Wholesale changes to rules are needed to enable DB consolidation

DWP explores consolidation

There is £1.5tn invested in UK DB schemes. Employers have spent £120bn over the past decade in special contributions to repair their deficits, yet they have remained at more than £400bn on a buyout basis, according to the Pensions and Lifetime Savings Association.

In February 2017, the Department for Work and Pensions published a green paper exploring solutions to improve DB pension fund security and sustainability.

There will be pressure on government to move towards making real legislative change to support further moves towards consolidation

Kate Richards, CMS

It drew attention to the ways in which consolidation of corporate DB schemes could help cut costs and boost efficiency by creating economies of scale.

The DWP is set to publish a follow-up white paper in winter, which should provide further clarity on the case for consolidation.

Meanwhile, the PLSA’s DB Taskforce has also become immersed in the world of pensions pooling, citing so-called superfunds as a possible remedy for a system made up mainly of small schemes.

In its interim report, published in March, it warned that the strain on scheme sponsors and the economy, as well as the risk to scheme members and future generations of pensioners, “means doing nothing is not an option”.

Creating a superfund would involve removing the employer altogether, in return for financial consideration to replace the value of their covenant, and pooling both assets and liabilities.

The taskforce says this would offer members a step change increase in the probability of receiving their benefits, while offering employers “an affordable means of removing themselves from the uncertain future of managing DB run-off”.

PLSA advocates superfunds

The PLSA Taskforce’s final report, published this month, revealed that superfunds could pay members the full value of their benefits in more than 90 per cent of scenarios, potentially improving outcomes for more than 3m members.

It also said fully merging administration, governance and investment managers could save about £1.2bn a year.

“Based on the assumptions that we’ve run, the numbers are looking pretty good,” says Joe Dabrowski, the PLSA’s head of governance and investment.

However, the creation and operation of superfunds would require specific legislation to allow the Pensions Regulator to authorise and supervise them.

Dabrowski suggested the vehicles “would need a supervisory regime” that “might look and feel a bit like the [defined contribution] mastertrust regime” that was set out in the Pension Schemes Act 2017.

In setting up a superfund, the taskforce’s final report suggests employers and trustees would need to jointly agree to transfer their scheme, including all assets and liabilities.

The employer would pay a fee to discharge themselves from responsibility for the scheme, and superfunds would aim to pay members the full value of their benefits in more than 90 per cent of scenarios.

Dabrowski notes that “it will take a little bit of time” to facilitate consolidation.

Nevertheless, “having looked at the maturity of schemes and the headwinds that they’re going to face over the next five, 10-plus years”, as well as the benefits of “lifting people from relatively… precarious positions in many schemes to a stronger position”, he says it is clear that there are a lot of advantages.

Obstacles are set in law

Kate Richards, partner at law firm CMS, notes how trying to simplify and reshape the benefits in a consolidated scheme can be problematic.

“If you merge different schemes, they will have different benefit structures,” she says. Trying to align these structures can be difficult, given legislation that protects detrimental changes being made to accrued past service benefits.

Richards says the government needs to think about what sort of legislative easements could be given to overcome this obstacle.

Thought also needs to be given to consolidation risk, she says. “Is it going to fall on the employer, or does it fall on the member?”

Source: PPF

But while facilitating consolidation is a complex feat, this does not mean it will not happen. “Certainly, this is the direction of travel,” says Richards.

She highlights that “there will be pressure on government to move towards making real legislative change to support further moves towards consolidation”, subject to legislative timetabling and how much of its time will be spent on Brexit.

With the DWP’s white paper anticipated this winter, “the ball has started rolling”, she says, drawing attention to the number of organisations supporting a move towards consolidation, including the Financial Conduct Authority.

There are various ways in which pension schemes can work together to achieve efficiencies, and it does not have to involve full amalgamation.

The PLSA’s DB Taskforce has highlighted different consolidation models that could be used, such as shared services, asset pooling and creating single governance, as well as the full merger option of superfunds.

Good governance is needed

Local Government Pension Schemes in England and Wales, for example, are collaborating to create eight asset pools, with a view to facilitating infrastructure investment and saving money.

One of these is the Local Pensions Partnership, a collaboration between the London Pensions Fund Authority and Lancashire County Pension Fund.

It was set up around an asset and liability management model providing a range of pension services to both founding funds and other pension schemes.

The schemes joined forces for various reasons, including the fact that “they had the same philosophy and approach” to investment risk, says Susan Martin, the LPP’s chief executive officer. “It was a natural fit for them to come together.”

On the topic of private sector schemes joining up, Martin says that “any collaboration is good”, whether it is sharing administration resources or forming an asset and liability management partnership.

“The most important thing is to get the governance right,” she says.

Considerable challenges

Andy Todd, head of UK pensions at State Street, stresses that LGPS pooling is consolidation purely on the asset side, which differs from a complete amalgamation, including liabilities.

Todd explains that asset pooling with investors who have similar investment time horizons can “maximise your economies of scale and buying power relative to your collective assets”, leading to cost savings.

Another advantage is there are more opportunities in terms of new potential investments and “general access to diversity in the alternatives space”, he says.

But the model might not work as easily in the private sector. In the LGPS, “you know who your peers are”, says Todd, but when it comes to corporate DB schemes, “there isn’t the same umbrella structure”, making it difficult to find partners to aggregate with.

This obstacle is not insurmountable, according to Todd. He notes, however, that the administration that would be required, both legal and operational, to effectively govern a consolidated structure “would be a major challenge”.

DB is a mature segment, whereas the emergence of DC mastertrusts shows the advantages of being relatively immature, he says, as DC mastertrusts do not have the legacy position that has to be accommodated in the same ways DB schemes have to.

“If new DB schemes were being opened up today, then the mastertrust model in DC would be very much worth looking at,” he says.

But since almost no new DB schemes are being created, he says the focus has to be on how to best bring efficiency to a mature structure.