Serkan Bektas: We urge the government to take decisive action within the next 12 months to unlock the potential of DB schemes
Simple policy changes could help the UK realise a once-in-a generation opportunity to positively shape the future for the £1.4trn of capital held by UK defined benefit (DB) schemes, for the benefit of all, if structured appropriately.
A well-funded DB pension scheme has scope to provide capital to finance productive and green projects, and help reinvigorate domestic markets, while also holding gilts and corporate bonds to ensure the security of members' retirement income. Overfunded pension schemes have the means to back their liabilities through lower risk holdings and deploy their surpluses towards longer term growth assets to achieve the dual objectives of member security and higher returns.
However, without appropriate reforms, this potential is unlikely to be realised, as a widespread transfer of DB schemes' assets and liabilities to insurers continues to occur.
This in turn could lead to large sales of gilts which would likely be harmful for gilt pricing, increasing the cost of borrowing for the UK as a whole and raising pressure to increase taxes and/or reduce spending on vital services. It would also affect the pricing for other UK asset classes. Whilst insurance buyouts are appropriate for some pension schemes, in the majority of cases, running on can be cheaper, more efficient and more beneficial to members and corporate sponsors in the long run.
The government can unlock this potential by enabling and encouraging trustees and sponsors to run on their DB pension schemes for the long term, rather than focusing only on achieving a transfer of assets to an insurer in the near term. The result would be a positive outcome for members and sponsors, and for the UK economy as a whole.
We therefore urge the government to take decisive action within the next 12 months in order to unlock the potential of DB schemes. We believe the following simple changes are required.
- Adjustments to create an environment where DB scheme trustees understand that they can fulfil their fiduciary duties by running on their pension schemes for the long term. This is needed to change the perception that a transfer to insurance companies is the only prudent option available for well-funded schemes.
- The Pension Protection Fund (PPF) currently provides some protection for DB scheme members if the sponsor is unable to offer support. The PPF must be bolstered to provide full protection covering all pension promises – giving DB schemes greater confidence to deploy their capital efficiently for the benefit of all.
- More streamlined mechanisms for surplus sharing between members and corporate sponsors as well as mechanisms for sponsors to extract surplus, with appropriate guard rails in place to protect members' security. This would also enable discretionary benefit increases as a way for the members to benefit from surpluses, for example in higher inflation scenarios to protect the real purchasing power of pensions.
The result would be clear incentives for DB schemes to run on and invest for the long term, giving scope to invest excess surplus assets in a broad spectrum of productive and green investments whilst also supporting the gilt and UK corporate bond markets.
Sponsors could also choose to extract surplus assets and contribute more to their DC schemes, potentially helping to address the country's intergenerational pension gap. The potential for widespread benefits for the UK economy must not be underestimated.
Serkan Bektas is head of the client solutions group at Insight Investment
This article was published as part of Professional Pensions' PP Pensions Commission – which is bringing together industry opinion and ideas on the future of pensions to send to the new government
