Department of Work and Pensions – Green Paper

Security and sustainability in defined benefit pension schemes

Unite is the UK’s largest trade union with over 1.4 million members across all sectors of the economy including manufacturing, financial services, transport, food and agriculture, construction, energy and utilities, information technology, service industries, health, local government and the not for profit sector. Unite also organises in the community, enabling those who are not in employment to be part of our Union.

Unite welcomes this consultation not because we think defined benefit (DB) pensions are a problem for business which needs to be managed away but because we want to see reforms which will reinvigorate DB pensions. We hope the Government’s policy response will focus on the latter perspective and reject calls from the business lobby to legislate to allow them to cut member benefits.

DB schemes offer the best means for ordinary working people to achieve a decent standard of living in retirement. They have the potential to provide much better returns from contributions and much more predictable and secure outcomes for members.

This is because DB schemes are collective schemes which involve the sharing of risks on a basis which should allow much greater investment in return-seeking assets.

While lower investment returns and longer life expectancy have posed a challenge to DB schemes, this is a challenge which could have been overcome were it not for misguided accounting and actuarial practices which have been consolidated and reinforced by misguided regulation of scheme funding.

Even given the funding difficulties that schemes face, we would agree with the Green Paper’s view that DB pensions are not ‘unaffordable’ for most employers. There is an issue that some employers do not want to meet these liabilities but not generally speaking that, in most cases, they cannot do so. It is not surprising that companies prioritise paying dividends to their shareholders above paying off pension scheme deficits.

Some employers argue that DB costs are restricting their ability to invest in their business or prejudicing the pension offer they can make to younger employees in DC schemes. For the most part this is an argument of convenience to support a case for cutting their DB liabilities and, in reality, their investment is not being restricted and they could afford to improve their DC schemes as well as meet their DB costs.

There can be no return to the past where companies could walk away from their pension schemes and their past and present employees lost the pension benefits that they had been promised. Allowing schemes to make retrospective changes in benefits would be a big step down this path and the protection which the law gives on this must be maintained.

There is, and always will be, a risk to schemes where employers become insolvent. However, we have a safety net to deal with that eventuality – the PPF - one that needs to be improved but one which is doing the job it was intended to.

The challenge which this consultation needs to address is not just about providing a basis whereby closed DB scheme can be managed to make sure that their members get their promised benefits, it is about finding a basis whereby the tide of DB closures can be halted and reversed. It is not just about ensuring people get the benefits they have earned for their past service, it is about finding a basis which will facilitate the provision of DB pensions for their future service.

The Green Paper invites comments in four areas

Funding and Investment

Contrary to the conclusion of the Green Paper we believe that, in general, the discount rates used in DB Scheme Valuations are overly pessimistic. The approach being taken both reflects and encourages overly cautious investment strategies focussed on the short-term rather than the long term.

Excessive prudence in funding and investment has compounded the impact of the factors increasing the cost of pensions and contributed greatly to the downgrading and demise of DB schemes.


Rising life expectancy, volatile financial markets and low interest rates do present a big challenge to defined benefit schemes but we do believe that those challenges can and should have been managed in a better way as would have allowed more schemes to continue on a sustainable basis, and those continuing to provide better benefits than are often now provided.

Actuarial and accounting practices compounded by mis-guided regulation have compounded the economic and demographic challenges rather than helping schemes and employers to manage them. In particular the drive to de-risk investments has inflated pension deficits and hugely increased the cost of future service benefits.

This situation has been developing over many years with notable factors being the change to mark to market accounting and valuation of pension schemes on current market values, denying the opportunity to take a long term view, through to the current approach of gilts-plus methodology to determine investment returns, regardless of that market being grossly distorted.

If decent levels of pensions are to be provided then schemes necessarily must invest contributions in return-seeking investments over the long term. Without taking some risk there will be little reward and pension saving ceases to be viable. Yet all the pressure on defined benefit schemes has been to reduce risk.

Too great an orientation towards bond-based investment strategies results in excessive prudence and guarantees that the cost of benefits will be high. It represents a ‘solution’ which crystallises a problem rather than solving it.

At the current time Unite members are in dispute with BMW about the continuation of accrual in their DB Scheme. BMW argue the Scheme is unaffordable but, despite having a strong covenant, the employer feels obliged to cost and fund future service benefits using a discount rate equal to the return on corporate bonds (the basis required by the accounting standard IAS 19). The Scheme’s investment policy means that on a best-estimate return thre would be no defict at all and the cost of new benefits would be greatly reduced.

We also have experience of asking employers to withdraw proposals to close off DB schemes and them responding by saying they will only do so if the contributions they are prepared to provide are invested on a risk-free basis (generally defined as being gilts) and benefits are reduced to reflect what contributions invested on that basis will pay for. This generally means that the cost of providing pensions might double and so the future pension is halved. This then makes a defined contribution scheme look relatively more attractive.

