The government has launched a consultation on ways to reduce the British Steel Pension Scheme's (BSPS) liabilities to find a buyer for Tata Steel UK, which could require controversial legislation.
It sets out four potential solutions to separate the scheme from Tata in the hope to secure members' benefits at above Pension Protection Fund (PPF) compensation levels but below full benefits.
Potential bidders for the steel works are likely to be unwilling to take on the £14bn liabilities of the defined benefit (DB) scheme which has 130,000 members of which 14,000 are active.
While the government said it does not prefer any particular option, it will be clear to many in the pensions industry that some are less likely to work than others.
For example doing a buyout to secure member benefits at above PPF compensation levels would be unaffordable for Tata Steel UK. The government estimates the deficit to buy out the benefits in full to be around £7.5bn.
Another option is to use existing regulatory mechanisms to separate the scheme in order to reduce benefits to a fully funded level, possibly through moving the scheme to a new employer. While the agreement would be a matter for The Pensions Regulator, there are certain actions Tata could take, and the government could facilitate to achieve this.
The other two options are more radical and would require major legislative changes, which has sparked concern they could set precedent for other pension funds. These solutions would both involve reducing indexation and revaluation on member benefits either within the scheme itself or by transferring to a new scheme.
Measures to reduce members' rights could include using the generally lower Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI) to calculate the level of inflation protection. This is expected to reduce the liabilities by around £2.5bn and would make Tata much more attractive to potential buyers.
One option involves lowering the scheme's liabilities by reducing the level of future inflation increases payable on all pensions in payment and deferment to a similar or slightly better level than that paid by the PPF. Future existing pensioners would receive lower pension increases than under the current scheme rules, or possibly no increases at all.
This option has been put forward by the trustees and sponsor as a way to ensure members are better off than going into the PPF. Although, the government noted it would still be a substantial loss to many members compared with the pension they would have expected.
As the legislative system does not allow trustees or sponsor to reduce accrued pension rights without member consent, it would be very difficult to make this happen. Therefore the government would likely have to make regulations to make an exception for the scheme. It would do this by disapplying the subsisting rights provisions under section 67 of the 1995 Pensions Act. The trustees' proposal to make regulations under section 68 to allow changes to their scheme rules has been found to be unlawful, according to the consultation paper.
Although the government is not considering extending this proposal beyond BSPS, it has been exploring whether there is more to ensure the best possible outcomes are secured from the considerable sums being invested in DB schemes.
The other option would allow for bulk transfers to a new scheme paying lower levels of indexation and revaluation without having to get the individual consent of members. This would involve making regulations under section 73 of the Pension Schemes Act 1993 amending the Occupational Pension Schemes (Preservation of Benefits) Regulations 1991.
The new scheme could either be part of a solvent sale agreement or would need to be separated from Tata Steel to allow it to run on independently with a new sponsor. This could be achieved through existing mechanisms such as a flexible apportionment arrangement if it meets the funding test.
Members would be transferred automatically into a new scheme unless they chose not to, and BSPS would then enter a PPF assessment period. The government said it would put safeguards in place and look to impose conditions on Tata.
The consultation period on options for BSPS runs from 26 May and until 23 June.
The consultation paper reveals the £13.3bn scheme has a £700m deficit on technical provisions, based on a roll forward of the funding position from the 31 March 2014 actuarial valuation.
This is much higher than the £485m deficit which has been recently cited.
Earlier this week former pensions minister Steve Webb warned allowing exemptions for BSPS must not create a precedent or loophole that would be exploited by other sponsors keen to walk away from their liabilities.
The scheme's trustee board chairman Allan Johnston welcomed the government's decision to consult on changes to the law applying to the scheme.
"The trustee will be writing to members over the coming days to make clear its belief that, with government support, it should be possible to modify benefits so as to allow the scheme to remain outside the PPF indefinitely and on a low-risk basis," he said.
"Although this would entail future pension increases being cut back from their current levels, benefits would be more generous than those provided by the PPF for the vast majority of scheme members.
"The primary focus of the trustee is to secure the best outcome for scheme members. While the current pension protection framework provides a valuable safeguard for pension scheme members generally, the circumstances of the British Steel Pension Scheme are such that its assets could be better used in paying member benefits than potentially swelling a PPF surplus or insurance companies' profits."
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