Defined-benefit Pension Schemes

Julian Knight Excerpts

Tuesday 10th July 2018 Westminster Hall

[Laura Smith]

I apologise to the hon. Gentleman—it was hard to hear him because of the sound of the fans. I will come on to those points.

Basing assumptions on gilts may artificially inflate deficits and future service costs for the sponsoring employer and scheme members. That may lead to the unnecessary closure of schemes to new members and future benefit accrual. Unison’s experience is that some employers would rather pay more and use the increase in costs as an excuse to close their DB scheme, saving money by transferring members into a DC scheme with lower employer contributions, which results in reduced pension benefits for scheme members.

Not only are DB schemes desirable, but they can be affordable and good value for money. We should do everything we can to protect them. The Government’s role should be to provide an adequate regulatory framework, meaningful enforcement and appropriate incentives to help encourage sound decision making and ultimately to provide decent pensions. I welcome the Government’s White Paper and the regulator’s ambition to be clearer, quicker and tougher.

I hope that the Minister can provide me with a little more clarity or reassurance about three issues. First, there appears to be no new relief for employers struggling with DB liabilities. Although I welcome the suggestion that there should be penalties for directors who do not take sufficient care of scheme members’ interests, without support for struggling employers, tougher rules may simply incentivise more of them to close DB schemes in favour of DC schemes with inferior pensions for workers. Secondly, what additional resources are being provided to ensure TPR has the capability and capacity to effectively regulate the sector?

Thirdly, encouraging consolidation over alternative options would not prioritise the protection of members’ benefits, which should be the Government’s primary focus. I understand that insurance buy-out remains the best solution for guaranteeing member benefits in DB schemes. Securing member benefits should be paramount. With an insurer, members are almost certain to receive their benefits in full. The Association of British Insurers believes that prices are the best consultants have ever seen, and that that option is available to smaller schemes.

Although I understand there is a need to provide options for employers that simply cannot secure a buy-out, any new framework should not incentivise consolidation purely on the basis that it is a cheaper option. The risk of investment failure was highlighted by the Pension Protection Fund in a submission to the Select Committee on Work and Pensions. In the absence of a substantive employer, the security of members is entirely dependent on the investment performance of the fund and the associated buffer. Consolidation is therefore less secure than buy-out, and profit withdrawal in years of good investment returns may lead to scheme failure by preventing a strong build-up of reserves.

Consolidation also means that risk, rather than being dispersed across several schemes, becomes focused on one investment strategy. Different consolidators may be inclined to pursue the same investment strategy, resulting in a high correlation of risk in the DB sector. Obviously, that may lead to all schemes failing at the same time. I am also concerned that younger members may shoulder the risk of commercial consolidators collapsing. We should not pursue any policy that leads to greater intergenerational unfairness.

To put it plainly, I am concerned that the option to consolidate or transfer into a super-fund may be seen by some employers as another bolthole to escape their liabilities on the cheap.

[Julian Knight (Solihull) (Con)]

I thank the hon. Lady for securing this important debate. She is making a very good speech in many respects, but one of the concerns about DB schemes is that some that have existed for a long time have few members but a large legacy. A scheme may have only 100 employees, for example, but a very large legacy behind it. I wonder whether she recognises that super-consolidation may be an option for such schemes.

[Laura Smith]

I touched on why I have concerns about that.

As I said, securing member benefits should be paramount. What reassurance can the Minister give me that the eventual framework will ensure that employers’ decisions are focused on that objective? If an employer has the means to get a buy-out and that is the best way to guarantee scheme members’ benefits, it should get a buy-out. We need a framework that incentivises decision making on that basis.

Will any legislation that is enacted be applied retrospectively to cover commercial consolidators formed in the intervening period? I am concerned that a two-tier system of regulation would provide loopholes for those willing to exploit them. Directors of sponsoring employers must have personal liability—there must be criminal offences and heavy fines.

I support the White Paper’s push for clearer, quicker and tougher regulation. I commend the Minister’s efforts and I hope that the White Paper leads to measures that further protect defined-benefit pensions. However, I remain concerned that over-zealous prudence and assumptions threaten otherwise affordable DB schemes. There should be additional support and relief for struggling schemes. I would like to be confident that TPR will be given the resources it needs to have the capability and capacity to regulate effectively in the light of any changes. I am concerned that consolidation—although it may be the best option for some schemes—will be seen as an acceptable cheaper option that does not prioritise protecting scheme members’ benefits when more secure alternatives, such as buy-out, are available and within the means of the employer.

We must endeavour to build a framework that incentivises workers to save responsibly and deters directors from behaving irresponsibly. Paying dividends must not be prioritised at the expense of protecting pensions. I would be grateful if the Minister responded to the issues I have outlined and committed to looking into the ongoing matter at Bentley Motors, which is of concern to more than 1,000 people in Crewe and Nantwich who work for the company, and to working with me to promote a dialogue that has the protection of scheme members’ benefits at its heart.

