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Extracting DB surplus funds and introducing a public consolidator

Extracting DB surplus funds and introducing a public consolidator

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Volume 2024 | Issue 04

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The government’s Mansion House reforms are focused on ensuring that the wider economy can benefit from the funds invested in UK pension schemes. This encompasses both DB and DC pension schemes.

In the DB space, a consultation has been published that seeks to make it easier to share surpluses in DB schemes with both employers and members, while also developing the scope of the proposed public consolidator vehicle, to be run by the Pension Protection Fund (PPF), from 2026.

Background

These issues were first raised in a call for evidence last summer, with the government response published (with the Autumn Statement) last November, committing to consult on measures to make surplus extraction easier and the design of a future public sector consolidator.

The consultation builds on the principles of the call for evidence and those in the forthcoming DB funding regime, to understand what may be considered surplus funding and to provide more options for sponsors in dealing with legacy DB liabilities. It also seeks views on additional safeguards with respect to treatment of scheme surplus and the model for a future public sector consolidator run by the PPF.

The consultation runs until 19 April 2024.

Accessing scheme surplus

The government aims to support schemes to invest for surplus in productive assets by making it easier to share surpluses with employers and members. There is also a drive to remove both the practical and behavioural barriers to surplus extraction.

The consultation makes it clear that:

  • Surplus should only be extracted where the security of members’ benefits is not impacted.
  • Trustees always retain responsibility for managing scheme funding levels.
  • Extracting surplus is not conditional on using the funds for particular purposes.

Introducing a statutory override

Respondents to last year’s call for evidence suggested that the provisions of many scheme rules often prohibit trustees from making surplus payments. This government is considering the introduction of a statutory power to enable trustees to amend their scheme rules to allow for this, or alternatively introducing a statutory power to make payments. The consultation seeks feedback on how this should be achieved.

The tax position of making surplus payments is also considered, as one-off surplus payments to members are often classed as unauthorised payments, and therefore subject to tax charges as a result. The consultation seeks views on how this problem could be alleviated.

Any extraction of surplus could risk reducing member security. The introduction of any new basis to permit surplus extraction needs to ensure a very high probability of member benefits being paid in full (implying that any surplus extraction should still leave the scheme over 100% funded on a prudent basis). However, the level of investment risk and the strength of the sponsoring employer have a significant bearing on what level of surplus is ‘safe’ to extract. Various eligibility criteria for surplus extraction are considered, both in terms of funding and employer covenant requirements.

100% PPF underpins

Last year’s call for evidence also sought views on employers opting to pay a higher “super levy” to the PPF in exchange for the PPF offering a 100% level of compensation in the event of insolvency of the sponsoring employer (a 100% PPF underpin).

The government is looking to see if the additional security of a 100% PPF underpin is still valued and necessary to enable increased surplus extraction, and whether schemes and sponsors see wider benefits in this approach – for example, providing an additional level of security for large schemes that plan to run on over the long term rather than seek to buy out with an insurer or transfer to a consolidator.

The government is also seeking feedback on the most appropriate design for any 100% PPF underpin.

Developing a public sector consolidator

The DB superfund market is gradually taking shape, but the government acknowledges that this is unlikely to be a practical option for some schemes, particularly smaller schemes and those that are less than fully funded.

To address this, the government has already stated its intention to establish a public sector consolidator administered by the Pension Protection Fund (the consolidator) by 2026. The aims of the consolidator will be to:

  • Maintain the security of members’ benefits by ensuring that members’ interests are protected.
  • Provide an alternative endgame solution for DB schemes unattractive to commercial consolidation providers.
  • Enable greater investment in high-growth UK assets than would be achievable by eligible schemes in the absence of a public sector consolidator.
  • Minimise the potential distortion of the superfund and insurance buyout markets.

The consolidator will have the following key characteristics:

  • It will be a public sector vehicle set up to effect the consolidation of certain private sector DB pension schemes’ liabilities.
  • The link between the employer and pension scheme will be severed when the scheme transfers to the consolidator, apart from underfunded schemes where the employer will enter into an obligation to pay off the deficit over time.
  • It will operate as an unsegregated fund on a run-on basis.

The operation of the consolidator will be very similar to a superfund, but the consolidator will not be backed by private sector capital and will be administered in line with legislation, with voluntary entry into the consolidator. The proposal is that the consolidator operates as a pooled fund, to enable the consolidator to benefit from economies of scale.

The consultation seeks feedback on whether the consolidator should operate with multiple standalone sections, with ringfenced assets and liabilities, or as a single fund, meaning that all incoming schemes will be pooled together. The government recognises that there are advantages to both approaches.

Consolidator governance

The consolidator is intended to operate as a statutory fund administered by the PPF Board. It will be ring fenced, so legally separate from the PPF’s main funds in relation to its compensation role (and comparable to the separation of the Board’s existing functions in relation to the PPF and the Fraud Compensation Fund).

Funding and investment considerations

It is expected that the consolidator could be required to meet the same funding standards as commercial consolidators, which will need to comply with the forthcoming superfund legislation.

The intention is that the consolidator will maintain an investment strategy that supports a prudent funding basis as well as increasing productive asset allocation, to benefit both members and the broader economy. The consolidator’s investment strategy will be subject to the scale, form and size of underwriting it receives. The PPF’s Board will have a key role to play in shaping this strategy and will publish its statement of investment principles. More detailed reporting requirements may also be considered.

PPF initial feedback

Shortly after the consultation was issued, the PPF published its initial views on the structure of the consolidator to help to support an effective debate on the government’s proposals.

Comment

This appears to be a consultation where the government is genuinely seeking to advance these reforms, which is welcomed in a DB world where surpluses are increasingly the norm and where this provides practical challenges for trustees and employers.

It should be noted, however, that no clear timescale is given by the government for bringing these matters into effect (and there’s the increasingly normal caveat to note about the forthcoming General Election potentially changing everything).