The Work and Pensions Committee’s inquiry into defined benefit (DB) pension schemes kicked off this week, as the committee heard updates from a number of industry experts, with warnings that pensions policy could risk being stuck in a "bygone era”.

The WPC launched the inquiry into DB pension schemes in March, suggesting that the recent improvement in aggregate scheme funding makes this "an important time to consider the future".

Following an initial call for evidence, the WPC held its first oral session yesterday (21 June), hearing initially from University of Leeds Centre for Financial Technology director and professor of pensions and finance, Iain Clacher, LCP partner, Steve Webb, Pensions and Lifetime Savings Association (PLSA) deputy director of policy, Joe Dabrowski, and Brighton Rock Group head of research, Dr Con Keating.

This was followed by a second panel, with insights shared from Railpen head of integrated funding, Martin Hunter, Institute and Faculty of Actuaries pensions board chair, Leah Evans, independent pensions consultant, John Ralfe, and First Actuarial senior consultant, Derek Benstead.

Establishing the right foundation

Opening the first session, Keating threw recent claims around DB pension funding improvements into question, arguing that despite claims that funding levels have improved by 15-20 per cent, that number is “nearer to nothing or perhaps 5 per cent”.

In addition to his own analysis, Keating highlighted the recent WTW FTSE350 research as evidence of this, pointing out that whilst this showed an improvement in scheme funding, it was less than the 26 per cent increase being described in the industry.

“Everything that's come in has suggested that, actually, scheme performance is nowhere near as strong as we have been led to believe,” he stated. “Overall, there are some schemes which have done very well, and there are some schemes which have done extremely badly.”

Keating also argued that those schemes who have done extremely well are those schemes who did not utilise liability-driven investment (LDI) in any meaningful way.

Adding to this, Clacher acknowledged that different measurements and approaches can throw headline figures into question, arguing that "the problem with pensions is it's so terribly technical and tedious".

However, Webb argued that whilst there is a lot of detail to discuss around the measurements, it is “vital to get the foundations right [for the WPC's inquiry], and the foundations are utterly staggering”.

In support of the improvements in DB funding, Webb cited four different ways to measure the financial strength of DB pension schemes, arguing that “they all tell the same story”.

In particular, Webb highlighted recent analysis from the Pension Protection Fund (PPF), which showed that while DB pension schemes held a combined deficit of nearly £400bn in 2014, the latest figures revealed a surplus of "well over £400bn".

In addition to this, he highlighted recent LCP analysis of the FTSE100, which revealed that DB schemes for FTSE100 companies are around £70bn in surplus, marking a £10bn improvement on the previous year.

He also cited the latest figures from The Pensions Regulator, which suggested that 75 per cent of schemes are in surplus on technical provisions basis.

"Even with the nitpicking on the detail and the definitions, you can't lose that story," he said. "So whatever conclusions we might come to about the nitty gritty of the fine detail, there has been a massive swing in funding levels".

Dabrowski agreed with Webb, arguing that while there will be nuances, “and there are always arguments in the industry about approaches and measures”, on the whole, the consensus feeling is largely that there have been big improvements.

“I think we are in a really nice position now actually, given the kind of funding position of schemes, we can make some choices around policy interventions," he continued.

“We should also recognise that not is all rosy in the wider garden, whilst scheme funding is strong, we are facing recessionary forces which will have a call on employers in future, and that may be coming sooner rather than later,

"But the funding position of schemes is really strong, members benefits have probably not been as secure for 10 to 20 years, so we need to be really pleased about where we are and think about the flexibility we can introduce."

Raising tensions

With a divide in the panel, Keating was asked to share further thoughts, disagreeing with Webb's suggestion that schemes have more money than ever, clarifying that while schemes "apparently” have better funding levels, the amount of money being held is around the same as a decade ago.

He also reflected on recent research around fiduciary fund manager performance in 2022, which, according to Keating, revealed “quite surprising” results, as schemes did not do better, and “none actually reached their attempted targets”.

Commenting shortly after this, Webb said that he “wasn’t actually quite sure what Con was saying”, stating that while the autumn volatility was “bumpy” for pension schemes, the net effect, including asset falls and interest rate changes, is that “of the schemes we work with, 75 per cent are up on the year”.

The second panel also suggested that funding improvements have been seen, as Evans argued that “certainly we are in much better shape than we've been in the past”, noting that funding levels by most measures have broadly increased.

“Where that's positive is that it's allowing sponsors and trustees a little bit of breathing space to really think about what they want to do with their pension schemes, whereas in the past it's sort of been firefighting increasing deficits,” she added.

Ralfe also agreed that funding has improved, stating that policy changes aren’t needed, but rather “little tweaks here and there”.

“I don't want to sound too panglossian about it, but I think we are in the best of all possible worlds,” he continued, suggesting that TPR is "broadly doing what it should be".

"Broadly speaking, I'm very comfortable about where we are and I think where we will be going over the next few years."