The whole point of defined benefit schemes is that they are collective schemes which can and should be able to take more risk than an individually invested pension and so deliver better value. This, just as much as the employer underwriting them, is what makes scheme’s viable. The effect of de-risking makes the employer the first resort for additional pension funding rather than the last resort.

What is needed is a greater emphasis on the long term funding position as will allow greater investment in return-seeking assets. Discount rates should be based on the expected returns which schemes actually hold, with a margin for prudence, rather than a gilts-plus methodology. This is particularly important now as the margin between expected returns on gilts and on other assets has widened markedly.

A clear illustration of the impact of a more enlightened approach to funding and investment can be found by comparing the PPF’s assessment of the general level of scheme funding (of FTSE350 companies DB Schemes) on a bond-based investment approach, which shows a large aggregate deficit, and the First Actuarial FAB Index which adjusts to allow for best estimate investment returns and shows an aggregate picture of a large surplus.

There is scope for greater flexibility in terms of funding and investment than schemes are currently minded to adopt but trustees are conditioned to press a prudent approach on employers. Advisers and the Regulator are geared up to reinforce that perspective rather than to critically evaluate it. It will rquire a strong intervention by Government and by the Regulator to overcome the herd instincts in this area which are driving DB schemes over a cliff.

Employer Contributions and affordability

In reality this section of the Green Paper is focused on the question as to whether employers should be helped to reduce the pensions of their current and former employees.

Companies, and their advisers, are using the climate created by the widespread reporting of pension deficits to argue for Government intervention to make it easier for them to escape the pension promises they have made.

As noted above, this climate is to an extent a natural result of market interest rates being at a depressed level and the prevalence of gilts plus valuation methodology. Even in this climate, however, the Pension Regulator has pointed out that deficit recovery payments of FTSE 350 companies were only 10% of the amount those companies paid out in dividends.

The Green Paper is correct in pointing out that there is no general problem of affordability of pension contribution for employers.

We also welcome the views expressed that ‘DB pensions are hard promises – they are debts like any others, and debts should be honoured’

Unite does not believe the Government should be any more inclined to intervene to reduce companies’ debts to their pension scheme than it would be to intervene to reduce their debts to any other creditor.

The law currently provides that member benefits can only be reduced if members individually consent. This is a key principle and pivotal to member protection. That position is pretty much in line with the position in respect of commercial debts.

Members generally would regard their accrued pension entitlements as property rights and any legislation as would reduce these unilaterally would be bound to be responded to with legal challenges.

If there is to be any departure from this then it may be that changes in benefits might be allowed in some circumstances if a majority of the members vote for that. Members will not generally accept that the trustees of their scheme should be put in a position to determine members’ views on such a question.

The law provides that employers remain liable for any debt to the pension scheme for as long as they are solvent. This legislation was enacted to prevent employers walking away from underfunded pension schemes.

The main exception from this is where insolvency is accepted as inevitable within 12 months and a deal (a Regulated Apportionment Arrangement) is negotiated whereby the employer liability is discharged on the basis that the pension scheme gets a larger payment from the employer than they would have done had insolvency happened. Pension schemes generally enter the PPF where an RAA has been agreed.

We would generally support the continuation of this mechanism on a tightly controlled basis, as it can allow businesses to survive maintaining employment and jobs while not leaving pension scheme members any worse off. However, we do believe that where RA’s are being negotiatiated and there are recognised trade unions then those unions should be involved in consultation about this, subject to confidentiality assurances being given. At present deals are negotiated between companies, trustees and the Pension Regulator leaving all the members completely in the dark until the outcome is announced.

We do not see much scope to widen the criteria under which RAA’s can be negotiated.

In many cases company insolvency will be related to financial problems unrelated to their pension scheme. The pension scheme may be relatively well funded on an ongoing basis even it has insufficient funds to buy-out member members at a higher level than the PPF would provide (as would be required if members are to avoid transfer to the reduced benefits of the PPF).

The question can then arise as to whether schemes can and should be allowed to continue on a closed basis without a sponsoring employer. There may be proposals to reduce member benefits but to a level greater than PPF benefits.

We would have no objections in principle to such outcomes provided that member consent is required, that the scheme members remain eligible for the PPF safety net and that they accept the tight regulation required to limit the PPF’s risks.

The demand for such outcomes to be contrived would be reduced if the level of PPF benefits was increased, with greater provision for pension increases, as we believe it should be. The impact of this on the PPF Levy would be limited if the PPF adopted a less restrictive investment policy.

The Green Paper asks the question as to whether stressed employers should be allowed to reduce scheme benefits members have already earned. It says some commentators have suggested that in some circumstances this might be in members’ interests. The law already allows this to be done with member consent and so what this is really saying is that members are not to be trusted to determine whether a reduction is in their best interest.

If employers have a valid case they should put that case to the members of the scheme and let them vote on it. This will require more effort than securing agreement from a trustee board or the Pension Regulator but it leaves the decision with those directly affected and will mean, as it should, that such changes only proceed in genuinely exceptional cases.