SPP: Why did DB decline and how to treat scheme surpluses

Steve Hitchiner says the WPC’s inquiry into DB schemes poses a number of questions to consider

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Steve Hitchiner: It is difficult for open DB schemes to thrive under the current regulatory framework
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Steve Hitchiner: It is difficult for open DB schemes to thrive under the current regulatory framework

In the Society of Pension Professionals’ (SPP’s) latest column for Professional Pensions, the organisation’s president takes a look at the WPC’s inquiry into DB pension schemes and writes his tribute to former SPP chair, Hugh Nolan, who passed away at the end of April.

Earlier this year, the Work and Pensions Committee issued a call for evidence relating to defined benefit (DB) pension schemes. One of the questions they asked was whether the right regulatory framework is in place to allow DB schemes to thrive.

The view of the SPP is that it is difficult for open DB schemes to thrive under the current regulatory framework. It also seems clear that the proposed changes to the DB funding regime are designed for the growing majority of schemes that are closed and looking towards their ‘end game'.

However, the more interesting question is did the regulatory framework cause the decline in open DB schemes, or are the risks and costs such that they would have declined anyway?

There is certainly an argument that the ‘marked-to-market' approach advocated by The Pensions Regulator through the scheme funding regime has led to greater de-risking and reduced expectations for investment returns, hastening the demise of open schemes. You can also argue that the legislative framework and guarantees within DB have made it impossible for sponsors to manage risks appropriately.

It is also important to acknowledge, though, that this isn't all due to regulation, and that a different view of risk management by sponsors and their advisers means that open DB schemes would have declined regardless. Operating a DB scheme exposes a sponsoring employer to significant financial risk, and the early part of this century saw those risks come to fruition. Falling interest rates and increased life expectancy led to a decades long battle against deficits, and neither of these factors were created by regulation.

In any event, whatever the cause, it seems very unlikely that employers will be keen to establish new pension arrangements where their contributions are not fixed. It would be helpful if the regulatory framework could do more to support the open DB schemes that remain, but it is hard to envisage changes leading to new DB pension schemes being established in meaningful numbers.

A further question posed by the call for evidence is how surpluses that are now commonly emerging in DB pension schemes should be treated. Whilst it is tempting to suggest that these surpluses could be used to subsidise pension contributions for a new generation of saver, such an approach would be fraught with difficulties, and would need to be considered very carefully.

Ultimately, the use of surplus for any DB scheme should be driven by the provisions of its governing documentation, and we would caution against introducing any new legislation that seeks to direct how such surpluses should be used.

Hugh Nolan

It was with great sadness that we learned of the passing of Hugh Nolan on 30 April 2023, aged 54, after a long battle with cancer (read Professional Pensions' obituary here). Hugh was president of the SPP from 2016 to 2018 and a passionate advocate of the SPP's activities.

The SPP is reliant on our members giving their time to enable our activities, and the generous contribution from someone as talented as Hugh has been key to the development and successes of the SPP in recent years. He will be sorely missed, and our thoughts are with his friends and family.

Steve Hitchiner is president of the Society of Pension Professionals and a partner at Barnett Waddingham

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