My Lords, I thank all those who have spoken in this short debate. As usual, there were a number of specific and quite technical questions, notably from the noble Baroness, Lady Sherlock. I shall do my best to answer them. I think that some of them may be included in some of my rounding-up answers to other questions—but, as she will expect me to, I shall write a letter copying in all Peers if I fail to answer all of them.
Just on the question that the noble Baroness raised about the draft regulations, we outlined in the consultation response, as she alluded to, on 26 January 2024, that we would legislate for the regulations to come into force from April 2024, applying to scheme valuations from September 2024. That recognised feedback through the consultation about the need to give the pensions industry sufficient time to prepare before the requirements took effect. The regulations as drafted meant that one component of the reforms, the recovery plans, would come into effect on 6 April 2024 and not 22 September 2024. Since laying the regulations, we have recognised that this has the potential to cause confusion and additional administrative requirements for schemes. That is why we withdrew the regulations and relaid a revised version.
For clarity, we made two changes to the regulations. The first amendment was to ensure that the changes to recovery plans took effect only when the effective date of the actuarial valuation to which the recovery plan
relates is on or after 22 September 2024. The second, in light of the first, is to clarify that changes which relate to actuarial valuations and reports also apply only on or after 22 September 2024. I reassure the noble Baroness that no other changes were made. These changes restate our intention to give sponsoring employers, scheme trustees and managers the same amount of time to prepare for the new requirements in the recovery plan.
I do not believe that I have an answer to the Explanatory Memorandum question, but I shall see whether I can address that before my remarks have concluded.
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Let me say at the outset that it is important that defined benefit pension schemes are well managed and properly funded for the long term, and that schemes and their sponsoring employers have the best possible support to manage their funding and investment decisions. As I said in my opening speech, these regulations will make sure that DB pension schemes are following best practice and looking forward towards their long-term outlook. They will ensure that schemes are doing the best they can to deliver the promised pensions to the people who depend on them in retirement while giving schemes the flexibility that they need to suit their own individual circumstances. As it has been a theme of this debate, I stress that last point about flexibility; I know that it was an area of particular concern to the pensions industry during the consultation. I am happy to confirm again that flexibility will continue to be a key feature of the new regime.
I will dive straight into the questions asked. The noble Lord, Lord Palmer, asked whether the regulations impose a disproportionate administrative burden and cost compliance. That is a fair question. The requirement to determine and review a funding and investment strategy alongside each actuarial valuation, as well as the requirement to prepare a statement of strategy and send it to the TPR, will undoubtedly impose some additional burden on DB schemes. However, most schemes that are well managed will already be planning for the long term and managing their risks effectively; for many, the additional burden of compliance with these regulations is likely to be pretty minimal.
We have sought to ensure that the information to be provided on the statement of strategy is limited to that needed by the TPR. The regulations provide discretion for the regulator to ask for less detail from some schemes. We have also taken the opportunity to eliminate duplication in existing arrangements for schemes to provide a summary of the actuarial valuation. It may be helpful to the noble Lord to know that schemes face an average of £7,000 in implementation costs and £1,100 in ongoing costs, although these costs may of course vary from one scheme to the next. We would argue that this is a small cost relative to the £1.4 trillion in aggregate assets held by DB schemes.
The noble Lord, Lord Palmer, and the noble Baroness, Lady Drake, asked about the regulations changing the balance of power. It is important that sponsoring employers are involved in the DB scheme’s long-term funding and investment strategy because the employer is responsible for funding it. The regulations do not
undermine the independence of scheme trustees, who will continue to invest in the best interests of members in line with their fiduciary duties. Although trustees must take account of the objective that, on and after the relevant date, the assets are invested, in accordance with a low-dependency investment allocation, the actual scheme investments may diverge from this. This ensures that the sponsor employer agrees the long-term funding targets but, importantly, that it continues to offer trustees the independence they need to invest scheme funds in the best way possible and, of course, in the interests of the scheme members.
The noble Lords, Lord Davies and Lord Palmer, asked about the new measures and how we will ensure that they do not result in a disproportionate governance burden for small schemes. As I mentioned earlier, the TPR operates a risk-based approach to the supervision and regulation of schemes; it will be proportionate in its approach to regulating smaller schemes. These regulations provide the regulator with discretion to ask for less detail from some schemes, which will enable it to operate the fast-track approach. The regulator intends to make some adjustments to what data small schemes must provide to reduce the burden on them. It is currently consulting with industry on data submissions and how to ensure such a proportionate approach.
Our impact assessment acknowledged that small or micro schemes are less likely to be following some of the proposed standards already. Therefore, they may incur extra costs. As the sponsoring employer will be responsible for additional costs, this may increase costs to smaller businesses, but it should be remembered that not all small schemes are supported by small businesses: data shows that DB schemes are now generally run by larger employers as a pooling process. Data from the TPR indicates that most small schemes are well funded, with those with fewer than 100 members having an aggregate funding ratio of 112%, on a technical provisions basis; those figures are as at March 2023.
