UK employers could be forced to pay down pension deficits

Reforms to pension rules will mean some UK employers will have to clear scheme deficits faster than currently scheduled, the sector regulator has said.

Draft regulations published by the government last month for the first time hard-coded the principle that employers must pay down any deficit in their “defined benefit” scheme as soon as they can reasonably afford.

The Pensions Regulator — which oversees workplace pensions — will later this year set out how this principle should be applied to around 5,500 “final salary” style pension plans, managing about £1.7tn of assets.

Sarah Smart, chair of the regulator, said she expected the changes — aimed at improving protections for around 10mn DB members — would lead to “some” employers being asked to clear funding shortfalls more quickly than they had planned.

“There will be some schemes for which there is a lengthy (deficit) recovery plan, where if we went in tomorrow and said ‘where is your evidence for the length of your recovery plan’, I suspect that they would not be able to provide that,” said Smart in an interview with the FT.

“The (new code) is to give greater clarity to schemes as to what ‘good’ looks like from our perspective.”

The regulator said it was “too early” to say how many employers might be affected.

The proposals come as traditional DB plans, which pay a secure retirement income based on salary and length of service, have largely disappeared from the private sector, with the overwhelming majority of schemes closed to new joiners.

However, around 1mn savers are in plans still taking on new members, including the giant Universities Superannuation Scheme (USS), with 420,000 members.

The draft DB funding proposals will also set a new requirement for schemes to wean themselves off the financial support of their sponsoring employers by the time most of their members are, or are nearing, pension age and no longer actively building their retirement pots.

Some industry professionals say the proposals risk “straitjacketing” trustees’ freedom to invest in higher risk but potentially higher return assets, and fear the plans could hasten the end of schemes that are not currently planning to close, such as USS.

But Smart insisted schemes would still have “generally the same” investment flexibility under the new regime as now.

“What we have at the moment is effectively a bespoke system for every scheme,” she said. “For many schemes, many employers . . . life will not change under the [new] DB code.”

Smart added that it was “absolutely not” the intention for the new regime to place “unnecessary” investment constraints on open schemes.

The comments came as the regulator began its search for a new chief executive following a decision by Charles Counsell to step down in March 2023.

Smart revealed the search would go beyond the UK, noting that countries such as Australia and Holland had “many parallels” with Britain in terms of their pension systems.

“If there’s someone who can bring useful experience from overseas, then that’s absolutely something we would look at,” she said.

The leadership change comes as the regulator undergoes a significant expansion in its remit due to automatic enrolment, which has brought more than 10mn workers, and thousands of employers, into “defined contribution” pensions, which are replacing DB provision. The regulator also recently took on the supervision of new collective DC (CDC) plans and “superfunds”, or DB consolidators, all of which are stretching its resources.

“One of the key questions we ask ourselves everyday is how we apply our regulatory resources,” said Smart. “Realistically, with the economic situation, I have to think about the possibility we may suffer [budget cuts] and be asked to do more with less.”

The new chief executive is also likely to step into an ongoing storm over a funding hole at the USS with some members blaming recent pension cuts on an overly prudent approach by the regulator to the scheme’s 2020 valuation.

Smart declined to comment on the USS dispute but said: “As a regulator we have a number of different statutory objectives, with one of them looking after the security of members’ benefits . . . and the other is to pay attention to the sustainable growth of the employer.

“It has always been difficult as a regulator to balance the different objectives . . . and this will be something that is important for the new chief executive to understand.”