If policy made it easier for defined benefit (DB) pension scheme surpluses to be put to use, the resulting changes in investment strategy could help deliver the Government’s objectives around productive investment, according to a new white paper published today by WTW.
The paper, entitled Six changes to seize the DB pension surplus opportunity, is published ahead of the Chancellor’s imminent Mansion House speech, which is expected to outline proposals for getting more UK pension savings invested in productive assets.
WTW argues that, where DB assets are concerned, this will only be achieved if some schemes adopt different objectives; schemes would invest differently if fewer were looking to transfer their liabilities to an insurer as soon as possible and if more were instead seeking to generate surpluses. It should therefore be made easier for schemes to use surpluses to benefit pensioners, sponsoring employers and current employees, so that they see value in pursuing higher investment returns. This would also allow surpluses that have emerged already to be utilised sooner.
WTW proposes six key changes the Government should make to pensions legislation:
1. Provide a straightforward legal route by which DB surpluses can finance contributions to a DC scheme used by the same employer. Provided that the DB scheme remains fully funded on a cautious ‘low dependency’ basis (a way of valuing pension liabilities under a new regulatory framework, which is intended to apply from April 2024).
2. Make one-off lump sums paid to DB pensioners ‘authorised payments’ (like lump sums from DC schemes). To create another way of sharing surplus with members without triggering tax penalties.
3. Change draft funding and investment strategy regulations. These threaten to funnel schemes into excessive de-risking (for example, by seemingly heavily restricting significantly mature schemes from taking risk, even if they have a healthy surplus) and to make it harder for open DB schemes to thrive.
4. Reduce the 35% tax rate on refunds of surpluses to an employer. This would ideally match the main rate of corporation tax (currently 25%, which would still be above the rate of corporation tax relief associated with contributions paid between 2012 and 2023).
5. Amend legislation to more readily allow refunds of surplus when a scheme is not winding up. This should include permitting refunds where the scheme is fully funded on a “low dependency” basis, rather than only when it could buy out all benefits with an insurer.
6. Revisit the Pensions Regulator’s statutory objectives. For example, to take account of scheme members’ wider interests and/or the adequacy of workplace pension provision.
Rash Bhabra, Head of WTW’s UK Retirement business, said: “With DB members getting older, and less time left until pensions need to be paid, there is no going back to the days when schemes routinely invested mostly in return-seeking assets. Proposals for change that are not realistic about this risk flying too close to the sun.
“But, with almost £1.5 trillion of assets in private sector DB schemes, it would only take a minority of schemes choosing to keep a small proportion of their portfolios in return-seeking assets for longer to have a big effect. The resources available for productive investment could be tens of billions of pounds higher than if schemes continued on their current path.
"The current regulatory framework incentivises schemes to predominantly de-risk once they are well funded, rather than continue to invest more productively. Our proposals are aimed at shifting that balance. The key is to change the environment schemes operate in, so that there is seen to be value in generating surpluses that can be used to benefit employers, pensioners and current employees saving through DC schemes.
“For example, one reason why few well-funded schemes have helped pensioners affected by high inflation is that employers have been reluctant to sanction pension increases that will affect pension values decades into the future; so it should be possible to give pensioners one-off lump sums. Employers will also be more comfortable supporting strategies that could see a scheme become over-funded if they can access some of the surplus sooner and without a tax penalty.
“Most schemes are already in surplus even on the cautious basis that they were supposed to be working towards over the coming years. So there is an opportunity to put some of this money to use now. By making clear that this is acceptable, which current draft regulations do not, the Government could give employers and trustees an appetite for pursuing further surpluses.
“Employers, pensioners, employees saving in DC schemes, and the wider economy could all benefit if the Government makes the right policy calls.”
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