I turn to TPR and the questions asked by the noble Baronesses, Lady Sherlock and Lady Drake, on its powers, looking ahead to when all the pieces of the new funding regime are in place. The Pensions Regulator will continue to be proportionate in its approach and take account of the circumstances of each scheme when supervising and regulating pension schemes. Although neither Ministers nor officials can become involved in the regulator’s decisions on whether to exercise its powers, my department has oversight of its performance. This oversight is exercised formally through the approval of its business plans and strategies and quarterly accountability reviews, and is augmented by regular informal dialogue and engagement.
The noble Baroness, Lady Drake, made a point about lack of powers and asked what enforcement powers the Pensions Regulator has to address non-compliance. The Pensions Regulator has significant powers under Section 231 of the Pensions Act 2004 to correct funding arrangements in certain circumstances. The existing powers have been extended to include failure to comply with the requirements for preparing a funding and investment strategy. It is important for there to be a sufficiently high bar to ensure that TPR’s Section 231 funding powers are used appropriately and fairly. Although enforceability is an important
objective, TPR will aim to be proportionate and targeted in respect of enforcement. In addition to Section 231, TPR has other powers that it can use in DB funding cases where there is a breach of legislation, including information-gathering powers to gather evidence, improvement notices and Section 10 financial penalties.
The noble Lord, Lord Davies of Brixton, made the point that TPR might be too risk averse. Perhaps I can reassure him by saying that TPR, which he will know more about than me, operates on a risk-based and outcome-focused approach when it comes to the supervising and regulating of pension schemes. It will continue to be proportionate in its approach and will take into account the circumstances of each scheme, including, as I mentioned earlier, smaller schemes. I have covered the fast-track approach on that.
The noble Baroness, Lady Drake, asked about duration of liabilities. We want the funding and investment strategy to provide a stable framework for long-term planning and to be regularly reviewed. We do not want excessive revisions driven by the volatility of the method used to measure maturity. The Government acknowledge that the duration of liabilities measure is sensitive to economic conditions, so these regulations require the economic assumptions used to calculate this duration to be based on the economic conditions prevailing on 31 March 2023. The TPR will remodel the duration of liabilities at which schemes will reach significant maturity using the economic conditions on 31 March 2023. It will not be the 12 years’ duration proposed in its draft DB funding code, which was based on different economic circumstances. Although different measures of maturity have advantages and disadvantages, they can all be sensitive to economic volatility; on balance, we continue to believe that the duration of liabilities measure is the best option.
The noble Baroness, Lady Drake, asked about trustees and their roles, including what happens if trustees and employers fail to agree a funding approach. We expect and encourage sponsor employers and scheme trustees to have positive discussions to agree their funding and investment strategy. In situations where a suitable funding and investment strategy has not been agreed between the two, the regulator will encourage and assist them to work together to agree their strategy. If there is still no agreement, the regulator can take enforcement action. It will have the power to set a funding and investment strategy for them or may take other enforcement action depending on the circumstances. This can range from appointing a trustee to a scheme to enable it to be run effectively through to issuing fines where that is considered appropriate. However, I would argue that that would be pretty extreme.
The noble Baroness, Lady Sherlock, asked whether the regulator will be able to impose its own view on the covenant. I assure her that further detail will be set out in the code and covenant guidance and that the code will be published this summer. As she knows, this will come into force on 22 September 2024.
In opening this debate, I mentioned that these regulations will help schemes to invest more productively to the benefit of members, sponsoring employers and the UK economy as a whole. My department’s impact assessment estimates that the regulations could provide
a greater incentive for almost 1,400 schemes to invest more productively. This could potentially unlock up to £5 billion of further investment in private equity and venture capital. Indeed, analysis from the TPR shows that most schemes already have headroom for more productive investments and that perhaps between 70% and 75% of schemes can invest more productively. This means that, where appropriate, schemes can invest in a wider range of long-term, return-seeking assets. The aim is that the scheme assets will be working harder for all stakeholders while, importantly, keeping members’ pension benefits secure.
Certain questions were asked in this area, in particular by the noble Lord, Lord Davies. He asked about forced investment into gilts. As DB schemes mature, they generally invest a growing proportion of funds in more secure assets, such as bonds and gilts, to protect their funding position and to ensure that they have sufficient funds to pay the increasing number of pensioner members when benefits are due. Most DB schemes are maturing and there has already been a significant shift to a higher proportion of investments in more secure assets. At the end of March 2023, around 70% of all DB funds were invested in bonds. We do not believe that these regulations will drive further overall de-risking of DB scheme investments or increase systemic risk by driving more investment in bonds. I hope that the noble Lord agrees with that.
The noble Baroness, Lady Sherlock, asked about the covenant. Her question was: is it a weakness and where is the bite? That was the gist, I think. She is looking a bit puzzled. Even if that was not the question, I am still going to give the answer. This is the first time that the employer covenant has been defined in regulations. The regulations provide clarity on what must be considered when assessing the employer covenant as a key underpin for supportable risk. For most, this will simply be embedding current good practice. The Pensions Regulator will set out clear expectations on the provision of information from employers to trustees in order to enable them to assess the employer covenant.
There are probably questions that I have not addressed. I will certainly look very closely at Hansard and will be sure to answer any outstanding questions. Before I conclude, I think the noble Baroness has a question.