Looking ahead

However, Webb argued that "policy has to be made in a world of surpluses", warning that recent funding improvements mean that pension policy is at risk of being "stuck in a previous era" rather than reflecting the realities of scheme funding levels today.

Given this, he suggested that policy changes were needed to address concerns that huge amounts of pension assets are now generating very little return, warning that this was a "costly missed opportunity" for schemes, their sponsoring employers, and for the country.

In particular, Webb outlined plans for a “game-changer” idea, which would allow sponsors of well-funded schemes to pay a top up PPF ‘super-levy’ which would underwrite 100 per cent of member benefits.

Webb also argued that this secure underpin would mean that scheme assets could be more freely invested for higher returns, generating surplus funds which could benefit DB members, the DC generation, employers and the wider economy.

He also clarified that this would be different to the recent proposals from the Tony Blair Institute, as it would be focused on the “cream of the pensions world”.

Commenting after the evidence session, Webb added: “There is no doubt that DB pension scheme funding has been transformed for the better in the last decade. Yet policy risks being stuck in a previous era.

“For many of our clients the issues we are now discussing are about managing surplus risk through de-risking, rather than dealing with deficits. It is time for some creative policy thinking that would allow nearly £1.5trn of DB assets to be invested for long term growth rather than being increasingly locked into low-return and low-risk assets”.

Commenting in response, Dabrowski said that while the proposals at this stage “probably bring more questions than answers”, such solutions are worth thinking about amid a time where “we have options to think about the future of the DB sector, the changes that we could make to enhance and support it going forward”.

Given this, he suggested that an industry or government consultation could be used to address some of the key questions around the proposals, and consider how such changes could work in practice.

In particular, Dabrowski queried how the proposals would alter the role and functions of the PPF and what impact that would have on levy payers, as well as how the changes could fit in with the broader landscape, particularly the buy-in and buyout market,

While Clacher agreed with Dabrowski’s call for more detail, he suggested that Webb’s proposals are “interesting”, acknowleding that the "homogeneous approach to pensions" needs to change.

"What we really need to do is have a more systemic look at this, because we need different business models, for want of a better description, as to how we deliver benefits," he stated.

"I think we have to have a much better understanding of different business models and having different approaches caveated with the fact that they might not all work.

"If the only solution was to transfer the world of DB pensions to the world of insurance would essentially double the size of the insurance sector.

"I don't think the capacity is there in the market, and I don't think the demand for that is there in the market either."

Erring on the side of caution?

When specifically asked whether the regulator had been too cautious, and in particular whether the objective to protect the PPF should drop away to instead support sponsors and encourage growth, Keating argued that it should, noting that “no other PPF anywhere in the world needs a guardian angel, and many of them take on far more risk”.

"One of the problems with TPR having regard to protecting the PPF, is they have done so consistently at the cost of schemes.

"Take that away, and you give the PPF an alternative objective, which is to provide retirement income, not to protect schemes."

However, commenting on the same issue in the second panel, Ralfe said that "the idea that TPR should not have the job of protecting the PPF, well you might as well tear it up".

Supporting open schemes

Both panels were also asked about the potential issues around open pension schemes, with both Dabrowski and Webb emphasising the need to ensure that open schemes remain supported in the new DB funding regime.

"We want open schemes," Webb emphasised, "we want employers who are willing to run these things on and the regime has got to encourage them, not penalise them."

Commenting during the second panel session, Hunter also provided insight on the issue from the perspective of an open scheme, agreeing with Webb’s comments that DB schemes are in a “fundamentally position now”.

He also suggested that there are some "incredible opportunities" that the industry and the government has through policy to use the DB pensions industry as a "power for good", both to help members and savers, but also to help the UK economy more widely.

In particular, Hunter pointed out that, despite the recent focus on funding level improvements, progress has also been made in terms of the cost of providing DB pensions to current active member.

"That has fallen materially in the last few years as well,” he continued, revealing that costs for the around 40 open railway pension schemes have fallen by around 5 per cent over the past few years.

According to Hunter, this could mean that some employers could reconsider whether defined contribution (DC) is the right option for their employees, or whether they should be looking to put some back into DB again.

Evans also argued that being able to do something “specific and appropriate” for open schemes is needed, to provide TPR with the flexibility to agree something specific with those schemes.

In addition to this, Evans argued that there is a broader opportunity in the sector, given the “huge amounts of money” within pensions.

She stated: “I think under the current regime, the opportunities for doing something really significant is probably limited and that's because if you're investing into different types of assets that provide greater return, there is some risk that comes with that, and ultimately somebody's got to pick up the risk.

"Unless you kind of come up with some way of separating the schemes from the sponsors, the sponsors will still be taking some risk and the question is whether they would want to.

"I think there is potential there for opportunities and I think it's really positive that there's so much debate and different ideas being put forward, but I do think that it's not a sort of easy change around the edges.

"If you want to really harness that then something bigger needs to happen."

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