Investors call for UK government to reform defined benefit pensions

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The UK Government should prioritize reforming the £1.2tn defined benefit pension system to unlock billions of pounds for investment, according to asset managers.

In November the government announced plans for a series of “megafunds” across defined contribution (DC) and local government pension schemes to drive further investment in British infrastructure and fast-growing companies.

But it is yet to draw up plans for the corporate defined benefit (DB) pension scheme, despite advice from the previous government earlier this year to explore options to allow companies to access scheme surpluses, which could encourage them to invest more in riskier assets.

“We think it’s important that DB schemes are seen as a priority – they have the potential to get money to land more quickly than other sectors,” said Jos Vermeulen, head of solutions design at Insight Investments, which manages £665bn of assets in the UK.

“There is an opportunity to release up to £100bn over the next 12 to 24 months. . . This is a generational opportunity to change the fortunes of the UK. . . If you miss that opportunity, it can be gone forever,” he added.

Wayne McCrossan, head of investment for abrdn group pension schemes, said DB pension schemes were “certainly pools of capital that could help fill the productive money gap”.

A 5 percent allocation to productive assets such as real estate and infrastructure “could raise about £50 billion”, he added.

This is the same amount the government hopes to channel into productive assets by 2030 under its plan to consolidate defined contribution workplace schemes into a wealth fund of at least £25bn.

There have been calls for the government to reform the rules around DB schemes as it delays pension adequacy reviews. The review was expected to produce plans to increase auto-enrolment pension savings rates, which the government hoped would drive further investment in the UK.

Vermeulen said it was important that the DB pension reforms were included in the pension bill by the middle of next year.

In an interview with the Financial Times last month, Pensions Minister Emma Reynolds said she prioritized defined contribution workplace schemes because that was “where the growth is”.

He noted that the majority of corporate defined benefit pension schemes were closed to new members and “typically had a less long tenure” as schemes moved into less risky assets as they offloaded or sold their pension obligations to an insurance company.

However, industry insiders say a radical improvement in the funding position of defined benefit pension schemes in recent years meant many were now in a position to take on more risk, if rules enabled companies and scheme members to benefit from it.

To encourage schemes to “run” and invest in productive British assets, Vermeulen suggested that the Pension Protection Fund cover 100 per cent of pensions if a scheme cannot meet its obligations. Currently it provides between 70 and 90 percent.

As a result the annual PPF levy is likely to increase, but the government can waive the fee if a fund invests a certain amount in British infrastructure or scale-up companies.

“The government can say, to encourage schemes to invest in productive assets, if you invest 5 per cent you pay zero levy,” Vermeulen said.

Companies have been rushing to offload their pension obligations to insurance companies in recent years, with transactions totaling a record £60bn last year, according to the PPF. But it will be slower if the schemes can guarantee full protection from PPF and if the companies can benefit from the surplus.

In response to the first phase of the pension review, the Investment Association, which represents the UK fund management industry, urged the government to “allow the safe disposal of funding surpluses” of DB schemes, although formally outside the scope of the review.

“Specific guardrails are placed around surplus extraction so that facility security is not undermined. Consistent with the government’s broader objectives, the ability to extract surplus can provide an incentive to build surplus by taking on more investment risk,” the IA said.

The Department for Work and Pensions said it was reviewing the response to the previous government’s consultation on options for defined benefit schemes and a decision on surplus flexibility “will be made in the coming months”.