British Steel Pension Scheme: Public Consultation Response from the Pension Protection Fund

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1 British Steel Pension Scheme: Public Consultation Response from the Pension Protection Fund

2 Summary The PPF recognises the Government s commitment to securing a sustainable future for the UK steel industry whilst also achieving the best outcome for members of the British Steel Pension Scheme (BSPS). As part of the framework set up by the 2004 Pensions Act to protect members of DB schemes, the PPF also wants the best possible outcome for BSPS members. However, the PPF provides a safety net for some 11 million individuals and is funded by a levy on around 6,000 defined benefit (DB) schemes. We must, therefore, ensure that any solution balances outcomes for BSPS members with the interests of PPF levy payers and members in general and the integrity of the wider system in which the PPF operates. Of the options set out in the consultation: Option 1 using existing regulatory mechanisms to separate scheme and employer, with BSPS entering a PPF assessment period provides a tried and tested route that would allow the emergence of a business free from pension liabilities whilst ensuring members receive at least PPF compensation levels (and more if funding allows). PPF compensation has been set by Parliament to offer substantive protection to members whilst balancing the impact on levy payers. Option 2 which would require Tata Steel UK (TSUK) to make payments to remove the deficit in the scheme (the section 75 debt) has already been ruled out by TSUK. Option 3 legislation to enable reduction in scheme benefit levels, allowing the scheme to run on outside the PPF and Option 4 enabling a bulk transfer of scheme members (with an opt out provision) to a new scheme with a reduced benefit structure. Both options 3 and 4 pose significant risks for relatively limited gains and raise significant questions of equity between the treatment of BSPS and the PPF s members and levy payers, which could be tackled in different ways. The reduced benefit levels proposed by the trustees under each of these options would remove much of the distinction between the benefits members would receive in the existing scheme (or any new scheme under option 4) and the level of compensation they would receive from the PPF. The majority of members would receive roughly the same as they would in the PPF and a minority would be worse off. The number that are worse off could grow depending on the early retirement and lump sum commutation factors the scheme intends to use. Against this - in the absence of a genuine sponsoring employer - PPF levy payers would be directly underwriting the risk of the existing or new scheme s investment strategy failing. There would also be risks of other schemes seeking similar arrangements. We therefore believe that if Government wishes to enable either of these options it should seriously consider making any such scheme ineligible for PPF protection. If PPF eligibility is retained wider legislation may be needed to allow the risk based levy to be calculated appropriately and to provide effective protection for PPF levy payers (including appropriate controls over investment strategy, and triggers for PPF entry to prevent a significant deficit accumulating). 2 Summary

