British Steel is a missed opportunity to reform DB pensions

October 2016
Kerrin Rosenberg, Cardano's UK CEO, gives his thoughts on DB pensions reform.

This article originally appeared in FTfm, 31st October 2016.

The defined benefit market is in a state of crisis, says Cardano’s Kerrin Rosenberg

Last month, this paper reported that government proposals to change the law to help salvage Tata Steel and the British Steel pension fund are to be shelved. This would be a huge shame. The defined benefit pension market is in a state of crisis and desperately needs reform.

The government may shy away from dealing with the problems at British Steel, but over the coming years we will see more and more cases of insolvent pension funds limping into the Pension Protection Fund, the lifeboat for capsized corporate pension plans.

Companies will be forced into bankruptcy and members will lose substantial portions of their pension. Not dealing with this delays the inevitable and simply bequeaths a bigger problem to future generations to try to solve.

In May, the government announced a consultation on a series of “exceptional” measures they were considering in the British Steel case. Two proposals went against a previous taboo; the consultation openly discussed how the trustees might be able to cut accrued pension rights without members’ consent.

True, the government was at pains to point out that any legislative change would single British Steel out due to its “unique circumstances”. It would also be subject to many limits on how far the trustees could go with cuts. It is fairly obvious, though, that British Steel is not unique. According to a report by the Pensions Institute at London’s Cass Business School, a worst-case scenario could see 1,000 more pension funds enter the PPF.

Much more interesting was the tacit acknowledgment that UK law does not necessarily provide the best outcomes for members of pension funds associated with almost insolvent companies. This recognition is a vital first step in the path to reforming UK pension law.

Struggling businesses should not be allowed to offload their pension liabilities and leave pensioners high and dry. However, the law only provides one option to a business that cannot afford its pension promises: go bankrupt and pass the pension fund to the PPF. As the government consultation acknowledged, this is a lose-lose situation as the members take a heavy haircut to their pensions and shareholders suffer a complete loss of equity.

It is not legally possible for trustees to renegotiate the pension contract before a bankruptcy in order to salvage value on behalf of their members. However, a restructuring could provide members with a better pension outcome than the statutory PPF route. It would also allow the company additional breathing space to find a solution that might save thousands of jobs.

For many underfunded schemes with weak sponsors, it is a question of when, rather than if, a haircut will be applied. The members should not have to wait and watch the pension fund enter the PPF, resulting in reduced benefits.

Trustees should have the power to negotiate with the sponsor and consider other options. These should include cutting guaranteed benefits, thereby alleviating the financial burden, and introducing risk sharing through, for example, a defined contribution top-up. This would allow the members to continue to save for their future. Instead of locking into the reduced benefits the PPF offers, it would be possible to provide members with a higher pension by taking controlled investment risks.

The British Steel consultation did not go quite this far. Proposed benefit cuts were limited to future pension increases and the proposed solutions would still have been reasonably onerous to any sponsoring company. But it seemed that the government was thinking seriously about how to release Tata Steel from its pension obligations.

That may not have been enough to save this company, but more flexibility in the law would be very helpful in providing more options for other corporates in similar circumstances. With the right regulatory oversight, pension restructuring could be a win-win for both the company and pension fund members.

Shelving the British Steel consultation is a huge missed opportunity, but the pensions crisis isn’t going to go away. At some point, hopefully sooner rather than later, all those responses to the recent consultation will be aired and discussed with the seriousness they deserve.