Is consolidation only for the healthy?

The Department for Work and Pensions recently published its consultation on pension consolidation, promised in its 2017 green paper.

The idea that companies that support a DB pension plan can replace themselves as that sponsor with another organisation with better resources opens the door to fundamental change

Consolidation involves a specially created entity (of which only Clara Pensions and The Pension Superfund are openly active) absorbing the assets and liabilities of a company’s pension scheme.

They are targeting healthy pension schemes, adding their money to the pot and running them more efficiently, enjoying the benefits of greater scale.   

Consolidation has the potential to be a game changer for pension funds. The idea that companies that support a DB pension plan can replace themselves as that sponsor with another organisation with better resources opens the door to fundamental change.

What about weaker schemes?

While this approach may work well for healthier schemes, it is far from clear for how consolidation might work for weaker ones – those that may not yet require the intervention of the Pension Protection Fund but whose members are still at risk of not receiving their full entitlement.

The failure to properly address this is what is missing from the DWP consultation – despite it being a key issue in the 2017 green paper.

For healthy schemes it is easy to see how consolidation can work. It requires corporate pension sponsors to provide extra cash, which is added to capital supplied by external investors, and the consolidator runs the pension fund more efficiently.

By definition this requires a sponsor with capital to spend, and a pension fund with assets not far below its liabilities. This is a good business for the consolidator, while scheme members benefit from potential economies of scale and an immediate improvement in financial security.

Leaving aside the legal acrobatics needed to make this happen, it is difficult to argue that greater protection for members is anything but a good thing.

But is there a way to bring weaker, so-called ‘zombie’ schemes, into the consolidation fold to benefit members, corporate sponsors and the Pensions Regulator in the same way?

By the DWP’s estimates, there are 1,000 pension schemes in the UK where the employer is likely to become insolvent by 2020 in the worst 10 per cent of outcomes. The majority of those are small pension funds (79 per cent of all schemes have fewer than 1,000 members).

Modified RAAs could help

Critically, the green paper went on to discuss simplifying regulated apportionment arrangements; these are a legal mechanism that allows companies to restructure and offload their pension obligation, under certain conditions, such as if insolvency is expected within the next year. However, the DWP’s response makes no mention of this.

This is an important omission. It is an irony that if a means can be found for companies to reduce their pension liability, they may actually be able to flourish.

This is a more attractive option than leaving them to limp on for a few years longer, delaying the inevitable insolvency and the accompanying entry of the failed company’s scheme into the PPF. But payments made to members of schemes in the PPF can be substantially lower than if the company had survived and benefits were paid in full.

The green paper also discussed changing member benefits. The difficulty is that a solvent business that elects to cuts its member benefits, even when done with the best of intentions, is seen as fundamentally attacking workers’ rights, and it is extremely difficult to achieve. But not doing it ultimately puts a big strain on a company otherwise struggling to make good on its shortfall in pension fund assets.

If a weak company could more easily enter an RAA, or even sidestep it altogether, with the aim of shedding its pension scheme, the benefits for that company are clear.

If the new provider could also set member payments at PPF-equivalent levels or above with the assets available, then pension fund members would be no worse off than if their scheme enters the lifeboat. Additional capital can then be provided to give greater security and offer members the opportunity to improve benefits over time.

This would be a way of offering consolidation to weaker schemes as well as more attractive, healthy ones. Such a system would be a win for members, a win for the PPF and a win for weak companies.  

Implementing such change is easier said than done; it will require the government to accept that continuing as we are is not acceptable, and for politicians to get out of their comfort zone and pass legislation that will unlock a much-needed solution.

Mark Hodgson is managing director for the UK at Gatemore Capital Management