3 Background 1. The Pension Protection Fund (PPF) was founded by the Pensions Act This Act also established the Pensions Regulator as successor body to the Occupational Pensions Regulatory Authority and introduced other changes that collectively represented a new framework for the management and protection of defined benefit (DB) schemes, and their members, in the UK. The Act was to a large degree a response to the scale of losses facing members of pension schemes if their employer became insolvent (in many cases individual losses could be well in excess of 50% of accrued pension) and complemented earlier legislation that required a buy-out with an insurance company in the event of a solvent employer winding up a scheme. 2. The 2004 Act and specifically the introduction of the PPF prevents such losses happening again. Under the current system, if insolvency leaves a PPF-eligible scheme without a sponsoring employer a valuation must be undertaken to assess whether the scheme can afford to secure with an insurer a level of benefits at least equal to the level of compensation members would receive from the PPF. If it can the scheme must proceed to wind up and buy-out member benefits with an insurer. If it can t the scheme will transfer to the PPF and members will receive compensation in line with the provisions of the Pensions Act As a result the 11 million members of DB schemes in the UK can be assured that, as a minimum, they will receive the substantive level of compensation the PPF provides regardless of what happens to their employer and the extent of any deficit in their scheme. 3. The PPF is not tax-payer funded and has no Government guarantee. The PPF seeks to fill the deficits it inherits through a levy on eligible schemes, from returns on its investments and through recoveries from insolvent employers. The Act ensures that the amount of levy paid by organisations is dictated by the amount of risk they pose in terms of potential insolvency and size of their pension deficit. 4. PPF compensation levels were set carefully by Parliament with a view to amongst other factors - striking a balance between compensation for scheme members and the amount of levy that would need to be raised. Parliament took the view that scheme members who would not have an opportunity to make up any shortfall in pension i.e. those who have passed normal pension age or retired due to ill health should have their current payments protected, whereas those still below that age should have their compensation reduced to balance the obligation on levy payers (and to tackle moral hazard issues). If Parliament felt that the original balance needed adjusting, it has the power to do so. 5. As at end March 2015 the PPF was in a robust position with a funding level of 115% (a surplus of 3.6bn). However, it is important to recognise the extent of the risks facing the PPF. At end May 2016 nearly 5000 DB schemes (out of a total population of around 6000) were in deficit on a PPF basis i.e. they could not afford to secure with an insurer a level of benefit equivalent to that which the PPF would provide. The aggregate shortfall across these schemes was estimated to be 332 billion dwarfing the PPF s current surplus. In worst case scenarios e.g. where an unexpectedly high number of these schemes fall into the PPF or where the value of claims is unexpectedly high the levy would have to be increased significantly. In extreme situations, the PPF and the Secretary of State for Work and Pensions have powers to reduce the level of compensation paid to members. 6. Managing the level of deficits in schemes and the risks they pose is therefore critical in enabling the PPF to maintain a robust level of protection for scheme members whilst limiting demands on levy payers. 7. In that context, whilst the PPF recognises the Government s objectives set out in the Consultation for maintaining steel production in the UK and for securing the best possible outcome for members of the British Steel Pension Scheme (an objective the PPF shares), we consider it vital that this is done in a way which does not see a meaningful increase in risk to the PPF s levy payers and existing members. Background 3

4 General views on consultation proposals 8. The consultation document sets out four options. The document makes clear that Option 2 payment of pension debts has been ruled out by Tata and we have not considered it further in this response. The remaining options are: Option 1 use existing regulatory mechanisms to separate the BSPS 9. In our view the existing regulatory levers provide effective mechanisms to enable a separation of the scheme and employer in a way that balances and protects the needs of all concerned. 10. Regulated Apportionment Arrangements (RAA) provide a tried and tested route for employer / scheme separation whilst guarding against moral hazard and protecting the interests of the scheme and the PPF (by ensuring key safeguards are met, including that the scheme is left better off than in insolvency). 11. Following an RAA the scheme would enter a PPF assessment period and would undertake an actuarial valuation to assess whether it could afford to secure with an insurer a level of benefits at least equivalent to that which the PPF could pay. If it can the scheme would leave the assessment period and seek to buy-out benefits with an insurer. If the scheme were sufficiently well funded to meet this test but could not in practice secure a buy-out quotation (e.g. if the scale of the scheme is an issue) the existing legislation would allow for BSPS to run on as a closed scheme that is winding up. 12. If the scheme could not afford PPF compensation levels, the scheme would transfer to the PPF and we would become responsible for paying compensation to members. In other words, this route provides a clear mechanism to separate employer and scheme, freeing the business from pension scheme liabilities whilst ensuring members receive at least the level of underpin which Parliament has specified should be provided in these scenarios. 13. The PPF is in a robust financial position (with a funding level of 115% and a surplus of 3.6bn) and the levy is set at a level that allows for potential future claims. As a result, whilst the scale of BSPS is significant, a claim on the PPF would be manageable without - in itself - triggering an increase in the PPF levy. Going forward, the PPF is protected against future shocks or adverse scenarios by its well-established low risk investment strategy, including effective hedging of interest rate and inflation risks, and the income stream provided by the levy. The PPF would remain on course to reach its target of self-sufficiency by Option 3 reduction of the scheme s liabilities through legislation 14. In assessing this option, it is essential to recognise that PPF compensation levels are substantive and that the trustees proposed cuts would mean that the difference between scheme benefits and PPF compensation is significantly reduced: Around 70,000 scheme members (those over normal pension age, NPA) would see very little difference between what they would get from the scheme (following proposed cuts) and what they would receive from the PPF. Pensioners with only pre-88 service will receive identical benefits. Pensioners with post-88 service will only see a difference on the indexation of their post 1988 Guaranteed Minimum Pension (the GMP comprises about 10% of their total benefits), and a difference on benefits only if CPI inflation is above 2.5%. 50,000 members (those below NPA) would receive the 90% level of PPF compensation based on the pension accrued at the point the scheme entered a PPF assessment period; and Within that 50,000 around 776 would also have their compensation capped. The cap is currently 37,420 at age 65 (equating to 33,678 once the 10% reduction is applied). However, the Government intends to implement increases to the level of the cap for those with long service (by 3% for each year of service above 20 years to a new maximum cap of 59,872). Of the 776 BSPS members currently expected to have their compensation capped 665 are expected to benefit from this change (of which around 165 would no longer have their compensation capped). A minority of members would be worse off in the scheme than in the PPF (because of the relative treatment of bridging pensions and spouses pensions). This number could increase depending on the actuarial factors the trustees intend to use. The PPF sets actuarial factors on a cost neutral basis, which is frequently more generous to members than that provided by schemes. This could mean that members seeking early or late retirement or wishing to take a tax free lump sum would actually be better off in the PPF despite the 10% reduction in headline benefit levels. 4 General views on consultation proposals

