"Do you remember when Amazon only sold books?"
"How about when the Pension Protection Fund only took over pension schemes with insolvent employers?"
The Pension Protection Fund (PPF) has told the Government that severing links between defined benefit schemes and the employers who set them up is the “only way” to get DB assets flowing into “productive finance”[1] to any significant degree. It supports creating a “public consolidator” for this purpose and says it is “well placed” to take on this “additional and separate” role.
Replete with job application buzzwords (“enthusiastic”; “skills and experience”; “proven track record”); the PPF’s submission[2] to the Government also conveys a willingness to follow instructions. A “particular advantage” of establishing a public consolidator, it says, would be that “the government controls the design and can therefore ensure its objectives are achieved. This could involve informing the investment risk budget and setting parameters for the target asset allocation.” Conveniently, though, “Our asset allocation is scalable and is already aligned with the government’s objectives to support the gilts market and investment in UK productive assets.”
While counselling that “the more the size of the scheme is restricted, the less the consolidator’s investment strategy will be able to have an impact on the government’s productive finance goals,” the PPF sketches out a “purely hypothetical” scenario in which it would swallow up the smallest 4,500 schemes out of around 5,100.
We are not told where the PPF sees the line being drawn in terms of scheme size, but it looks as though schemes with more than 2,000 members or asset values in the hundreds of millions could be in scope in this scenario. More than one million people could become PPF “members”[3].
Between them, the smallest 4,500 schemes hold around £200 billion, compared with the £34 billion of assets overseen by the PPF in March 2023. The usual metaphor for the PPF is a lifeboat; alongside it, the new consolidator would look like a cruise liner.
Becoming so much bigger would be a win for those involved (whose submission takes a swipe at others’ “desire to maintain the status quo”), but what about for scheme members?
Besides getting used to having their pensions paid by someone else, there are three ways in which members might be affected.
First, most members transferred to a public consolidator without their consent would see their pensions shoehorned into “standardised benefit structures (but with an actuarial value equal to full scheme benefits)”. In other words, they would get different pensions, options and survivor benefits from the ones they were promised.
As an example, imagine that the PPF’s “standardised benefit structures” included pension increases in line with the statutory minimum[4]. Members whose schemes currently provide increases above statutory minimums would then get a bigger Day One pension in the PPF. However, the gap between this annual PPF pension and the scheme pension it replaced would gradually shrink. Eventually the PPF pension would be smaller; this gap would then widen.
If the boost to the initial pension were based on an assumed average lifespan, members who live longest would lose and members who die soonest would gain[5]. Nor will scheme-wide mortality rates or future inflation precisely match what was assumed: how might someone whose scheme offered uncapped pension increases feel today if they had been forced to transfer to a public consolidator a few years ago with an uplift that assumed CPI inflation would always be close to the Bank of England’s 2% target? It is because of these difficulties that the Government has so far chosen not to allow commercial consolidators to reshape members’ benefits without their consent.
Differences between “standardised” benefits and the original benefits might also be stark where a member dies shortly after retirement and the survivor’s pension is a different percentage of the member’s pension.
Second, for some current employees, a public consolidator might hasten the day when new benefit accrual ends. Around 52,000 employees were still accruing benefits in schemes with fewer than 1,000 members, according to the latest data cut[6]. If exit terms are appealing, some employers might freeze their schemes earlier than they otherwise would have done. That will be even more likely if employers are effectively fined £10,000/year for not consolidating schemes with under 10,000 members, as the Government has recently suggested[7].
Third, consolidation would affect the prospects of benefits being augmented or cut back – but how these prospects change would depend on how the PPF consolidator was set up.
The first option would be to model the public consolidator on the Government’s vision for commercial consolidators. The Government envisages that these “superfunds” will charge “around 90%...or below” of what an insurer would demand before taking over responsibility for paying a scheme’s liabilities – but with benefits less secure than under an insured buyout[8]. The entry price (met through a combination of scheme assets and a cash injection from the employer) would be enough for the liabilities to be fully funded on a prudent basis and would also include a contribution to a capital buffer, which could be called upon if a deficit arose (replacing future recourse to the sponsor). The superfund’s investors would also supply part of the capital buffer.
