IGG’s responses to DWP Consultation September 2023

Independent Governance Group (IGG), has called on Government to use its Mansion House Reforms to help resolve intergenerational unfairness between DB and DC scheme members.

In our response to the Options for DB schemes consultation, we identify the lack of incentive to take necessary level of investment risk, and the lack of mitigation of the risks involved, as the key barriers to achieving the Government’s desire to make more innovative use of pension scheme assets to support the UK economy.

To encourage corporate DB pension schemes to build a surplus, we believe sponsors should be offered the chance to deploy some, or all, of that surplus to boost DC contributions ahead of winding-up the scheme.

Supplementing DC funds in this way would not only promote investment in productive assets, but will go some way to close the gap in outcomes for DB and DC scheme members, which is a key driver in the growing financial divide between generations.

In the response to the call for evidence on Pension trustee skills, capability and culture, we also highlight seven barriers which Government needs to address across DC and DB schemes for its plans to succeed, while warning against the risk of deterring people from becoming lay trustees.

Andrew Bradshaw, Chief Executive Officer of IGG, comments:

“We believe fresh thinking and new ideas are required in order to realise the Chancellor’s ambition. We have proposed ideas regarding surplus reforms within an appropriate framework and with clear and proportionate regulatory supervision. We believe this approach will enable trustees to demonstrate to sponsors how schemes can invest in productive assets with acceptable levels of risk and with members’ interests at the forefront. This is a win-win for employers, the Government and the UK economy.

“At the same time, the recent increase in pensions-related regulation and legislation, coupled with major events such as the LDI crisis, means the need for a higher level of knowledge and understanding on trustee boards has never been greater.

“We support a move to mandate the appointment of a professional trustee for all schemes over a workable timeframe, but caution against the potential unintended consequences of implementing an accreditation regime for lay trustees that deters people from coming forward. The broad range of skills, qualifications, and experience of lay trustees, together with their first-hand knowledge of the businesses that sponsor pension schemes, is a vast resource that has helped to underpin good governance.”

Options for DB schemes

• We do not accept the premise that the current system is broken. While there is always room for innovation and new thinking, the existing system ensures that trustees meet their fiduciary duties to beneficiaries. This obligation will always remain at the heart of the decision-making process.
• Trustees can already invest in productive assets, in line with their usual fiduciary duty where it is the right thing at that time for that scheme. However, the reforms need to address why this is not happening at the scale Government wants: in our view a lack of incentive and impetus and opportunity, as well as too much risk which isn’t managed legislatively for pension schemes as it currently is for other private investors.
• Whilst we recognise the benefits consolidation delivers, achieving the proposed reforms set out in the Mansion House speech is not dependent on further consolidation in the DB universe. What is really missing is the impetus to invest in productive assets as opposed to staying in low-risk assets to protect the funding level or other more traditional global growth assets.
• We believe it would be more beneficial for Government to focus its efforts on addressing the two main barriers to increased investment in productive assets in the UK:

Incentives:

• We believe reform of surplus rules could give way to greater investment in productive assets. Allowing the use of a surplus for a wider range of benefits within an appropriate framework with clear and proportionate regulatory supervision is good? for employers, trustees and the economy alike.
• To enable schemes to invest in other assets it would also help to bring into the mix an adjustment to how liabilities are valued and paid for. We see TPR’s amendments to the superfund guidance recently recognise change is needed.
• If the Government is not aligned with incentivising employers, a consequence will be that the main aim for most employers will be to buy out schemes with insurance companies as soon as practicable. On buy-out, the pension scheme will sell its gilts; however, insurers are not in the market for large quantities of inflation-linked gilts and there are typically no other buyers of these assets, meaning increased Government borrowing. Incentivising schemes to remain invested in gilts may prove to be a necessary policy for Government to protect its own borrowing.

Risk:

• Investing in productive assets is likely to result in the sponsor and trustees taking more risk. We recommend that Government at the very least provides a clear definition of productive assets, what it wants to see pension funds invest in and what effect the reforms hope to achieve. For example, is the aim GDP growth or employment growth? Do the underlying companies need to be start-ups or listed in the UK? The Government must also consider the necessity of a mechanism to incentivise pension schemes to avoid buy-out for the next 10-15 years.
• Reform is also needed to protect pension scheme investors, so they feel able to invest. For high-net-worth investors, tax breaks are the carrot used to incentivise investment in some productive asset classes and negate the risk borne by the investor. Government must work with the industry to provide an equivalent form of protection – we propose an underlying guarantee – for pension schemes (who don’t pay tax) to manage the risk so trustees can invest without worrying about what happens should a large deficit appear.

Trustee skills

• The recent increase in pensions-related regulation and legislation, coupled with major events such as the LDI crisis, means the need for a higher level of knowledge and understanding on trustee boards has never been greater. It is increasingly difficult for lay trustees to make informed decisions efficiently and without over reliance on advisers. Pensions is not the day job for the vast majority of lay trustees and so it can often be challenging for them to keep on top of an already demanding role.
• We do not believe that an accreditation regime for lay trustees will necessarily deliver the economic growth and investment in productive assets that the Chancellor advocated in his Mansion House speech. There is little evidence it will materially enhance knowledge and understanding on trustee boards. It will also likely act as a further deterrent to people coming forward to act as lay trustees.
• The broad range of skills, qualifications, and experience of lay trustees, together with their first-hand knowledge of the businesses that sponsor pension schemes, is a vast resource that has helped to underpin good governance. This can be enhanced significantly through the introduction of a professional trustee to the board.
• Additionally, the appointment of a professional trustee that is part of a broad, diverse team with the full range of skillsets required for highly effective trusteeship will ensure that inclusivity, representation and high quality can be achieved. We are supportive of a move to mandate the appointment of a professional trustee for all schemes, over a workable timeframe, to enhance knowledge and understanding.
• We see four material barriers for DC schemes beyond trustee knowledge and skill that Government must consider as part of the next steps following this call for evidence. They are:
  1. The cost of administering schemes,
  2. Liquidity management policies and prudential supervision,
  3. Scheme and employer longevity in single employer schemes, and
  4. Suitability of pooled funds, platform structures and inter-scheme transfer arrangements.

For DB schemes, the barriers beyond trustee knowledge and skill are as follows:

• Due to improvements in DB funding positions, a large number of schemes and employers in a perfectly functioning bulk annuity market are at – or near the stage where – they would be ready to transact with an insurance company within timescales that are too short to make investment in productive finance suitable from a risk / return and liquidity perspective.
• There is potential for “regret risk” should the level of investment risk be increased through investment in productive finance assets. There is also risk where the strength of the sponsor covenant subsequently reduces to the extent that the sponsor is unable to make good any shortfall as a result of the productive finance assets underperforming.
• Suitability of available assets in the UK.

DWP Consultation September 2023: Options for Defined Benefit Schemes. IGG response.

DWP Consultation September 2023: Pension trustee skills, capability, and culture. IGG response.