The Pension Schemes Bill currently making its way through parliament looks like making it easy for employers to pull any surplus from a defined benefit plan.
Is this not highly risky in terms of the future security of the plan? And secondly, the Bill seems heavily loaded in favour of the employer.
The facility to share some portion of a surplus with the pensioners appears to be left to the plan’s trustees to dictate, but in reality many plan trustees are effectively powerless and the employer has full control.
I know that’s not the theory of how trustees and employers work but sadly it’s the reality in many cases. I know, I’m a pensioner in one such plan.
Steve Webb replies: For many years, the story around traditional final salary pension schemes in the private sector has been about deficits.
Until recently, the majority of schemes were in deficit, and pensions legislation was focused on getting tough on employers who refused to fund their schemes adequately.
But the transformation in the funding of such defined benefit schemes in recent years has been remarkable. This is due to three main factors.
– The companies which stand behind these schemes have pumped in billions of pounds, year after year, to put them on a firmer financial footing.
– Many schemes have enjoyed good rates of return on their investments, helping to reduce the funding gap.
– The ending of a decade of ultra low interest rates has transformed the way the cost of paying pensions is assessed.
In simple terms if the money you have in your pension scheme today is expected to grow more rapidly (as interest rates rise) then the ‘burden’ of future pension payments falls.
As a result, the latest figures from the Pensions Regulator suggest that just over three in five schemes are now in surplus, compared with only around one in four three years ago.
What will pension schemes do with surpluses?
The trustees who oversee these schemes now have a range of ‘endgame’ options. The two main ones are a ‘buyout’ with an insurance company or ‘running on’, potentially to generate further surplus.
Some trustees may choose to use the funds to secure member benefits with an insurance company, a process known as a buyout.
In the event that there are spare funds when the scheme is wound up, the rules of the scheme will generally determine who gets anything left over.
Alternatively, the trustees can reduce the level of risk the scheme is running, and then run the scheme on for the medium term.Â
The idea of this is to see if they can secure further ‘upside’ for members and/or the employer by continuing the invest the funds which have been built up.
As you rightly say, the Pension Schemes Bill which is currently going through Parliament will change some of these options.
In particular, where a scheme has surplus funds, it will no longer be necessary to wait until the scheme is wound up before this surplus can be touched.
But there are considerable safeguards around this process, which I cover below, and employers cannot simply ‘dip their hands into the pension’.
In future, provided that the scheme remains funded at a minimum specified level (details are still to be filled in), the trustees will have the option to use some of that surplus.
Some of the potential uses of the surplus are below.
– Enhancing member benefits – for example, providing better protection against inflation for those who served before 1997, or perhaps the payment of lump sums to members.
– Funding the pension pots of today’s workers – particularly if the pension trust has a ‘defined contribution’ section used for current employees.
– Benefiting the employer directly – through payments out of the scheme.
The upside of all of this could mean that you, as a member of the scheme, potentially get a bigger pension, whilst your former employer gets back some of the money it has paid in to build up the surplus.
But I entirely understand why you might be nervous that this would be done irresponsibly and could put your pension at risk.
How will savers be protected?
There are a number of safeguards that may offer some reassurance.
The first is that the Pensions Regulator remains fully involved in overseeing the scheme and its funding.Â
Crucially, for as long as your former employer remains in business, they will remain under a legal duty to make sure that the scheme is properly funded.
The Government and the Regulator will set limits beyond which schemes cannot extract surplus and these will generally require schemes to retain enough money that they have very low risk of needing to go back to the employer for a top-up.
Second, the investment mix of a scheme in surplus is likely to be low risk.
It is possible to ‘lock in’ a good funding position to a large extent by use of what is called ‘hedging’.Â
This involves a kind of insurance strategy so that if investment returns or inflation turn out worse than expected, the policy pays out to cushion the impact of these changes.
It is true that back in the 1990s schemes were briefly in surplus and those surpluses in many cases disappeared quite quickly.
But this was a world of typically open, immature schemes, heavily invested in volatile assets such as equities. Today’s DB schemes are typically closed, highly mature schemes, with very low exposure to volatile investments of this sort.
Third, the trustees of your scheme retain a ‘fiduciary duty’ to act in your best interests. They do not have to agree to release of any surplus if they do not think it is safe to do so.
Having spoken to lots of trustees over the years, they tend to be a pretty cautious bunch. Having painstakingly shepherded the scheme from deficit to surplus, the last thing they want to do is go back to a situation where the scheme is short of cash.
It is, of course, possible that employers may put pressure on trustees to go further in releasing surplus than would be in the interest of members.
But, especially in larger schemes, trustees are increasingly professionals, typically part of professional trustee firms, and there would be considerable reputational damage to them and their firms (not to say potential regulatory sanction) if they were to behave recklessly.
In short, the aim of the current legislation is to strike a better balance than in the past when it comes to scheme funding.
Until now, politicians and regulators have been so fixated on the downside risk of underfunding of schemes that they have taken a very cautious approach.
This has, in part, led to the current situation where the majority of schemes are now over-funded – often largely based on substantial employer contributions over a period of decades.
The current rules seek to redress that balance, whilst not throwing away all the progress that has been made in terms of the security of your pension.
Ask Steve Webb a pension question
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at pensionquestions@thisismoney.co.uk.
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact MoneyHelper, a Government-backed organisation which gives free assistance on pensions to the public. It can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE ¿ the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful. Â
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