The incoming Labour government was quick to make clear its commitment to the momentum sparked by last year’s Mansion House pension reforms.
During his brief tenure as Chancellor of the Exchequer, Jeremy Hunt committed the then Conservative-led regime to an ambitious programme of pension reforms that, among many things, included encouraging more investment in UK companies.
His replacement, Rachel Reeves, wasted no time in launching what she claimed was a ‘landmark pension review’ to boost investment, increase pension pots and tackle waste in the pensions system.
In its Pensions Bill confirmed in the King’s Speech last month, the new government outlined proposals for an investment shift which, initially targeted defined contribution schemes and the Local Government Pension Scheme (LGPS).
The Pensions Review, which is part of wider consultation, will go further by looking at the UK’s entire £2trn pension pot.
The Pensions Review had been promised in the Labour party manifesto while the Pension Scheme Bill outlined in the King’s Speech included only a narrow range of measures, such as a value for money framework to drive the consolidation of defined contribution (DC) pensions; measures on consolidating micro pension pots, the so-called small pension pots issue; a legal framework for Superfunds; and new duties on pension scheme trustees to look after members after retirement.
Steve Webb, Partner at LCP and a former pensions minister, said the new government is now suggesting the Pension Review could result in further measures being introduced in the Pension Schemes Bill, rather than waiting 12 months for another Bill in another King’s Speech.
These would include the use of the Pension Protection Fund (PPF) as a public sector consolidator – this means the PPF would have a remit to invest over a longer-term and in assets out of reach for some smaller pension schemes – and measures to allow sponsors to extract surplus from the best funded schemes. This in turn could slow gilt sales, sustain productive investment for longer and generate surplus cash to benefit corporate sponsors, DB members and potentially the DC generation.
“By operating a two-stage pensions review, with an early hunt for measures which could be added in to the current Bill, the Government has the potential for faster implementation of measures which it believes would promote the ‘productive’ use of pension scheme finances,” said Webb.
How far the new Labour government will decide to take the Pensions Review, in terms of UK defined benefit schemes, will depend on its appetite for reform.
Paul Kitson, Partner and Head of EY’s Pension Consulting Business, said the new government already had the beginnings of a framework in the pension industry’s response to the DB options consultation, one of many which came out of the Mansion House reforms and closed for responses in April.
“I think it’s too early to say what direction the Pensions Review might go in, particularly on the defined benefit side. But one of the first things the new pensions minister will have been able to do is review all of the industry responses to the previous DB Consultation.”
Kitson also said the proposal for the PPF as a consolidator was likely to be a profound one for the UK’s PRT if implemented. This is because the original proposal, that the PPF would act as a buyout provider to small struggling schemes, had grown to funds not yet able to afford a buyout.
“It will be interesting to see how such an evolved PPF will sit alongside its commercial counterparts,” Kitson added.
DB surpluses will also be on the new government’s radar. If the government acts on surpluses, Kitson believes it would be a game changer.
“Currently, most employers will opt for a buyout. However, if a surplus can be returned to the employer in an easier way than currently allowed, that could drive a very significant shift to longer term run-on. We may see schemes that are confident they won’t revert back into deficit saying they won’t opt for a buyout and will choose to run on instead.”
Kitson also said the new government had been clear it wanted to continue the previous administration’s push to get pension funds investing in UK-based productive finance and private equity assets.
“Pension funds in surplus are often cautious with their investment strategy. They generally do not want to risk that surplus, so they invest in lower yielding assets by moving more into government bonds, for example. However, if this approach is taken by a large portion of the UK pensions sector, we need to consider the impact this may have on the UK economy in the long-term,” he said.
So, you end up in this position where we are today, where the UK pension sector is now investing in a way that’s far more cautious than the commercial insurers. So, if all of these pension funds, which account for £1.5trn are now investing in ultra cautious assets, is that helpful to the UK economy?
This in turn would also mean funds could use their surplus to better fund their DC schemes.
“DC contribution rates from both the employer and employee are currently too low for a secure retirement, and one of the things we’re asking employers is whether their DC pension cost is likely going to increase for current employees,” added Kitson.
The Pensions Review could, Kitson argued, make life easier for insurers when pricing and negotiating buyouts.
If the PPF emerges as a consolidator, organic change may evolve around the standardisation of benefits, whereby insurance companies would be able to price buyouts using what Kitson predicted could be just five different benefit tranches. This would mean, Kitson predicted, five standard ways of calculating liabilities allowing for different modelling scenarios.
“Anything that standardises benefit calculation ultimately leads to better pricing for schemes,” explained Kitson.
Such simplicity may still be some way off and as Kitson and Webb admit, the Pensions Review is going to have some complex and urgent issues to address.
“Even if we did see some changes coming out of the review that mean more schemes run on, the industry is so large – currently only insuring about £50bn a year, or about 3% of the market p.a – so insurers are not going to be struggling for volume.
“The UK will still have a very vibrant buyout market, even if run on becomes more of a norm,” Kitson said.
Calum Cooper, Head of Pensions Policy Innovation at Hymans Robertson said the Pension Review had already had an impact by focusing trustees and sponsors on their endgame and whether to transfer risk to the insurance market.
“We do expect that a number of schemes may choose to run-on that may not otherwise have chosen to do so, but still expect to see a very busy risk transfer market for the foreseeable future, focussed on insurance but with the potential for superfunds to become an established part of the landscape.”
