy risks.

Employers also need to deliver on pension responsibilities or face an increasing risk of enforcement by regulatory authorities. Penalties for breaches by employers are becoming more common. The Pensions Regulator has imposed penalties on employers for breach of auto-enrolment duties.

In December 2018, the former director and majority shareholder of BHS was convicted and fined £50,000, had to pay prosecution costs and a victim surcharge after failing to provide information to the Pensions Regulator about the BHS pension scheme.