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[Paul Masterton]

I am pleased to hear that, because the Pensions Regulator performs a vital role in overseeing occupational pension schemes. One of the big frustrations on the trustee side—not usually on the employer side—was that the regulator did not seem to have the time or resources to get stuck in or do anything serious to encourage or require an employer to change course. Some of the suggested improvements are very good.

In the past, pension schemes operated in a world of high interest rates and good equity returns. We now live in a different world. Investment decisions reflect ongoing uncertainty and volatility, which has led to widespread de-risking and a preference for investing in bonds and gilts. That has been a huge loss to the UK economy, with funding being taken out of equities. We could do more to look at how to unlock some of the vast sums that sit behind pension schemes.

[Julian Knight]

Does my hon. Friend share my frustration that often UK infrastructure is owned by overseas pension schemes and that, despite exhortations from the Government for schemes to invest more in the UK and in these stable, high-producing assets, they still seem reluctant to do so?

[Paul Masterton]

I do. Big pension funds—Canadian pension schemes and many others—invest a lot, and those investment projects provide good returns. We could unlock huge amounts of money.

Final salary pension schemes will end up in one of two places. They will either be successful and be bought out with an insurance company or fail and end up in the PPF. The hon. Member for Crewe and Nantwich was right that deficits have been pushed up by low gilt yields and low interest rates. Many employers, pushed by their trustees, and to a certain extent by the regulator, have prudent assumptions in their valuation setting, which increases the amount they have to pay in. That can provide a false picture of the deficit, but it does match the reality of trying to buy on the market. There is flexibility in the system, and one thing the regulator is looking at is being more akin to employer affordability in the valuation assumption setting, which should help with some of these problems.

Fundamentally, this drives to a system that is completely linked to the employer covenant. The stronger the employer, the more flexibility there is, which gives much more leverage to play around with assumptions. A weak employer cannot afford to take as much risk, so it is much tighter with its assumptions. That pushes the deficit up, which means more money has to be paid in. It is a self-perpetuating cycle where the weakest schemes, which need the greatest support, do not get it. They need the breathing space, but they have to pay high levels of deficit repair contributions. As my hon. Friend the Member for Solihull (Julian Knight) said, we should consider that many such schemes are legacy schemes, predominantly in old-school manufacturing industries, and many of those companies are shells of what they were in the ’70s and ’80s when their schemes were brought in. Those employers already provide weak covenants, and that situation may only get worse as we move forward.

It is remarkable that “The Purple Book” from the PPF estimates that 3 million DB members have only a 50% chance of seeing their benefits paid in full. The PPF is a fantastic lifeboat scheme to ensure that people still get decent payment of pensions, but we do not really want people to be reliant on it.

I disagree with the hon. Lady about consolidation. What the Government have been looking to do on that is sensible. Lack of scale is crucial. Two thirds of the UK’s defined-benefit schemes have fewer than 1,000 members, and small schemes cannot access the same sophisticated investment opportunities as bigger schemes. Even costs such as advisory fees, accountancy fees, actuarial fees and legal fees are disproportionately high for small schemes. There is a good place for consolidation, but she is right to worry about governance and ensuring that we do not go from a situation under an employer scheme with high levels of governance to one under a bigger scheme where that gets lost. That can probably be worked through in a scheme’s design and set-up. Ultimately, the solution to protecting DB schemes is not governmental but in the economy and the strength of the sponsor or, where available, the parent company. One of the big difficulties is volatility and the lack of certainty around risk.

The Government continue to take steps to pick apart the issues faced by the DB sector. They are doing good work, but fundamentally we need a clear understanding that governance, funding and covenants are intrinsically linked. I look forward to hearing the good story the Minister has to tell on what the Government are doing.

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[Julian Knight (Solihull) (Con)]

It is a pleasure to serve under your chairmanship, Mr Hollobone. I congratulate the hon. Member for Crewe and Nantwich (Laura Smith) on securing this important debate. I was heartened by it. I had thought that cross-party working and the recognition that we are all trying to do something in a positive space had been lost to a certain extent, but her speech was incredibly positive in that regard. I am sure the Front-Bench speaker, the hon. Member for Birmingham, Erdington (Jack Dromey), will reflect that later. I also want to say that the speech by my hon. Friend the Member for East Renfrewshire (Paul Masterton) was the speech I wanted to give. We have just been discussing that. It was absolutely top drawer and very thoughtful.

