Investors call for UK government to reform defined benefit pensions

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The UK government should prioritise reform of the UK’s £1.2tn defined benefit pensions 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 more investment in British infrastructure and fast-growing companies.

But it has yet to lay out plans for corporate defined benefit (DB) pension schemes, despite a consultation from the previous government earlier this year that explored options to allow companies to access scheme surpluses, which could encourage them to invest more in risky assets. 

“We think it’s important that DB schemes are looked at as a priority — they have the potential to get money into the ground more quickly than other areas,” said Jos Vermeulen, head of solution design at Insight Investment, which manages £665bn of assets in the UK.

“There’s scope for up to £100bn to be released in the next 12 to 24 months . . . this is a once in a generational opportunity to change the fortunes of the UK . . . if you lose that opportunity it may be permanently gone,” he added.

Owen McCrossan, head of investments for abrdn group pension schemes, said DB pension schemes were “certainly a pool of capital that could help fill the gap in productive finance”.

A 5 per cent allocation to productive assets such as real estate and infrastructure “could raise around £50bn”, he added.  

That is the same amount the government hopes to drive into productive assets by 2030 under its plans to consolidate defined contribution workplace schemes to funds of at least £25bn of assets.

Calls for the government to reform rules around DB schemes come as it has delayed a review into pension adequacy. The review had been expected to lay out plans to increase auto-enrolment pension savings rates, which the government had hoped would drive more investment in the UK. 

Vermeulen said it was key that DB pension reforms should be incorporated in the pensions bill due in the middle of next year.  

In an interview with the Financial Times last month, pensions minister Emma Reynolds said she had prioritised reforming defined contribution workplace schemes because that was “where the growth is”.

She pointed out that the majority of corporate defined benefit pension schemes were closed to new members and “naturally had a less long time frame” as schemes move into less risky assets as they wind down or sell 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 the rules enabled companies and scheme members to benefit from it. 

To encourage schemes to “run on” and invest in productive British assets, Vermeulen suggested that the Pension Protection Fund covered 100 per cent of pensions owed in the event a scheme could not meet its obligations. Currently it pays between 70 and 90 per cent.

The annual PPF levy would likely have to go up as a result, but the government could waive the fee if a fund invested a certain amount in British infrastructure or scale-up companies. 

“The government could say going forward, to incentivise 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 a record £60bn of transactions last year, according to the PPF. But this would slow if schemes could guarantee full protection from the PPF and if companies could benefit from surpluses.

In its response to the first phase of the pensions review, the Investment Association, which represents the UK fund management industry encouraged the government to “allow for the safe extraction of funding surpluses” of DB schemes, although formally out of scope for the review. 

“Subject to certain guardrails being put around surplus extraction such that benefit security is not weakened, the ability to extract surplus could provide an incentive to build surpluses up by taking more investment risk, in line with the government’s broader objectives,” the IA said. 

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