A public consolidator could operate in much the same way but, lacking investors, it would need to source capital elsewhere, unless it were to charge a higher entry price or offer less security. The PPF has suggested that capital could come from “making some use of PPF reserves” (£12bn at March 2023[9]). These reserves exist in part because the PPF understandably raised more in levies than its best estimate of how much it would need. Levypayers hoping to get some money back (or existing PPF beneficiaries hoping for a compensation boost) may or may not be reassured by the suggestion that reserves need only be lent to the new vehicle and could be repaid with interest if the consolidator’s investments perform well.
Trustees will be able to imagine possible futures in which the employer quickly becomes insolvent, and others in which the employer makes tidy profits while the consolidator (commercial or public) burns through its capital. In either adverse scenario, PPF compensation (which is usually worth less than full scheme benefits) would be available; reflecting this, the PPF’s lifeboat arm could charge a levy to its consolidator arm, just as it would charge a levy to commercial consolidators. If things go well, consolidation offers the prospect for members to get a share of any surplus generated – but this would also be possible if the scheme ran on, especially if the Government relaxes restrictions on surplus distribution.
Whether consolidation along those lines is in members’ interests overall is a “balance of risks” judgement, even without accounting for how benefit standardisation may redistribute value between members. It seems unlikely that all 4,500 of the smallest schemes would reach the same conclusion, regardless of their circumstances (at least assuming that consolidation is voluntary). Even if they did, many would be ineligible under the Government’s recently reaffirmed “gateway” test for commercial consolidators; this says that consolidation is not permitted if the scheme has a realistic prospect of buying out its benefits with an insurer within five years. In its latest Purple Book, the PPF reported that, on average, “the smallest schemes are the most well-funded on a full buyout measure”[10].
As an alternative to using its reserves to provide capital, the PPF suggests that “in return” for informing the consolidator’s investment strategy, the Government could “underwrite risks” and “give complete reassurance”[11]; presumably, any surplus generated by the PPF’s investment strategy would then go to the Exchequer.
This model might make trustees eager to consolidate. It would also kick away the rationale for the gateway, which is that “employers should never have a choice between the ‘gold standard’ for security of insurance, and a weaker, cheaper option”[12]. A public consolidator would no longer be weaker than buyout (subject to one’s views on the relative likelihood of insurer default and Government default). It would, though, still be cheaper, which might allow some members’ benefits to be enhanced (and not only where buyout is instantly affordable – for example, a scheme might be able to afford 95% of the buyout price but only be charged 90% to enter a public consolidator guaranteed by the taxpayer).
Ministers would then have to justify why stopping some DB members from losing a penny of benefit should be a priority use of taxpayers’ money (especially if these members had received a windfall on the way in), and why only members of schemes judged sufficiently small should qualify for this treatment.
Sometimes the “exit fee” that an employer can pay to get pension liabilities off its balance sheet would not take the scheme’s assets up to the public consolidator’s “entry price,” even allowing for the buy-now-pay-later facility that the PPF says could be considered. To capture all 4,500 of the smallest schemes, the PPF may have to cut some members’ benefits as well as harmonising them; often, this may bring forward the inevitable, but in some cases the sponsor may have recovered and been able to honour the full benefits originally promised.
The presence or absence of a government guarantee is only one aspect of policy design that may affect how hard a bargain trustees can strike when negotiating a golden goodbye from the employer, whether they are looking to maximise enhancements or minimise haircuts. Trustees’ negotiating position will be strongest if they can credibly threaten to veto an employer’s wish to transfer the scheme to the public consolidator. It will be weakest if consolidation is mandatory or strongly encouraged (for example, via the tax penalties for schemes under £25bn proposed by the Tony Blair Institute for Global Change[13]).
