The Government has responded to two significant consultations relating to pensions: the first confirms several reforms aimed at making it easier for trustees to make surplus payments from defined benefit (DB) pension schemes to sponsoring employers and scheme members, while the second sets out fundamental changes to the defined contribution (DC) pension scheme market. The Government has also published the final report of the Pensions Investment Review, which focusses on steps to encourage investment in private assets, including in the UK.

The changes will be included in the Pension Schemes Bill, which is due to be introduced to Parliament before the summer recess on 22 July. This means that it will be some time before the reforms take effect. However, schemes and employers will be keen to understand the implications.

Changes to make surplus payments easier

The Government has confirmed that it will proceed with the following changes aimed at making surplus payments easier:

• an overriding statutory power will be introduced, allowing trustees to modify their scheme rules to provide for surplus payments where the rules do not already allow for this;
• the requirement for trustees to have passed a resolution under Section 251 of the Pensions Act 2004 prior to 6 April 2016 in order to pay surplus to an employer will be repealed;
• the threshold at which trustees can share surplus with the employer will be changed from the current buy-out threshold to a threshold set at full funding on the low dependency funding basis. Further detail on this aspect will be set out in draft regulations, on which the Government will consult; and
• the requirement for trustees to be satisfied that it is in the interests of members for surplus to be paid to the employer will be removed. Instead, trustees will be required to act in accordance with their overarching duties to scheme beneficiaries (which apply in any event).

The response also confirms several other points relating to surplus payments:

• the Government will not mandate how the extracted surplus is used;
• the authorised surplus payments charge will remain at 25% but the Government is continuing to consider the wider tax regime for surplus extraction; and
• the Government will work with the Pensions Regulator to develop guidance on surplus extraction.

In terms of the other proposals included in the original consultation on options for DB schemes, the Government has confirmed that:

• it will not proceed with the proposed regime under which certain employers could opt to pay a higher Pension Protection Fund levy in exchange for the PPF offering 100% compensation in the event of employer insolvency; and
• it is continuing to explore the possibility of a Government consolidator administered by the PPF, but this will not be included in the Pension Schemes Bill.

With many DB schemes currently in surplus, the Government’s confirmation that it will proceed with changes aimed at making surplus payments easier will be welcomed by employers. However, the power to release surplus will remain in the hands of trustees, who will be conscious of the need to act in accordance with their duties. Whether the changes will lead to more schemes releasing surplus in practice therefore remains to be seen.

Reforms to the DC pensions market

The Government has confirmed that it will proceed with the following changes aimed at accelerating consolidation in the DC market:

• providers and master trusts will be required to have a minimum of £25bn in assets under management (AUM) in at least one “main scale default arrangement” by 2030. This term will be defined in regulations following consultation. The requirement will not apply to single employer schemes, connected multi-employer schemes or multi-employer collective defined contribution (CDC) schemes;
• providers or master trusts with at least £10bn in AUM in a “main scale default arrangement” by 2030 and a credible plan to have £25bn in AUM by 2035 will be able to apply to be on the “transition pathway”. The requirements for the transition pathway will be set out in regulations following consultation;
• there will also be a “new entrant pathway”, which will allow new market entrants to seek authorisation where they are offering something significantly different that could benefit savers or employers and have plans to reach scale in the longer term;
• new default arrangements will be prohibited, except in certain circumstances and with regulatory approval. The precise nature of these conditions will be subject to further consultation and set out in regulations;
• a contractual override regime for contract-based pension arrangements will be introduced, to enable transfers without consent (including bulk transfers) into either trust-based or contract-based arrangements. The detailed rules will be developed by the FCA and subject to consultation. The Government will also explore with the Regulator whether any updates to regulation or guidance are needed to clarify the role and duties of receiving trustees; and
• a ministerial led review commencing in 2029 will look at the market impact and operation of the contractual override measure and the value for money framework (also due to be included in the Pension Schemes Bill) and a legislative underpin will be included in the Bill to tackle any remaining fragmentation as needed.

The response also confirms that the Government will not be proceeding with several proposals included in the original consultation:

• there will not be a maximum number of default arrangements or funds for any given DC scheme, although the Government expects providers and trustees to proactively consider consolidating their defaults;
• standardised pricing for default funds will not be introduced;
• there will not be any new duties on employers relating to their workplace pensions; and
• there will not be any new requirements relating to the advice employers receive on pension scheme selection.

These are significant proposals, with the potential to fundamentally change the DC pensions market in the UK. Master trusts and contract-based arrangements vary greatly in size, from tens of millions of pounds in AUM to around £100bn. The impact on these schemes will therefore be significant, with widescale consolidation likely to follow.

DC scheme investment

The Government has confirmed that the Pension Schemes Bill will include provisions enabling the Government to set quantitative baseline targets for DC pension schemes to invest in a broader range of private assets, including in the UK.

The Government describes this as a “reserve power” and says it does not anticipate exercising the power unless it considers that the industry has not delivered the change on its own, following the Mansion House commitment by 17 of the largest DC pension providers to invest 10% of their main default funds in private markets, including 5% in the UK. However, there is no doubt that this will be a significant potential power for the Government to dictate how DC pension schemes invest.

For more information on any of these developments, please speak to your usual Linklaters contact.