What could the UK pension system give its members this Christmas?

I was mulling this over with a colleague over a mince pie last week, and it struck me that, for all the 'big picture' talk from the Government about how the UK pension system could work better for the UK economy, there is a much more specific and tangible bauble hanging low on the tree.

The Pension Protection Fund has been a huge success story for DB pension schemes and their members over the last few decades. Since it was first formed in 2005, it has protected the pensions of around 300,000 members and has grown from zero to over £30bn of assets. However, it has now become so well-funded that it arguably has more than it needs. Indeed in its press release last week, the PPF confirmed that they don’t want to charge the levy for longer than is needed and are working towards that goal (albeit they are currently hamstrung by legislation).

With a funding level of 170% on 31 March 2024 (corresponding to a surplus of c£13.3bn), there is a very good case to be made that those assets could be put to better use. There are a number of stakeholders who would have a good argument that they should be getting their fair share of the (mince) pie, but there are 3 key stakeholders that stand out:

1. Members - although the PPF has done a great job of providing pensions to members, the terms attached to those pensions are typically 10-30% less generous than they would have been under the original scheme. One topical example of this (given recent rises in living costs) is increases that members receive to their pensions in payment, which are either zero or capped at 2.5% pa. This has led to PPF members’ pensions being significantly eroded in real terms in recent times. The PPF’s members would have a very good argument for a call on the PPF surplus to help offset the historic reductions to their pensions.

2. Employers - UK employers of DB pension schemes have paid billions of pounds in PPF levies over the years. Although there were good reasons for this at the time, with the benefit of hindsight it is not difficult to argue that employers have overpaid and that some form of refund to correct that position is appropriate.

3. PPF - although distributing a large slice of the surplus makes sense, there is a balance to be struck here. Distributing too much surplus could put the security of members’ benefits at risk and, in the extreme, could lead to benefits having to be cut back for members or significant PPF levies having to be re-introduced for employers. Retaining some of the surplus as a buffer therefore makes a lot of sense.

Let's do the maths on this briefly...

To keep things simple, let’s suppose an illustrative equal three-way split between the above parties (that’s c£4.4bn each).

1. An equal split amongst the c300,000 members equates to c£15,000 per member.  Like the Christmas turkey, clearly, there are a whole host of challenges around how you would carve this up in practice, and this would need some careful thought - should it be DC pots for each member, additional inflation protection on pensions going forward, or an additional uplift to pensions? For illustrative purposes, if you went with the latter, you might be looking at an increase in members’ pensions of £1,000 pa. That would be a c25% increase on members’ current pensions and would be a huge boost to those members in the current economic climate.
    
2. An equal split amongst the c5,000 principal employers of current DB pension schemes equates to £900,000 per employer. Again there are challenges around how you would split this up - some larger employers will have provided the PPF with the funding equivalent of gold, frankincense and myrrh over the years, others maybe more like the straw and hay, but most employers will have contributed something and so should be in the mix. You could, for example, calculate a one-off refund for each employer by pro-rating the levies paid by each employer’s scheme over the years.  With employers facing the challenge of higher National Insurance contributions following the Chancellor’s recent Budget, this would be a welcome year 1 boost to help offset some of this increase in cost.
    
3. Retaining c£4.4bn in the PPF as a buffer would still equate to a funding level of 123% for the PPF.  Is this sufficient? TPR’s interim regulations for superfunds are a useful reference point here. Superfunds are not dissimilar to the PPF - large, pooled funds, with no recourse to employer deficit contributions. TPR’s interim regulations permit superfunds to operate at a funding level of, broadly, 110-115% on a low-risk basis, and even permit profit release at a funding level, of, broadly, 120%. So a funding level of 123% for the PPF still feels perfectly appropriate. And on top of that, unlike superfunds, the PPF always has recourse to the wider population of UK pension scheme employers in the form of PPF levies, should there be a downside event that means a further top-up to funding is needed.

On a related note, here's a quick-fire Christmas quiz on a few other PPF-related items…

1. Should PPF levies be zero? With a funding level of 170% (or even 123% under my illustration above) clearly the answer to this in theory is yes. However, in practice I have a lot of sympathy for the PPF’s position - it is hamstrung by the current legislative framework, which caps increases to the PPF levy at 25% each year.  This gives the PPF a problem - if it reduces levies too low and needs to raise them again, it can’t do that quickly. In the extreme, if it reduces levies to zero, it can never get them back up again (a 25% increase on zero is still zero). A simple stroke of the legislative pen to amend this rule would solve the problem, and enable the PPF to reduce levies to zero immediately, which would be a further boost to the cashflow of UK pension scheme employers. In last week's press release, it seems clear that the PPF are looking at the options on the table to reduce the levy before the legislative changes are made and have said they will report back in January.
    
2. Should the PPF become a public sector consolidator? In short, I believe no. The PPF has done a fantastic job in its lifeboat role, providing pensions for 300,000 members and providing a safety net for millions more, but blurring the boundaries by becoming a public sector consolidator for schemes with solvent employers is dangerous. Put another way, whilst it is a good idea to have lifeboats on passenger ferries in case of an emergency, that doesn’t mean lifeboats are the best way of getting from A to B.
    
3. Is a 95% probability of receiving 100% of full benefits a better outcome for members than a 99.5% probability of receiving 90% of full benefits? This question strikes at whether the PPF could play an extended role in providing better pensions to members of schemes whose employers have gone bust when the scheme is fully funded on the PPF's measure but not fully funded on an insurance measure.  In these circumstances, the status quo is that members’ benefits are secured through a “PPF plus” buyout with an insurer. In other words, with certainty (or 99.5% certainty as per the Solvency II regime) the scheme fails to secure full benefits for members. There is a good case to be made that a ‘PPF mark II’ could step in here to provide members with a high degree of certainty (but no guarantee) of receiving full benefits.

To wrap up then (penultimate Christmas pun, I promise)…

I think there is a great opportunity, and a very tangible and specific one, for the UK pension system to work better for members and employers. Quite rightly the Government is looking at ‘big picture’ pensions issues such as consolidation of the DC and LGPS markets and how to use surplus effectively in private sector DB schemes. However, we should not lose sight of the fact that there is a fantastic Christmas present for 300,000 pension scheme members and 5,000 UK employers that is already sitting right under the tree.