Paul Duffy puts forward a radical option to help small and medium sized businesses struggling with legacy defined benefit schemes
- Buyout is beyond the reach of many small businesses
- The PPF's remit could be broadened so schemes can enter, allowing the business to continue
- A working party will be set up to develop proposals on a proposed self-sufficiency basis for the transfer of liabilities to the PPF
Falling interest rates have increased the pensions funding crisis particularly for small- and medium-sized businesses (SMEs) running legacy defined benefit (DB) schemes.
Historically, companies could exit the pension scheme by meeting the weaker minimum funding requirement, but now a solvent company must fund an expensive bulk annuity buyout.
The current annuity obligations can be seen as an overreaction to the Maxwell pension scandal. For example, if a "bought-out" deferred member could sell back a deferred annuity and reinvest for several years, this could provide greater benefits than the original scheme, albeit for some investment risk.
SMEs targeting annuity costs does not accord with The Pensions Regulator's general funding objective "to minimise any adverse impact on the sustainable growth of an employer" where there is an acceptable covenant.
Insurers' annuity prices reflect the need to hold capital reserves, loadings for profit and (low) market interest rates.
This means annuity buyout is now unaffordable for many SMEs and for many large companies as well (reference the Pensions Regulator's 2015 Purple Book, showing a total wind-up deficit across all pension schemes of £800bn with an average funding level of 62%).
Given this background and the importance of SMEs to the economy, should there be another mechanism for SMEs to transfer pension benefits at reasonable value that also provides adequate security of benefits? Would this be preferable to alternative possible safety valves such as "conditional indexation", or more particularly persuade business owners that trading is worth continuing?
A wider brief for the PPF?
The Pension Protection Fund (PPF) was introduced primarily to protect members' benefits where a qualifying insolvency event has occurred. There is also a provision to protect members' benefits before an insolvency event occurs if the employer is unlikely to continue as a going concern.
Company insolvency is thus not a pre-requisite for a pension scheme to apply to enter the PPF, and a legislative amendment could remove the limited-life going concern criterion.
There are examples of deals where the pensions authorities, including the PPF, have allowed the transfer of pension benefits in the interests of maintaining ongoing employment, such as the Uniq case.
A more holistic and flexible approach to PPF entry could benefit all parties. The availability of this approach at an earlier stage could have saved other viable operating businesses that folded due to the inability to exit the pension risks.
New powers could enable full benefit provision for a new category of PPF entrant so that members do not lose out on the transfer of benefits.
The PPF's stated strategic plan appears eminently suitable for incorporating a wider brief, notably prudent management of funding allied to excellent customer service. The funding management of the PPF already includes a developed approach to self-sufficiency targeting and monitoring.
A self-sufficiency basis developed specifically for solvent transfers to the PPF, without the capital reserves or profit loadings, could provide SMEs with an affordable exit route for some, or all, of their pensions risks. Whether this would represent a termination of all risks from the employer would need to be agreed.
There is a precedent for the PPF's brief to expand, in that the government handed over responsibility for the day-to-day running of the Financial Assistance Scheme to the PPF in July 2009, with all FAS activities still funded by the taxpayer.
A natural evolution
As at March 2016, PPF assets were more than £23bn, with one quarter related to levy payments, nearly half derived from scheme transfers and recoveries, and the balance resulting from investment gains.
With this background, it is likely that the investment management and administration of benefits will become mainstream compared with the setting and collection of levies. Already £2.4bn has been paid out in benefits, including £616m in the past year.
These factors point to the potential suitability of the PPF to act as the home for SMEs wishing to transfer pension benefits on a self-sufficiency basis, where members could receive their expected scheme entitlements in full.
There will inevitably be many details to be agreed for such a radical approach, not least the accepted basis of self-sufficiency. Clearly, defining eligibility will also be critical if the facility is aimed at SMEs. The potential impacts on insurers and investment markets will also need careful consideration.
For change to receive government approval, market failure will need to be identified. This can be validated for small schemes where annuities might not be available. The potential hurdles are worth jumping to reap the wider benefits.
The underlying principle of a wider PPF brief would provide protection for more pension scheme members. At the same time, a pensions funding crisis (not of SMEs' own making, but linked to central banks' financial repression) could be alleviated.
The working party
I am part of a PPF Levy Consultation Group for SMEs, which provided a submission to the PPF Inquiry of the Work and Pension Committee (relating to the BHS pension scheme).
The submission focused on inconsistencies and difficulties in levy assessments, but included a recommendation on the objectives outlined in this article.
We advised the PPF that they would give the concepts wider publicity and invite comments via normal pensions communications.
Our intention is to establish a working party to carry out further research and develop proposals on a proposed self-sufficiency basis for the transfer of liabilities to the PPF. If you wish to send comments, please email [email protected]
Paul Duffy is an independent trustee.
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