Fasten your seatbelt: turbulence ahead for pensions

The world of pensions is changing faster than ever as companies and trustees find themselves facing new and growing challenges. An industry that was originally quite straightforward and even, perhaps, a little bit dull is now under the spotlight from government, regulators and commentators as it faces increasingly turbulent times.

The Green Paper on the Security and Sustainability in Defined Benefit Pensions addressed some important issues and made some sensible suggestions, such as targeting solutions for schemes with distressed employers, says Philip Goss, a partner in Linklaters pensions practice.

“However, some of the options could be a significant overreaction to recent high-profile cases, risking adverse consequences for the pensions regime generally,” he says.  “Take, for example, compulsory clearance of certain corporate transactions and punitive fines. Extreme caution should be exercised in making any such changes here – they should be carefully considered in the context of experience across the industry, rather than as a reaction to one or two specific cases.”

Corporate transactions, he argues, are in fact often in the interests of pension schemes as they can maintain or improve the health of the company supporting the scheme, thereby maximising long-term security of benefits. “Granting the Pensions Regulator the power to block transactions threatens to impede legitimate business activity, particularly when the regulator’s resources are limited.”

Another key risk is the volatility of pension liabilities, according to Mr Goss. “Many defined benefit schemes have reduced the volatility of their liabilities by hedging inflation and interest rate risks. But a key remaining risk is longevity – a significant contributor to the ballooning of scheme deficits in recent years.”  He advises corporates and trustees to consider managing this risk by passing it to an insurer, either through a bulk buy-in policy or a specific longevity swap, especially since recent pricing for buy-in policies is favourable.

As with almost every other aspect of life, Brexit and its inherent uncertainties, even beyond any immediate change to pension law, present another risk to be managed. “Defined benefit pension schemes are reliant on the covenant, in other words, the financial strength of the employers that sponsor them,” says Mr Goss. “If the economy is adversely impacted by Brexit, the security of UK pension schemes will suffer. Corporates and trustees will need to remain alive to changes in covenant and maintain a dialogue to mitigate adverse experience.”

The effect of any requirement in a Brexit deal for continued supervision by the European Union or for “equivalence” of regulation by UK companies, perhaps around solvency level funding, should also be considered.

Granting the Pensions Regulator the power to block transactions threatens to impede legitimate business activity

The government’s recent consultation Green Paper on Corporate Governance Reform is highly relevant to pensions, he points out, as it proposes changes to executive pay and aims to give a greater voice to stakeholders, including pension scheme investors, in the boardroom.

“It’s triggered calls for UK pension scheme trustees, as investors of over £1.4 trillion, to vote against proposed pay rises by the corporates in which they invest,” says Mr Goss. “But government and regulators should be wary of imposing additional obligations on trustees because of the cost and administrative burden they would bring.”

He points to other important issues that companies and trustees need to be ready for. These include the Pension Regulator’s Corporate Plan 2017-2020; potential changes to the funding regime and rules on accounting treatment of pensions; compliance with auto-enrolment obligations; and new EU data protection laws, which come into force in May 2018.

“Corporates and trustees will need to be well prepared to navigate their way through the uncertain times ahead in the pensions industry,” says Mr Goss. “They have to be more risk aware, more proactive about handling threats and more prepared to adapt quickly to the increasing pace of change.”

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