The government has been warned that it will take more than words of encouragement to get defined benefit (DB) pension schemes to take a different investment approach.

The government previously launched a call for evidence on how DB schemes could increase the amount invested in productive asset classes and the potential role that the Pension Protection Fund (PPF) could play in this as part of the Mansion House reforms.

In its response to the consultation, LCP noted that while is widespread concern that nearly £1.5trn of DB assets is not being invested as productively as it could be, after a decade of regulatory pressure to de-risk, it will take more than encouraging words to drive change.

In particular, LCP noted that trustees are currently focused on getting member benefits paid and have little reason to explore anything that might increase the downside risk on investments.

In addition to this, the firm argued that sponsors see little advantage in targeting higher returns, which could act to build up ‘trapped’ surpluses that they cannot access until schemes wind up, and even then not with any certainty and subject to penal tax.

However, it suggested that a "secret sauce" of enhanced PPF protections could provide trustees with the security needed to take more investment risk, as outlined in LCP's previous proposals.

LCP's two-part solution recommended a new opt-in regime whereby the sponsors of well-funded schemes could choose to pay an additional PPF ‘super levy’ which would ensure 100 per cent of member benefits were protected in the event of sponsor insolvency.

This would be accompanied by changes to the rules around the extraction of surpluses, allowing sponsors in this new regime to extract surpluses from ongoing schemes once funding reached a target level.

This approach, according to LCP, would allow trustees to take on more investment risk knowing that member benefits are fully under-written, while sponsors would also be keener to run a scheme on targeting higher rates of return, as they potentially share in the upside much sooner.

Although the government's consultation also sought views on other proposals, such as the Tony Blair Institute’s recommendation for 4,500 DB schemes to be consolidated into the PPF, LCP warned that this would be a "massive undertaking.

LCP explained that PPF would be required to carry out individual assessments of each scheme and need to understand the unique benefit structures and rules of each, as well as undertaking a data cleanse before scheme transfer.

In addition to this, it argued that a focus on smaller schemes could mean that a huge amount of effort is expended on consolidating large numbers of small schemes with little impact on the overall amount of productive investment.

LCP partner, Jonathan Camfield, stated: “There is widespread agreement that DB pension fund assets could be invested more productively.

“But trustees have little incentive to agree to any form of re-risking if this puts member benefits at greater risk.

"In our view the ‘secret sauce’ which would unlock this barrier would be the creation of a new PPF regime allowing sponsors to opt in to 100% protection of member benefits.

"Only with this security will trustees be more willing to take a fresh look at scheme investment strategy.

“We are delighted the government is consulting on our proposals to achieve this and in our response we are calling on the government to make the required regulatory changes that will in turn enable a step change in pension scheme productive finance that we believe has the potential to be worth £100bns to the UK economy.”.

“If the government is serious about getting DB assets more productively invested now, it should start with the biggest and best funded schemes, and should enable the assets to be more productively invested where they are, rather than be distracted by moving around the assets of the smallest schemes”.

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