My career as a financial journalist spanned what I would call the sharp decline of private workplace DB schemes. I remember all too well speaking to people at the Allied Steel and Wire steelworks in Cardiff, who had effectively lost their pensions when their company was wound up almost overnight. The same was true for Maersk, probably one of the worst examples of corporate acts in this country in the last generation. Under the laws at the time, retired members were understandably protected first, which meant that those who were even just a few weeks from retirement ended up with virtually nothing. I can remember the heartbreak in their voices.

That decline comes from many issues. In that instance, it came from poor company governance and the fact that the economics of DB schemes have been fundamentally undermined over time through demographics and investment returns. Frankly, for the last 15 years, DB schemes have been effectively dead in terms of new members for the private sector. They have existed in the public sector and have morphed and developed over time—we will see how that goes and whether the current models are sustainable.

In response to those issues at Maersk and ASW, we had the Pensions Act 2004, which helped to set up the PPF. Mr Rubenstein’s management of that has been pretty exceptional. The PPF has been well managed, but frankly it can take only so much. A lifeboat can take only so many passengers. The difficulty is, as my hon. Friend the Member for East Renfrewshire noted, that 3 million members face potentially only a 50% chance of having their pension. The more we load into a lifeboat and the greater the burden on other funds, the more likely they are to collapse in turn.

We need a longer-term solution, and we need to focus on the 2,000 schemes with fewer than 100 members. I believe conversion is a good idea. However, I take the point of the hon. Member for Crewe and Nantwich that perhaps the current models of conversion, which to a certain extent are zombie funds, are not the way we want to go. What we need is to transfer to scale, so that the returns come through back office. More than that, potentially, there is my big idea—I have written to the Minister about this before and he will not be particularly surprised that I mention it—of rebasing some work-based pensions over time, so that we end up putting everything on a sustainable footing. We could also adapt schemes to the modern world in terms of spousal pensions and, I would suggest, the potential provision of social care.

The tail is wagging the dog. We have a statutory architecture built for a system where people had jobs for life and DB schemes were ongoing entities. For increasing numbers of schemes, retired and deferred members far outweigh active members. Employers are not members, and members are not employees. In that context, the direct link between the employer and the scheme makes diminishing sense. Of the £80 billion or so paid into workplace pensions, around three quarters of which is in respect of DB schemes, nearly half goes to the public sector, yet active membership of DB schemes is now down to just 7 million workers and is falling daily.

We need to break the link. First, we should establish a universal benefit structure, or a kind of common denominator pension, based on a common structure—for example, a one-sixtieth or one-eightieth scheme, with 50% spousal pension and consumer prices index inflation-proofing up to 5%. We would then go through the time-consuming and laborious process of valuing existing DB schemes by reference to that universal scheme on an actuarially neutral basis. For example, in my 20s I contributed a negligible amount into a final salary pension scheme on a one-fiftieth accrual basis. As a result, I was guaranteed a pension of nearly £4,000, with RPI and a two-thirds widow’s pension. The scheme is now in the PPF, but that is because the promises were far too great for the contribution levels.

It would have been better if, at an earlier stage, those considerable benefits had been converted to, say, a £5,000 pension in a new scheme. People would not lose their pension initially, and hopefully not at all. Instead, it would be simplified and moved on to a surer footing. That is one point for the hon. Member for Crewe and Nantwich, who talked about consolidation schemes. We could invest in very large schemes indeed. Some of the governance in some of the smaller schemes with fewer than 100 members is frankly very amateur. It is pitiful and almost mothballed.

If we were to have larger schemes, privately run by something such as a type of National Employment Savings Trust, with Government involvement on the board and oversight by regulators, we could move to a situation where we all feel more invested and know exactly what we are getting. Crucially, we could rebase to enable us to provide better futures for spouses.

Another area I will mention is that we could offer a social care option. If I had a very large scheme involving maybe 500,000 to 1 million members, I would have the scale to offer a social care option. I could say to someone, “At the moment you will get a pension of £10,000 per year. What we will do is to give you a pension of £8,000 per year, but we will invest through our scheme, because we have scale and can do so.”

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On resuming—

[Julian Knight]

I apologise. We were so rudely interrupted by the Liberal Democrats.

The effective remodelling of these almost-zombie DB schemes could be a means by which we ostensibly kick-start a different approach to social care and allow people to choose whether to supplement their social care in the long term by actively deciding to put away a certain amount of pension in order to receive a certain amount of social care insurance. There are all sorts of options for that.

I conclude by saying that the Green Paper and White Paper were refreshing and thoughtful. We have an opportunity to do something that the Turner report did not do—it dealt mostly with public finances and the state pension—which is to shift the balance and the focus on to private sector workplace pension schemes. We need them to play a role, but we also need to repair the problems of the past.

[Mr Philip Hollobone (in the Chair)]

We now come to the first of the Front-Bench speeches. The new finish time for the debate, because of the Division, is 5.40 pm.