5 Information provided by the trustees to its members has so far not set out the commutation factors that would be used and further information on this point would be necessary to allow an accurate comparison to be made. 15. These distinctions in benefit levels need to be weighed against a number of substantive issues presented by this option. 16. There is a risk of setting a precedent. Although the Government (including in the consultation document) has been at pains to stress the unique circumstances surrounding BSPS we would nevertheless expect other employers or industries to seek similar arrangements to reduce their pension scheme liabilities effectively transferring value from scheme members to shareholders. 17. The scheme would still require a sponsoring employer in order to continue outside the PPF. If this is a genuine, viable employer e.g. the existing owners of TSUK or a purchaser of the business, that would not, in itself, present any additional or exceptional risk. However, the consultation document appears to indicate this is improbable, noting that it is highly unlikely that a purchaser would be willing to take on the pension scheme as part of the deal. It therefore appears most likely that the sponsoring employer would be a special purpose vehicle (SPV) or shell company set up with the sole purpose of allowing the scheme to run on and offering little or no substantive support for the scheme. 18. With no genuine employer to act as a buffer and provide additional contributions when needed, the risk of the scheme s investment strategy failing would either fall on the scheme members or if it was decided to maintain PPF eligibility - be directly underwritten by the PPF. Even using a low risk investment strategy the possibility of a substantive deterioration in funding levels remains. 19. If the scheme remains eligible for the PPF then, from the trustees and scheme members perspective, the impact of any such deterioration would be mitigated by the ability to trigger PPF entry at the point it was considered the scheme could no longer afford to pay benefits above PPF levels. In addition, the longer the scheme remains outside the PPF more scheme members will pass NPA and qualify for the higher level of PPF compensation (100%, uncapped). From the PPF s perspective, however, this scenario means the scheme would be likely to fall into the PPF with a more substantial deficit than at the point TSUK was separated from the scheme. It would effectively constitute a one way bet, against existing PPF members and levy payers, on the success of the scheme s investment strategy. 20. More generally, the option would facilitate an arrangement for one scheme to step outside the existing framework and the carefully constructed balance between compensation levels for members and cost to levy payers (as described in paragraph 4). As well as the risks described above, this raises questions of fairness and equality of outcomes for existing PPF members and members of DB schemes across the UK. If the option is driven by a reappraisal by Government of what constitutes the right level of compensation (i.e. that the balance between members and levy payers needs to shift towards members) then it is open to Government to adjust PPF compensation levels (building on the changes to the compensation cap already proposed). This would be relatively straightforward to give effect to, would retain equal treatment across the system and avoid the issues associated with putting in place a unique arrangement for one scheme. If Government chose to do this, it would mean that the overwhelming majority of members of the BSPS scheme would receive benefits equal to or greater than the Trustees proposals, but with far less risk to either the members of the BSPS scheme or PPF levy payers and the members of other schemes protected by the PPF. However, it should also be recognised that any improvements to compensation would be an additional cost that could be significant and would need to be met by levy payers in the long run. General views on consultation proposals 5

