Expanding the Pension Protection Fund: an investment in the future?
In its paper, Investing in the Future: Boosting savings and Prosperity for the UK, the Tony Blair Institute for Global Change (TBI) argues that “the UK’s pension-savings system is broken”, that there has been an “abandonment of investment in the domestic economy by United Kingdom pension funds” and that as a result, both pensioners and the UK economy are suffering.
The TBI has proposed a new way forward, suggesting that the government ‘lifeboat’ for failing pension schemes, the Pension Protection Fund (PPF), should be expanded to become a superfund, which it has dubbed ‘GB Savings One’.
The paper claims we do not have to look back far to see the fragility of the UK’s current pension system: the pension-fund crisis which occurred in the aftermath of then Chancellor Kwasi Kwarteng’s September 2023 mini-budget made this plain to see.
In this blog, we analyse some of the findings of the TBI and consider whether the answer to the UK’s current pension investment concerns can be found in a reimagining of the PPF’s role.
What is the PPF’s current role?
As many of you know, the PPF acts as a safety net to provide compensation to members of eligible defined benefit (DB) pension schemes, in situations where a sponsoring company has become insolvent and there are insufficient assets within the scheme to pay benefits of at least equal value to those that would be payable by the PPF.
How does the TBI propose to change the PPF’s role?
In a nutshell, the TBI proposes that instead of a company having to become insolvent before they can transfer their pension fund to the PPF, sponsors would be given the voluntary opportunity to request to transfer into the PPF on a “benefit-preserving basis to be agreed between the companies and the PPF" and by paying a capital buffer to provide for the continued payment of benefits.
The plan would be for this option to be granted to the 4,500 smallest UK DB schemes for now, with the intention being that the model is then replicated throughout the UK using return-generating, not-for-profit funds, on a regional basis. This would expand to cover not only the remaining DB schemes, but also some 27,000 defined contribution (DC) schemes and the Local Government Pension Schemes (LGPS). The paper suggests that the PPF could one day absorb all of the UK’s public-sector pension schemes too.
The authors state that this model would produce half a dozen professionally managed, long-term, diversified funds that would each constitute one of the ten largest funds globally.
Why does the TBI think that these changes should be made?
The TBI offers several rationales for expanding the PPF’s remit in this way. They can be summarised as:
- providing an opportunity to restore greater investment in British industry: through encouraging (or potentially mandating) long-term domestic equity investment. In doing so, the authors suggest that this would improve national security by reducing reliance on foreign investment into the UK;
- securing greater returns: improved returns could be achieved for UK pensioners through economies of scale and a more consistently high standard of professionalism in management. This would be cost-effective and would take the average UK pension scheme with assets of around £400 million each and add it to the PPF pot of some £40 billion. The authors cite previous successes of asset pooling and scheme consolidation, including in the UK government’s ongoing project of consolidating assets in the LGPS, which has seen average returns of 9% over the past nine years, compared to 6% for private sector DB schemes. GB Savings One could also invest in a more diversified portfolio, making it more resilient than other schemes to market shocks;
- eliminating the ‘corporate link’ between sponsors and schemes: the risk of sponsors having to make additional contributions to the scheme can lead to risk averse investment decisions. By severing the corporate link, greater potential returns for members and more investment in UK listed shares with higher growth potential could be achieved;
- removing the financial burden of DB scheme funding requirements: sponsors currently face strict funding requirements, and large contingent pension scheme liabilities on balance sheets can appear unattractive to potential investors. An expansion of the PPF could allow sponsors more scope for investing in their core businesses, whilst also shoring up their balance sheets; and
- improved regulation and monitoring: by consolidating all of the UK’s smaller pension schemes into a select few consolidators, monitoring scheme compliance with regulations would become far easier.
What are the potential issues with the TBI’s proposals?
Where appetite for buy-out is lower from an insurer perspective, particularly in relation to smaller schemes which command lower fees, the TBI’s proposals may sound convincing. However, whilst it is hard to argue with the logic of consolidating the vast number of small DB pension schemes the UK has into a single, large pot which can reap the benefits of economies of scale and create a more resilient, diverse portfolio of investments, there are some notable drawbacks to the TBI’s proposals that should be considered.
- There is already a buoyant buy-out market allowing sponsors to remove their scheme liabilities from their balance sheet, securing member benefits in the process. By adopting the TBI’s approach, the market for buy-out will be interfered with, reducing competition in the scheme ‘end-game’ space and potentially driving up costs for sponsors.
- The TBI’s timeline proposes that the first of the GB Savings superfunds, comprising the 4,500 smallest DB schemes, should be created by the end of 2024, with a target of all DB and DC funds as well as the LGPS being consolidated by the end of 2026. With the government focussed on managing inflation and continuing to deal with the aftermath of Brexit and the pandemic, it is questionable whether the TBI’s proposals will be on the government’s agenda for consideration any time soon. However, a recent article in the Financial Times quoted inside sources at Whitehall as saying that the TBI’s proposals were being “closely examined” by Chancellor Jeremy Hunt. Recent comments from Shadow Chancellor Rachel Reeves on mandating pension plans to invest domestically and to move to consolidating the fragmented market of small UK pension funds also suggest that if Labour are successful at the next general election, these proposals may move up the agenda.
- The TBI suggests that there should be minimum requirements for investing in UK companies and qualifying infrastructure assets. There are concerns over whether the government should be able to mandate investment in this way. Such an approach may not always lead to the best returns for members, and there are also fears that this would reduce diversification and leave funds overly exposed to the UK economy.
- With regards to DC schemes, as the sponsor is not ‘on the hook’ for any shortfall in the returns of the fund, the rationale for expanding the PPF in this direction is weaker.
- There are also concerns stemming from the fact that PPF compensation is typically less generous than the benefits provided by existing DB schemes. For example, the PPF imposes a 2.5% per year inflation cap on payments relating to pensionable service from 6 April 1997 and no indexation is paid on compensation relating to service accrued before that date, which may give rise to concerns in the current high inflation environment. Such issues would need to be addressed to ensure members aren’t worse off in the long-term if the TBI’s proposals are adopted.
Overall, there is still clearly much work to do and many issues to be addressed if the PPF is to one day take on this expanded role. Given that the PPF is a statutory corporation established by the Pensions Act 2004, expanding the PPF’s remit as envisioned by the TBI would require legislative change.