Investors urge UK government to reform defined benefit pensions

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The UK government should prioritize reforming the UK's £1.2 trillion defined benefit pension system to unlock billions of pounds of investment, according to an asset manager.

Last November, the government announced a series of megafund plans across defined contribution (DC) and local government pension schemes to drive more investment into UK infrastructure and fast-growing businesses.

However, plans are yet to be drawn up for a corporate defined benefit (DB) pension scheme, despite consultation by the previous government earlier this year which explored options to allow businesses to access scheme surpluses. This may encourage companies to invest more in risky assets.

Jos Vermeulen, head of solutions design at Insight Investment, which manages $665 billion in assets in the UK, believes it is important to prioritize DB plans as they have the potential to raise funds faster than other areas.

There is room for up to $100 billion to be released in the next 12 to 24 months…This is a once-in-a-generation opportunity to change Britain's destiny…If that opportunity is lost, it could be lost permanently, he added. . .

ABRDN Group Pension Plan Investment Director Owen McCrossan said DB Pension Plans were certainly a pool of capital that could help fill gaps in productive finance.

He added that allocating 5% to productive assets such as real estate and infrastructure could raise about $50 billion.

This is the same amount the government hopes to invest in productive assets by 2030 under plans to consolidate defined contribution workplace schemes into a fund of at least 25 billion assets.

There have been calls to reform regulations related to the DB system as the government delays its review of pension adequacy. The review is expected to set out plans to boost auto-enrolment pension savings rates, which the government hopes will lead to more investment in the UK.

Vermeulen said it was key that DB pension reforms were included in the pension bill due to expire in the middle of next year.

In an interview with the Financial Times last month, Pensions Secretary Emma Reynolds said reforming the defined contribution workplace system was a priority because it was the direction of growth.

She pointed out that most corporate defined benefit pension schemes are closed to new members, and as pension obligations come to an end or are sold to insurance companies, terms naturally shorten as schemes move to less risky assets.

But industry insiders say the funding situation for defined benefit pension plans has improved dramatically in recent years, making many more willing to take on more risk if they can ensure that companies and plan members benefit under the rules.

To encourage schemes to operate and invest in productive UK assets, Vermeulen proposed that the Pension Protection Fund guarantee 100% of pensions owed if the scheme is unable to meet its obligations. Currently, we are paying around 70-90%.

The annual PPF levy is likely to increase as a result, but the government may waive the fee if the fund invests a certain amount in UK infrastructure or scale-up companies.

Going forward, the government could say that if you invest 5% you won't pay the levy to encourage plans to invest in productive assets, Vermeulen said.

Companies have been rushing to hand over their pension obligations to insurers in recent years, with the number of transactions hitting 60 billion last year, according to PPF. However, this will likely slow down if the scheme ensures full protection from PPF and allows businesses to benefit from surpluses.

In response to the first phase of the pension review, the Investment Association, which represents the UK fund management industry, recommended that the government allow safe extraction of fund surpluses from DB schemes, although this is not formally within the scope of the review.

If certain guardrails are put in place around surplus extraction to ensure that benefit security is not undermined, surplus extraction capacity could provide an incentive to accumulate surplus by taking more investment risks in line with the government's broader goals, the IA said.

The Department for Work and Pensions said it was reviewing responses to previous government consultations on defined benefit scheme options and a decision on surplus flexibility would be made in the coming months.

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