With over £2tn in assets across the UK’s DB and DC pension schemes and with rumours swirling long before the Chancellor stood up, we’ve revisited our earlier article setting out Mercer’s hopes for pensions and investments in what we expected to be a pensions-heavy Autumn Statement.
Comment: It was indeed an unusually pensions-heavy Autumn Statement, not even deterred by the appointment of a new Minister for Pensions, Paul Maynard MP, in the last few weeks! The Chancellor had indicated it was time to stop talking and time to start taking action. True to his word, there were a number of firm decisions and commitments, although some new consultations were also promised, so the talking hasn’t stopped yet.
The Government is expected to respond to its Mansion House consultations on ways to increase pension schemes’ investment in what it calls “productive finance” to support UK growth. We might also see an update on DWP and TPR’s new funding regime for DB schemes.
Comment: As expected, there was a strong theme of encouraging and increasing productive investment across all of the pensions announcements. The new funding regulations have not yet emerged at the time of writing, but the Government confirmed that the regulations will make explicit that there is headroom for more productive investment, and they will be clearer about what prudent funding plans look like. We deduce that the new funding regime, still expected in force in autumn 2024, may be more flexible than current drafts suggest.
Productive finance should be pension-friendly
In its drive to deliver greater economic growth the UK Government is looking at ways to encourage investment by pension schemes into UK “productive finance”: assets like UK private equity, UK infrastructure and UK listed companies. For DB schemes, there are opportunities to make changes to increase investment in productive assets, but not all types of productive investment will be suitable for the guaranteed liabilities of a DB scheme. For assets to be attractive to DB schemes they need to be both a good match for their liabilities and, where a scheme's endgame is buyout, be attractive to insurers. This ideally calls for long-dated, predictable cashflows and liquidity - properties not associated with many of the productive asset types the Government has in mind. We therefore hope to see the Government seeking to create new opportunities for DB schemes to invest their assets both appropriately and productively.
Comment: The Chancellor is delivering, with the announcement that the Government intends to establish a Growth Fund within the British Business Bank (BBB), which will draw on a permanent capital base of over £7 billion and provide new productive investment opportunities for pension scheme assets. The Government also announced its intention to commit £250 million to two bidders under the Long-term Investment for Technology and Science (LIFTS) initiative, which would also create productive opportunities tailored to the needs of pension schemes. We are also pleased to see that the Chancellor is not attempting to mandate productive investment.
The DC landscape is continuing to change at pace, with many single employer schemes looking to move to Master Trust arrangements, driven by the increasing amount of regulation, pressure and cost involved in running a scheme. We’ve also seen an ongoing evolution in the commercial Master Trust space with providers continuing to invest and innovate, often meaning they can deliver better value for members. With their longer time horizon and scope to bear governance and operational costs, Master Trusts should be the Government’s key area of focus for productive investment. However, the focus on cost rather than value when selecting providers will be a challenge. The Government should carry out further work here to ensure Master Trusts can introduce these assets to portfolios.
Comment: There were a number of announcements affecting DC savers, including a review of the regulatory approach to Master Trusts, which the Government views as key to the delivery of its Mansion House reforms. The aim is to improve outcomes for members, whilst enhancing the supervision of investment governance, raising standards of trusteeship and building scale and expertise to invest in a diversified range of assets. We approve.
Surplus assets in DB schemes should be put to use
There has been speculation that, to stimulate the economy, the Government might reduce the tax levied when any DB surplus is refunded back to a scheme’s sponsoring employer. However, we believe it should go further than that. The Government should also change the current rules that make it difficult to release DB scheme surpluses. The marked improvement in many DB schemes’ funding positions since 2022 has left these schemes with a new or larger surplus. These are a valuable buffer against adverse experience and shouldn’t be recklessly released; but as surpluses grow, the marginal benefit of further funding improvements falls. Portions of the largest surpluses should be put to use, either by improving members’ benefits or returning them to the businesses that sponsor the schemes.
Comment: The Chancellor has listened. The tax levied on returns of surplus to the sponsor will reduce from 35% to 25% from 6 April 2024. In addition, the Government has confirmed it will consult on making it easier to extract surpluses whilst still protecting members’ benefits. It will also look to ensure surpluses ‘can’ (not ‘must’) be shared with members.
DB funding regulations should permit productive investment
DWP and the Pensions Regulator have been working on a new funding regime for DB pension schemes for some time. Once it comes into force, schemes will need to reach a status of “low dependency” on their sponsors before a deadline. The regime was devised to increase protection of members’ benefits at a time when schemes were generally less well funded. Its thrust is toward taking less risk, eliminating volatility and matching investment strategies closely to benefits owed, pulling schemes in the opposite direction to choosing productive finance.
Whilst protecting members’ benefits is crucial when setting strategy for a DB scheme, the proposed funding rules envisage only one source of protection: eliminating almost all volatility through matching investments. For some, taking this approach will make sense. But others might reasonably accept some level of volatility, and increased returns, where extra cash or the sponsor’s business can stand behind it. The new funding regime should be made much more flexible to allow trustees and sponsors to make the investment choices which are right for their schemes.
Comment: More information is still awaited, in both the revised DWP regulations and TPR’s revised Funding Code of Practice, but there are positive signs in the Government’s statements this week that they will be more flexible than the initial drafts had suggested.