DB consolidation: viability, security & protection

In its March 2018 ‘Protecting Defined Benefit Schemes’ White Paper the government suggests the majority of DB pension schemes work well for their 10.5m members, although a few cases mean we may see greater punitive powers for the Pension Regulator (tPR). Amongst the calls for new funding standards to support pension trustees and a new DB scheme chair’s statement, it is pension scheme consolidation that interests me most.

The idea is consolidation of DB pension schemes could deliver better investment performance with less volatility and is more likely to meet tPR’s governance standards. Whilst the majority of DB scheme sponsors will want to keep a long recovery plan and retain control of their own pension scheme and the link to members/employees, I can see consolidation could appeal to employers who want a clean exit (albeit having to pay off the pension deficit at a high price).

Consolidation is a viable option to consider, but is contingent upon:

• commercial viability of these new ‘superfund’ vehicles
• security of members’ benefits
• protection for the ceding employer

Where are we now?

According to the White Paper, only 12% of 5,500 DB pension schemes are open to accrual. Alan Rubenstein - who has just launched a new pension superfund after leaving the Pension Protection Fund (PPF) - projects all DB schemes will be closed by 2020. With 80% of DB schemes underfunded and 44% having fewer than 1,000 members, I can see why the government is talking about consolidation.

We can see that well capitalised employers are increasingly looking to off load their DB pension scheme liabilities. The buy-in/buy-out market valued at £12.3bn in 2017 is projected to be £15bn in 2018 according to LCP’s April 2018 report. With a small further reduction for life expectancy seemingly likely, pricing in this market appears increasingly competitive particularly for larger deals.

Will superfunds be an attractive option?

Superfunds will act as a staging post to buy out, providing an exit for sponsoring employers financially capable of paying the exit price (possibly equivalent to the superfund’s technical provisions plus, say, a 10% buffer/margin). I believe the majority of employers would prefer a full buy out and wind up but, for some, consolidation through a superfund could be an attractive alternative to the full buy out cost.

We have seen business plans for two superfunds already and both have secured financial backing in the City. Their propositions are built on potential economies of scale, which is supported by figures quoted in the White Paper:

• annual management charges (AMCs) reduce from 0.22% for externally managed funds to 0.12% for internally managed funds for £5bn+ funds, with lesser savings for funds of £2-5bn and no savings at all for smaller funds (source: State Street)
• administration/total cost per head reduces from £259 for pension schemes with 1,000-4,999 members to £177 for larger schemes (source: tPR)

Will consolidation actually happen?

A key area for consultation on DB scheme consolidation must be the authorisation/supervision regime. Scrutiny will no doubt also be given to the extent of a superfund’s financial backing, the projections for economies of scale to be added to the buffer over technical provisions sought by the provider and profit taking by investors.

For a transfer to a superfund to work, the employer will need to prioritise accelerated pension scheme funding over other uses of their cash. This will be a potentially sensitive piece of disclosure in the Chair’s statement as the financial plan for the pension scheme is disclosed.

Member consent won’t be needed, as they will receive equivalent benefits, but trustee consent will be required. If the pension trustees feel the consolidation route is analogous to a buy in and it is legally sound as a transaction, they may well consent.

Trustees will want to be comforted about the covenant of the new principal employer within the master trust vehicle too. PPF eligibility can be protected in a transfer to a new employer entity but a specific process needs to be followed and trustees will need certainty this vital protection for pension members will not be lost.

So, the Regulator will look to raise awareness and confidence by introducing a campaign and new toolkits for pension trustees. GMP simplification will be investigated to try and help ease the transfer process (please, someone find a solution everyone’s happy with!) and consultation on superfund consolidation will run (and run and run?) at least to 2019. Legislation in 2020?

 

 

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