Are mergers or other forms of consolidation likely for UK pensions? 

Key points

• A 2017 PLSA report called for pension superfunds to enable consolidation.
• Employers can make use of one of several existing defined benefit master trusts.
• The 1995 Pensions Act prohibits reductions in accrued rights without members’ consent.
• Members interests do not fully coincide with those of sponsors.

In March 2017, the bells of doom were sounded for defined benefit (DB) schemes in the UK. Schemes holding 42% of all benefit promises have a 50:50 chance of seeing them paid in full, claimed a report commissioned by the Pensions and Lifetime Savings Association (PLSA).

The report’s authors fear that rising pension costs are burdening UK businesses so greatly that many will break, pushing their occupational pension scheme into the Pension Protection Fund (PPF).

The report claimed UK DB pensions these days either get paid in full or end up in the PPF, spelling lower payouts for members. The PLSA’s remedy is to create a superfund that absorbs both assets and liabilities. By dint of scale, the superfund would achieve sustainability that thousands of smaller schemes cannot on their own. The report warns that the period for change is limited: it estimates that within 18 years, UK DB plans in aggregate will be cashflow negative. It also warned that simply merging schemes in small clusters would not achieve any improvement in occupational pension security.

Immediate responses to the superfund idea were muted. Neither the Pensions Regulator (TPR), the PPF nor the Department for Work and Pensions (DWP) believes the workplace retirement system needs such a major fix.

At a PLSA event in March, David Taylor, general counsel at the PPF, said the lifeboat shared the regulator’s view that “the system isn’t fundamentally broken from the protection side of things” and that “we don’t see a case for dramatic change to the current system”.

Such caution is telling. Greater enthusiasm by such bodies is essential if the groundwork to a superfund is to be laid. Politicians also have to endorse the idea via legislation in parliament. Meanwhile, the issue of scaling up has been around for decades, yet no radical reform has materialised organically from the market itself.

No Dutch solution

The Netherlands has achieved remarkable consolidation in less than a decade – with a view to ensuring sustainability. But the authorities there pushed for mergers and the predominance of industry-wide schemes made such a push pragmatic. The UK does have funded industry-wide schemes for electricity, universities, railways and local authorities (see LGPS takes the plunge into the pool) but their openness to new members and increasing risk-sharing is limited.

Current pension law in the UK works against scheme mergers. Specifically, section 67 of the 1995 Pensions Act forbids the reduction in accrued rights without consent from members. Judith Donnelly, a partner at law firm Squire Patton Boggs, says: “You cannot force a member to take a lower value.” She then lists all the elements to accrued rights that need to be evaluated, including inflation-linking, spouse or partner’s pension and benefits for dependants.

Satisfying current legislation therefore necessitates extra actuarial and legal advice plus communications exercises. The costs are upfront and that can deter employers, according to Donnelly. There are plenty of other checks that need to be made to ensure a merger is in the best possible interests of all parties. One deal-stopper, Donnelly notes, is when there is a shift in the balance of power between trustees and a sponsoring employer. Rarely does a party want to cede its own power. That these powers vary from scheme to scheme does not help.

Mark Latimour, partner in the pensions practice at law firm Eversheds Sutherlands, adds to balance of power the sense of control that many trust boards feel they own over trustee nomination, even if in legal terms that control should not matter because all trustees bear individual responsibility for their actions. Both the balance of power and sense of control matter because in UK mergers, sponsoring employers will not want to be liable for each other’s liabilities should they become insolvent. The law does not offer such protection. And so the way to avoid such risk is currently to segregate under the same umbrella. Latimour points out that this is not a full merger.

He adds that mergers are much easier if the schemes share a single sponsor. This consolidation is common within blue-chip companies, especially those that have grown via acquisition. But most sponsors in the UK are responsible for a single DB arrangement, so the convenience of an associated merger is absent.

Master trusts

The market may not have invented radical means of merging schemes, but third-party providers can bring non-associated schemes together. Aon Hewitt, Deloitte, Premier and TPT are four organisations offering to house schemes in DB master trusts for the sake of efficiency. TPT claims a 30% reduction in running costs. Marian Elliott, a director at Deloitte says 30-40% is a fair estimate.

These are not superfunds but a real option for employers and trustees to consider. Elliott reckons it takes four to six months to transfer in to the Deloitte Pensions Master Plan. There is a simple 12-page contract of adherence, and no cross-contamination of sponsor risk. Elliott says Deloitte is focused on expanding its pension scheme administration and actuarial business so schemes that join can keep their own trustee board, investment consulting and management arrangements.

Latimour says the key issue is to define the problem to be solved by aggregation. He sees a distinction between the objectives of government and business. On the one hand, the FCA and DWP are looking to increase the buying power of asset owners. Latimour feels this is already being done via pooled funds. Donnelly adds that Squire Patton Boggs has worked with trust boards to get better terms from investment managers. Either way, both lawyers argue that buying power can be improved by degrees without a change of system.

Scheme mergers, on the other hand, are instigated by employers. They may have common interests with trustees regarding greater buying power but the motives are not identical. Sponsoring employers merge schemes to make cost savings across the board – not just on investments but all other third-party service provision, even independent trusteeship.

It’s all in the timing

Realism and realpolitik suggest it will be many moons before DB superfunds get legal approval in the UK. The PLSA has been recommending them for over a decade, inspired by the Dutch system. But the current government has a wafer-thin majority and Brexit is set to interrupt new legislation. Pension advisers within the Labour Party are known to support superfunds for tertiary education, power supply and rail transport.

One of the report’s contentions that does require expansion is that in the UK DB benefits either get paid in full or via the PPF. ‘Paid in full’ is not set in stone. Numerous schemes, from the largest to the smallest, have undertaken significant benefit alterations – for instance, local authority workers and academics no longer contribute to a final-salary scheme. So, while it may be difficult to alter accrued rights and much legislation makes occupational pension provision in the UK more inflexible, there is flexibility of sorts: ‘full’ already means less for millions of scheme participants.

From afar, mergers between UK pension schemes already seem to be in motion. The 89 funds in England and Wales that look after retirement savings for local authority workers are in the process of pooling their assets into eight pools. These pools go live next April with assets between £15bn and £40bn each.

LGPS takes the plunge into the pool

This merger has happened at a pace hitherto unheard of, and the project is proof that when central government decides on change, it can happen fast. Nevertheless, the pools are not mergers. There is only the one Local Government Pension Scheme (LGPS) in the UK (Scotland and Northern Ireland are also covered). The 89 funds in England and Wales operate under the same rules, meaning members can readily transfer between employers within the LGPS. The changes were possible because instead of thousands of trust deeds, boards and sponsors to deal with – as is the case in the private sector – the LGPS is established by parliamentary legislation. This is another unusual characteristic of local authority pensions that enabled swift reform from Westminster.

Even if it is not a scheme merger, the asset pooling in the LGPS remains a major policy. It will provide real evidence of what efficiencies can be achieved. Some commentators are blunt about where some savings will materialise. “If thousands of sales managers in fund management lose their jobs, so be it,” says Henry Tapper, founder of Pensions PlayPen and a director at First Actuarial. “For the reduction in local council taxes, it will be worth it.”

Reported investment costs of the LGPS, however, have been rising in recent years. Whether this means asset pooling will make a dent in the council taxes and business rates that help pay local pensions remains to be seen.