How to make sure a scheme merger runs smoothly

While consolidation has been a hot topic in recent months, these discussions tend to be in relation to the Pensions and Lifetime Savings Association's idea of superfunds, or enabling numerous smaller isolated schemes to merge as discussed in the government's DB white paper.

You need to consider the views and the thoughts of the transferring trustees

Chantal Thompson, Baker McKenzie

However, many acquisitive companies have more than one pension fund, having bought various businesses over time. This means they may have the option of a group merger.

Cutting costs and admin

For those able to consolidate their schemes, what are the main benefits? And what are the key concerns for trustees?

"Mergers are generally company led, driven by a desire to achieve efficiencies of scale in terms of scheme administration and, where possible, harmonise pension provision,” said Sarah Boon, consultant at law firm Travers Smith.

Scheme mergers can also be undertaken with a view to future derisking.

Boon said: “A merger of smaller group schemes is often a useful first step in a derisking strategy, and buy-ins and buyouts tend to be offered on more favourable terms to larger schemes because they are more attractive propositions for bulk annuity insurers to take on.” 

In terms of cost benefits, Matthew Giles, partner at law firm Squire Patton Boggs, said that as a result of a merger, the vacated legacy scheme, or schemes, can be wound up. In a DB context, this provides the opportunity to settle small pension entitlements as winding up lump sums.

While this should not be the main driver for a merger, “for employers it helps to shrink the amount of their total defined benefit obligations [and] for trustees it reduces the administration challenge — and disproportionate cost — in relation to small benefits”, said Giles.  

Funding parity problems

However, there are a number of issues both employers and trustees need to address when it comes to a scheme merger.

Janet Brown, partner at law firm Sackers, highlighted the importance of funding parity.

“If you’re acting for the receiving trustees, you’re going to be very concerned if you’ve got a better funding position and it’s going to be diluted by another scheme coming in,” she said.

Brown added that different isolated benefits sections can be created within a scheme to remove some of these funding issues, because each section can have different funding levels.

Chantal Thompson, partner at law firm Baker McKenzie, said that this kind of segregated merger is a solution, “but that doesn’t necessarily achieve all the objectives that the employer might want to get”. There will still need to be separate valuations, for example.

All sets of trustees involved have to agree to the proposed merger, and trustees need to consider such proposals carefully. “From a trustee perspective, you’ll want to make sure that there isn’t an adverse impact on the employer covenant of the receiving scheme,” Thompson said.

Address trustee concerns upfront

Thompson also noted that trustees from the transferring scheme may be worried about the trustees from the receiving scheme not knowing enough about their members and the idiosyncrasies of their scheme benefits.

“It’s amazing how sensitive it can be… you need to consider the views and the thoughts of the transferring trustees,” she said.

A compromise approach could help, and in some instances all trustees of the transferring scheme are appointed to the board of the receiving plan, Thompson noted.

Thompson added: “It’s something that is really important to address upfront if you’re an employer preparing the proposal for a merger… it’s something that trustees whose agreement you need [for the merger] feel really quite strongly about.”

Brown also drew attention to the way in which concerns for trustees of a receiving scheme differ from those of a transferring scheme.

Trustees from the receiving scheme should focus on how well the transferring scheme is run, “because you’re bringing it under your roof”, she said.

The transferring trustees, on the other hand, will want “to know what the balance of powers is in the receiving scheme".

Brown noted that, “often, people get quite passionate about who the member-nominated trustees will be on the receiving scheme board”.

She said that if scheme B is disappearing, for example, trustees often want to know how their members are going to be represented on the new board, and the board should be reconfigured. However, this is something for the receiving trustee board to deal with.