In the event, defined benefit (DB) content was minimal in Mr Hunt’s parliamentary address at the despatch box. However, the government did not disappoint, and announced significant pensions reform details online alongside the Chancellor’s Autumn Statement transcript, including Department for Work & Pensions (DWP) consultation responses to recent call for evidence outcomes.
What do we know?
The Autumn Statement pensions reform aims to expand on announcements at Mansion House in the summer of 2023. It includes key focus items for DB pensions, some of which are intended to strengthen investment in UK productive finance assets.
Trustee skills
The Pensions Act 2004 set out requirements for the level of knowledge and understanding of pension scheme trustees, including on investment matters.
Questions have been asked over whether these requirements are being fulfilled, particularly within small schemes where there is an absence of professional trustees.
Future changes to trustee accreditation requirements have not been ruled out.
The DWP released a response to a recent consultation [1] regarding this matter and confirmed that actions will be taken to address some of these issues. This includes the development of a trustee register alongside The Pensions Regulator (TPR), accreditation of professional trustees, and updates to TPR’s investment guidance. Future changes to trustee accreditation requirements have not been ruled out.
Extraction of surplus
Most schemes are not permitted to refund surplus back to the employer without winding up. Where this is allowed for in scheme rules, caution from trustees due to the potential impact on member benefit security means that take-up is very low or non-existent.
A reduction in authorised refund of surplus tax charge (from 35% to 25%) will provide a 15% increase in the value of any net refund from 6 April 2024 onwards. This might help targeting surplus build-up become a mainstream strategy should a framework be created to facilitate refund of surplus without scheme wind-up for all schemes.
How such a refund will work is less clear. There will be a consultation in ‘Winter 2023/24’ which will explore the viability of allowing schemes to pay a higher Pension Protection Fund (PPF) levy in return for full member benefit coverage, alongside other safeguards to member benefits.
DB Consolidation
The recent consultation on options for DB Schemes [2] further highlighted some of the challenges faced by small schemes, including governance standards and access to the buyout market.
The Autumn Statement reforms confirm that a public sector consolidator will be launched by 2026.
Public sector consolidation still divides opinions, but the Autumn Statement reforms confirm that a public sector consolidator will be launched by 2026. The PPF is set to provide this.
With consolidation options already available in the market, the public consolidator could provide a home for those schemes that are unattractive to commercial providers. Further details on the design and eligibility of the consolidator will be covered in a consultation.
Reform impact: investment strategy considerations and opportunities
The pension reforms provide an opportunity to give schemes more choice over their end destination. While an insurer buyout has long been the ultimate objective for most schemes, the outcome of the consultations could mean that many schemes change tack and choose to run on, potentially benefitting members and sponsors. Even if the goal of a buyout transaction remains, schemes should consider whether now is the right time to do so.
Taking a pause to re-evaluate objectives and investment implications is very important for schemes and may solve some short-term problems. Some key investment strategy considerations are set out below:
- Illiquid assets: one of the key issues facing DB schemes is the disposal of illiquid assets as they approach buyout. By delaying a buyout transaction and considering running on for longer, schemes could avoid this and use the illiquid assets to grow more of a surplus. It may even be a good time to increase an illiquid asset allocation as other schemes are willing to accept a discounted price to sell quickly.
- Liability hedging: given that most schemes have experienced an improvement in funding level over the last few years, it’s important to review the level of interest rate and inflation hedging in place to lock in these gains.
- Credit allocations: for schemes looking to transact with an insurer in the short-term, a buyout-compatible credit portfolio is a key factor in reducing the volatility of the scheme’s funding level relative to buyout pricing.
Solutions for smaller DB schemes
The industry responses to the DWP’s call for evidence on options for DB schemes further highlights some of the disparity caused by scheme size. The Autumn Statement pensions reforms look to address some of the challenges facing smaller schemes. And at the very least they provide food for thought on what future options might look like.
TPR Chief Executive Officer Nausicaa Delfas said recently: “Many schemes lack scale to deliver the best returns, with around 5,000 schemes over 70% of which have assets under management of under £100 million. That is why trustees should be asking themselves tough questions around consolidation now and in the future.”
Several different types of consolidation options are already available in the industry, from investment consolidation to master trusts, and the first superfund transaction has now taken place. It remains to be seen what the public consolidation vehicle will look like, and what the requirements for entry will be, but the direction of travel in this space is clear.
At abrdn we have a range of solutions such as a master trust and fiduciary investment management offering. These offer significant governance model improvements for most small DB schemes, benefitting trustees, sponsoring employers and - most importantly - scheme members.
You can find out more about buyout-compatible credit portfolios and dynamic liability benchmarks by reading our previous articles.