DWP launches consultation on plans to relax DB surplus rules

The Department for Work and Pensions (DWP) has launched a consultation on plans designed to help make defined benefit (DB) surplus extraction easier, alongside plans for a public sector consolidator operated by the Pension Protection Fund (PPF).

The consultation, which will run until Friday 19 April, seeks views on how the money held in DB schemes can be best unlocked in the interest of savers and for sustainable investment in the wider economy.

In the papers, the DWP noted that most DB schemes have become better funded over the past decade, arguing that allowing DB schemes to invest these surplus funds in the UK’s productive finance assets could boost the UK’s leading position as a leading financial centre.

However, whilst the DWP argued that the recently revised DB Funding Regulations, laid earlier this year, made it more explicit that there is headroom in the regulatory environment for schemes to invest more productively, it acknowledged that current legislation makes it "difficult and costly" for many scheme trustees to do this.

Given this, the government said it remains committed to introducing measures to make surplus extraction easier for trustees, where they choose to do so, with a range of potential safeguards being considered to ensure these additional flexibilities for trustees do not threaten member security.

Despite improved funding levels and plans for a permenanet DB superfund regime, the DWP also acknowledged that opportunities could remain restricted for DB schemes less attractive to commercial providers.

As a result, it confirmed that it will look to establish a public sector consolidator by 2026 aimed at schemes unattractive to commercial endgame providers, with a number of new measures intended to balance enhanced options for trustees while also prioritising the security of member benefits.

Plans for the consultation were previously announced as part of the Chancellor’s 2023 Autumn Statement, after the DWP previously held a call for evidence on how DB pension schemes could increase the amount invested in productive asset classes, including the potential role of the PPF.

Commenting on the consultation launch, Pensions Minister, Paul Maynard, said: “We are in a welcome position with DB pension schemes enjoying high levels of funding, and we want to make this money work harder for savers and the wider economy.

“I welcome industry views on our plans to reform the pensions market.”

A closer look at the proposals - treatment of scheme surplus

A key aim of the government’s latest consultation is to support schemes to invest for surplus in productive asset allocations by making it easier to share scheme surplus with employers and scheme members, and removing both the practical and behavioural barriers to surplus extraction.

In particular, the government is consulting on plans to introduce a statutory override to ensure that all schemes can choose to share surplus subject to the appropriate funding levels.

According to the consultation, this could be done through introducing a statutory power for schemes to amend their rules to allow for payments from surplus funding, or by introducing a statutory power to make payments.

However, the government emphasised that DB scheme surpluses should be extracted only where safe to do so from a member benefit perspective, warning that “any extraction of surplus will reduce security for members”.

Given this, it stressed the need to ensure there remains a very high probability that member benefits will be paid in full, suggesting that any surplus extraction should still leave the scheme over 100 per cent funded on a prudent basis.

It also stressed that, in all cases, trustees would retain responsibility for managing scheme funding levels, and extracting surplus will not be conditional on use of funds for particular purposes.

However, it acknowledged that the level of investment risk and the strength of the sponsoring employer will also have a significant bearing on what level of surplus is ‘safe’ to extract.

The consultation therefore includes a range of eligibility criteria for surplus extraction currently being considered, including funding above the low dependency funding basis plus a fixed margin, or a covenant requirement.

The DWP confirmed that it would also plan to introduce additional guidance for trustees around the considerations required when considering extraction of DB scheme surplus, potetnailly by adding an additional module to the ‘Funding Defined Benefits’ code of practice, introducing a separate code on surplus extraction or via TPR guidance.

PPF Underpin

As an alternative safeguard option, the DWP is also seeking stakeholder views on the potential for a 100 per cent PPF underpin, under which employers could opt to pay a higher “super levy” to the PPF in exchange for the PPF offering a 100 per cent level of compensation in the event of insolvency of the sponsoring employer.

However, the government acknoweledged that there are “important trade-offs” between the level of protection provided, placing constraints on schemes to mitigate the level of risk posed to the PPF and the cost of the levy.

A public sector consolidator

In addition to the surplus extraction rule changes, the DWP intends to establish a public sector consolidator administered by the PPF by 2026, which will aim to maintain the security of members’ benefits by ensuring that members’ interests are protected, while also providing an alternative endgame solution for DB schemes unattractive to commercial consolidation providers.

This consolidator would be a public sector vehicle set up for the purposes of effecting consolidation of certain private sector DB pension schemes’ liabilities.

Under the government’s proposed model, the link between the employer and pension scheme would be severed when the scheme transfers to the consolidator, apart from underfunded schemes where the employer will enter into an obligation to pay off the deficit over time, and would operate on a ‘run on’ basis, rather than target insured buyout.

The government also recommended that the consolidator operate as a pooled fund, suggesting that this would allow the consolidator to benefit from economies of scale.

However, the DWP acknowledged that the extent to which existing consolidation and buyout providers serve the whole market is a matter of some contention.

“On the one hand, some transactions for small schemes occur,” it stated. “On the other, the number may be too limited to meet the needs of all those that would like to secure their scheme – and successful schemes often have to offer exclusivity to obtain a quote rather than seek competing offers.

“This makes it difficult to establish hard limits on eligibility for the public sector consolidator by reference to factors such as size or funding level.

Given this, it suggested that setting the consolidator statutory objectives to offer an option specifically for schemes unattractive to commercial consolidation providers will lead to an outcome whereby trustees select into the public sector consolidator where commercial alternatives are not available to them.

Commenting on the consultation, PPF interim chief executive, Katherine Easter, said: “We welcome DWP’s consultation and look forward to working collaboratively with DWP and industry to establish the best design for a public sector consolidator that delivers the government’s objectives.

“The proposed consolidator would maintain the security of members’ benefits, give more choice to schemes and, dependent on scale, invest materially more in assets which support the wider UK economy and UK gilt market.

“Given the £1.4trn scale of the DB sector, we believe the public consolidator can work alongside existing commercial providers, supporting a healthy market by providing an attractive option for schemes unable to access existing solutions on reasonable terms.

“We plan to engage with stakeholders both on the detailed design of the public consolidator and further viable approaches which use the PPF’s skills and capabilities; we stand ready to support the government achieve its objectives in any way we can.”

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