Private sector pooling is a costly red herring

Consolidation has been a popular topic for the pensions industry in recent months. The aim is to generate cost savings and use scale to increase investment in UK infrastructure projects.

The Department for Work and Pensions recently opened the doors for consolidation of corporate defined benefit pension schemes in its white paper on protecting DB schemes.

So is this an unstoppable move towards consolidation of all DB pensions? Or are these complex feats of engineering doomed to failure?

LGPS pooling set to succeed

The LGPS asset pools were originally born from a research paper written by consultant Hymans Robertson and commissioned by the Department for Communities and Local Government.

It found that significant cost savings could be made by local authorities if they pooled their assets – and that the benefits of using active rather than passive fund managers were highly debatable net of their fees.

This led to the complicated and time-consuming task of building regional asset pools that local authorities would be eligible to join. The pools range in size from £13bn to £36bn and have been established in a way that allows councils to retain control over their own asset allocation while benefiting from lower management fees and other costs.

It is a model that works well for the LGPS. With similar needs and a common legal framework, asset pooling provides sensible economies of scale – both in terms of explicit costs and governance resources – without removing strategic control from individual authorities.

Full mergers prove harder

What is notable, however, is that despite sharing a common set of rules over benefit structures, it was not found to be practical to merge liabilities between authorities. If that were possible, then all 89 pension schemes could become one – a massive efficiency improvement.

With that example in mind, proposals have continued to surface for superfunds – entities that would allow sponsors to divest their schemes for a lower cost than an insurance buyout. Now the DWP has called for these ideas to be given more detailed consideration.

There is no doubt that consolidation is attractive in principle. Costs per scheme member are significantly lower for larger schemes than for smaller ones.

The trouble is that corporate pension schemes have much less in common with each other. Each has its own set of rules, their own investment strategies and their own approach to managing assets. That makes pooling more difficult.

In particular it makes merging of liabilities almost impossible due to the complexity and cost involved.

Look to pre-existing tools

Even large multinational companies have given up on the idea of merging their own various DB pension schemes due to the headaches involved.

And while the superfund concept avoids much of that complexity, the Pensions and Lifetime Savings Association model still requires benefits to be put into a common framework and does little to help the schemes that need help the most – smaller schemes with significant deficits.

Fortunately for the corporate sector, many of the benefits of pooling can be achieved using products and tools widely available.

Mainstream pooled funds are a natural, existing form of asset pooling that allows pension schemes to join together to cut costs. And there are already ways of sharing investment governance too, so that individual trustee boards do not have to get involved in detailed investment decision making.

What this means is that corporate sector pension schemes should expect to see the benefits of asset pooling – but it won’t come in the form of a government-sponsored initiative for quite some years. In the meantime, there are plenty of other options already available.

Bob Campion is senior portfolio manager at fiduciary manager Charles Stanley Asset Management