Consolidation could provide economies of scale, wider investment opportunities and better governance for pension schemes
• The UK’s defined benefit pensions sector could benefit from consolidation
• Many sponsors are hoping to offload their responsibilities for pensions in the process
• There are significant legal barriers to comprehensive DB consolidation
The highly fragmented defined benefit (DB) pensions sector is ripe for consolidation. Indeed, the Pension Protection Fund’s Purple Book 2017 shows that of the 5,588 DB schemes listed, 36% have fewer than 100 members and another 44% have fewer than 1,000 members.
The Pensions Regulator (TPR) has repeatedly highlighted the regulatory challenge posed by small DB schemes, and consolidation was a key plank of the recent Department for Work and Pensions (DWP) DB White Paper and a core recommendation from the Pensions and Lifetime Savings Association (PLSA) DB Taskforce.
Bob Scott, a partner at Lane Clark & Peacock, says: “Smaller ‘sub-optimal’ funds (with assets of less than £5m, or €5.6m) can potentially get access to economies of scale, a wider range of investment opportunities and better governance as part of a consolidated scheme.”
DB schemes are clearly in need of a new approach as hundreds of thousands of members have seen their benefits cut back substantially over the past decade. Calum Cooper, a partner at Hymans Robertson, says: “For some, consolidation will improve risk management capabilities as well as reducing costs.”
Consolidation of DB schemes has precedents both in the Netherlands and Australia but in the UK there have been few moves to consolidate at the smaller end. Scott says: “The market has opened up to consolidator vehicles that focus on larger well-funded schemes with assets of £100m up to as much as £10bn. The consolidator provides a – possibly attractive – alternative to buyout at a discount to the premium that an insurer would charge. So an employer with a scheme that is currently reasonably well funded with a £100m buyout shortfall can potentially settle the liabilities by paying a premium of just, say, £20m to a consolidator vehicle.”
Darren Redmayne, CEO of Lincoln Pensions, says: “The Pensions Regulator has remained largely silent on this issue.” But a TPR spokesman told IPE that “consolidation vehicles are potentially a force for good. We need to make sure members are properly protected within well-governed schemes, run by fit and proper people and backed by adequate capital. We welcome the DWP’s intention to consult on new legislative framework for authorisation and supervision.
“In the meantime,” the TPR spokesman said, “we want potential entrants to the market to come and talk to us about their business model so that we can understand their plans and make clear our own expectations.
“At this stage, we encourage parties contemplating transactions to approach us for clearance and we plan to provide specific guidance for both consolidators and transferring schemes in this regard.
“We expect any material detriment to be adequately mitigated, or employers transferring their liabilities could face anti-avoidance action. In addition, we can also appoint an independent trustee to a pension scheme if we have concerns about governance and decision-making.”
It is possible that the first transfers to Pensions Consolidation Vehicles (PCVs) could be attempted before the DWP consultation is complete but Lincoln Pensions’ Redmayne says: “We believe that trustees will likely wait to see its outcome before transacting. It may be that, like master trusts in the DC [defined contribution] space, that the Pensions Regulator will look to authorise PCVs but the process will take time.”
Many sponsors are hoping to offload their responsibilities for pensions in a low-cost, low-touch fashion. While employers may be attracted to disconnecting the scheme from their balance sheets, trustees need to be convinced that it is in the members’ best interests.
Kevin Wesbroom, senior partner at Aon, says: “Pension funds have been a massive distraction in the past decade – many sponsors would welcome a respite from this. Their measure of success would be transfer to another organisation that will run off the scheme in a cost-effective, high-quality fashion, with little or no reference back to the sponsor.”
He cautions: “Trustees can be expected to be more wary – they may well be losing their jobs if they transfer to a master trust, commercial consolidator or insurance company. But in many cases the lack of suitable competent trustees associated with the scheme will drive a move to a new arrangement.”
No easy road
There are significant legal barriers to any wholesale DB consolidation. In other countries, benefits are often changed and reduced on a transfer to a larger scheme – but Penny Cogher, a partner at law firm Irwin Mitchell, points out: “The legislation to enable this to occur smoothly and quickly just isn’t there at the moment. Different funding levels and diluting the funding of a scheme by making a transfer is also difficult with current legislation.”
Janet Brown, a partner at law firm Sackers, agrees: “If benefits are to be changed on moving into the superfund to give a standard benefit structure, then changes to the legal framework on the tax side may be needed. That said, transferring trustees may not be keen on putting their much-loved benefits through the grinder.”
Brown points to other issues including: “employer debt – in the new superfund who is liable for what on exit? Scheme funding – without segregation of the new superfund, who is getting into the ‘funding bed’ with whom? Trustees and employers will want clarity on eligibility for the PPF [Pension Protection Fund] and security issues for the new consolidators.”
She concludes: “Lack of an authorisation regime for the new superfunds may make trustees feel that, as yet, the new territory is not fully established.”
There are two consolidators at present at various stages of development – the Pension SuperFund (see interview with Alan Rubenstein in this report) and Clara Pensions, which hopes to serve as a bridge to buyout and keep any pension schemes as segregated sections.
Severing the link with the sponsor without getting insurance levels of security will only be the right answer for a minority of schemes. However, others should still challenge themselves as to whether there are things they could be doing that would give some or all of the benefits. As Gareth Strange, OneDB lead at Willis Towers Watson, says: “These actions range from long-established ways of consolidating like using third-party administrators, to fiduciary management of assets, to appointing a single adviser team to cover several functions, to having common trustees for different schemes.”
Stewart Hastie, partner at KPMG, says: “Trustees (and sponsors) cannot assess a superfund in a vacuum. They have to be compared with the status quo and alternative strategies. And like other de-risking strategies, superfunds don’t have to be all or nothing – they can take on tranches of pension liabilities.”
Irwin Mitchell’s Cogher warns: “Think very carefully before committing. Twenty more [defined contribution] master trusts are unlikely to make it until October 2018 when the new full master trust authorisation process comes into operation. How many of the early super schemes are also likely to fail in their early years? Hang on and wait to see how the super schemes work in practice.”
Consolidation checklist for trustees
• Covenant – will members’ benefits be at least as secure post-transfer?
• How much third-party capital is provided and what is the level of the ‘step-up’ in security on day one following superfund entry?
• What is the superfund’s investment strategy and risk profile?
• What is the long-term target for the superfund – for example, run-off or buyout?
• Are individual schemes pooled together or segregated?
• Will member benefits be altered in any way?
• Who has the transfer-out power?
• What happens to any commercial profit made in the consolidator? How much risk is the consolidator taking?
• PPF cover – is the new scheme eligible? Is this clear?
• Ongoing governance – is the new scheme well-run, financially supported with a good governance board of both trustees and executives? How is the consolidator addressing the new proposed authorisation regime?
• Other options – taking into account the cost for the employer of entering the superfund, would a buyout or buy-in in parts be possible? Consolidation is an option; have other options been explored and discounted?
Sources: KPMG, Willis Towers Watson and Sackers