6 B) General views on consultation proposals continued Should the Government proceed with options that lead to the BSPS running on under a shell employer, then we strongly believe action should be taken to limit the impact on PPF members and levy payers and minimise precedent risk. More specifically the Government should seek to prevent bespoke arrangements for one scheme being underwritten by PPF members and levy payers. 22. The most effective way to achieve this would be to render the scheme ineligible for PPF protection, either in full or in part (perhaps by the provision of a Government guarantee, or by specifically prescribing the scheme as ineligible). If the scheme is in a position of selfsufficiency this move would be in line with that. The scheme would then not pay a PPF levy and the PPF would not bear the cost of compensation payments if at some future point the trustees concluded there were insufficient assets to meet the revised benefit levels. 23. If the Government is unwilling to provide a guarantee and feels that member benefits would face unacceptable risks without PPF protection then other action to be considered should include: Transferring to the PPF those members (together with a proportionate share of assets appropriately reflecting the liabilities represented by those members) who would see no significant difference in benefit levels. If, for example, the 70,000 pensioner members were transferred to the PPF the residual scheme would be much smaller in size and pose a much lower ongoing risk, whilst at the same time maximising the level of benefit received by members. Alternatively or in addition, in the event the BSPS scheme subsequently entered the PPF, they will have incurred costs that would not have been incurred had the scheme entered the PPF at the point of separation from the sponsoring employer (e.g. expenditure on benefits over and above PPF levels). Provision could be considered to allow recovery of these costs (though this may be complex to achieve). 24. As a minimum: The scheme should be able to demonstrate that its level of funding and its investment strategy meets a robust self-sufficiency test i.e. that the scheme genuinely can run on outside the PPF with no or extremely limited risk of making a subsequent call on the PPF. No action should be taken until a suitably qualified, independent third party has confirmed this test has been met. The PPF under its existing funding strategy is seeking to become self-sufficient by The PPF s definition of selfsufficiency for that purpose is: a funding level of 110%, with liabilities discounted on a gilts flat basis, and with no exposure to market, inflation or interest rate risks. The 10% margin is to provide protection against remaining risks such as unexpected longevity shocks as well as provide a buffer against claims in excess of levy income. Another potential reference point is the point at which the PPF determines that no risk based levy is payable from eligible schemes. This is where a scheme is fully funded on a PPF basis following the application of stresses to the scheme s assets in line with the scheme s investment strategy; The level of value received from any employers exiting the scheme should be maximised and be at least equal to the value that would be recovered in insolvency. It is not clear from the consultation document what level of payments from the existing employers is expected in lieu of enforcement of the section 75 debt. Particular care needs to be taken to avoid limiting the debt due from employers by reducing scheme benefits; and The Government should consider what wider changes to the pensions system are necessary to accommodate such an arrangement. The Pensions Regulator, for example, has a number of powers to ensure that schemes seek to reduce deficits; to a large degree these are based on the existence of a genuine employer and may cease to be applicable or effective in this scenario. However, it is essential for PPF members and levy payers that effective controls over the management of the scheme are in place (including triggers and powers to wind up the scheme to prevent substantial losses materialising before any claim on the PPF is made). Furthermore, the risk based levy assesses the likelihood of a scheme making a claim on the PPF by assessing the strength of the employer. That test is not relevant in this scenario because in the absence of any genuine business - the insolvency of the shell company could be triggered by the trustees at any point. We currently have no obvious basis to assess the risk this arrangement would pose to us in order to calculate an appropriate levy. Similarly, employer insolvency may not be the right trigger for the start of a PPF assessment period in this scenario. 6 General views on consultation proposals

7 Option 4 transfer to a new scheme 25. Option 4 presents similar issues to option 3. However, option 4 would allow BSPS members to opt out of a move to a new scheme with a reduced benefit structure (with those who do so remaining in the original scheme which enters a PPF assessment period). This would be beneficial from the BSPS members perspective but because members will choose the best option for them, the overall cost would be higher than under option More generally, we are concerned that this option would provide schemes in similar circumstances with a mechanism to reduce benefits (and potentially run on with a shell employer) without active consent from members. This has the potential to affect the risks faced by the PPF (given the safety net provided by the PPF schemes may feel they have nothing to lose by exploiting this option even where their funding position means they could not genuinely be considered self-sufficient). General views on consultation proposals 7

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