The creeping DB crisis

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One of the big discussion points in the industry this year has been the security and sustainability of defined benefit (DB) schemes and whether the system is ripe for reform. More is yet to come with the government due to publish a white paper this winter following on from its green paper on the published in February.  

At PP's annual Trustee Senate on 20 September, a panel of experts including the Pension Protection Fund's general counsel (PPF) David Taylor, discussed whether the DB system is in crisis and what the potential solutions might be. 

Slow burning crisis?

Pension and Lifetimes Savings Association (PLSA) DB Taskforce head Ashok Gupta pointed out there are four and a half million members in DB plans receiving benefits with a further 11 million members expecting them in the future. While the average sized pension is just under £9,000, the PLSA has estimated there are three million members who have a 50% chance of being paid. Of the 6,000 DB schemes, 900 schemes are in stress and another 900 schemes are in potential stress.

Gupta argued there is a crisis but it is chronic rather than acute as the schemes under stress experience a combination of underfunding and covenant risk.  

"The difficulty of this [situation] is that it is like watching a slow motion train crash and it happens over a long period of time and is not the sort of thing which generates headlines.

 "The covenant risk is usually bigger than people expect because they have been set up by traditionally large industries like manufacturing or retailing. These are precisely the industries challenged by globalisation and digitalisation.

As the causes of a scheme's collapse take a long time to be felt, solutions have to be proactive rather than reactive.

"We have a crisis because the time it takes to prevent the headlines is getting shorter and shorter," said Gupta."If we do not take action we will have more Tata Steel and BHS [situations] and it could undermine confidence in not just DB pensions, but all pensions," he added.

Hard to spot 

However, a problem is that there are different definitions of a 'stressed scheme' and what solutions follow from that.

Arc Pensions Law partner Rosalind Connor said it is difficult to know what a 'material risk' is.

"The reason why people disagree is that people never use the same definition exactly. I don't know what counts as a significant chance [of a scheme failing] and I have got nervous about the concept of stressed schemes. My worry is that looking at this, I don't know how we identify them and what to do about them."

Interestingly, the PPF's own figures appear to be less pessimistic than the PLSA's. The lifeboat fund's modelling shows that claims on the PPF until 2030 at the median will probably be less than the claims made so far.

Taylor explained how the lifeboat fund defines stressed schemes. 

"We see stressed schemes broadly in two categories: first the ones with a high short-term chance of insolvency and material deficit. And then there is the problem of the schemes with employers that currently look alright but where the deficit is vastly out of proportion to the employer's size."

Solutions

What can be done about this problem? Gupta outlined two forms of consolidation the PLSA's DB taskforce has been researching.

The first type is about the pooling of assets, administration and governance.

"It is a bit like the local authority consolidation but goes one stage further. It can work for some schemes, particularly where the covenant is strong," said Gupta.

But for very stressed schemes, the PLSA has worked on something more radical as the current system keeps employers on the hook for scheme contributions until it is too late.

"If we monetise the covenant and get the sponsor to make solid contributions early on, it would break the link between the employer and the scheme. We could then put those schemes into what we call consolidated ‘super funds'. This is solution can help stressed schemes, free up employers, reduce intergenerational inequalities and secure members' benefits," Gupta added.

Furthermore the government's DB green paper has opened the door to change and the industry should embrace it.

"I don't think we are going to get this opportunity for another five years so we as an industry need to rise to that," Gupta added.  

However, Connor expressed scepticism about what could be done, and said she is"still at a loss as to how we are going to solve this crisis".

The government's white paper later this winter will hopefully provide some answers for DB schemes under financial pressure.    

 

This article was written by Michael Klimes from Professional Pension and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.