Why do well-funded small schemes struggle to reach buyout?

Yet surprisingly, the number of these small schemes still in existence has only marginally dropped over the past five years, by around 3 per cent. So, why are so few small schemes moving to buyout?

While some will still be struggling to improve their funding to a buyout position, the sheer number that are not transacting suggests there are other barriers preventing these buyouts from taking place.

Buyout isn’t simply about transacting a deal on a given date when funding gradually improves, it’s about a progressive set of tasks and actions

Costs are high

For small schemes, a move towards buyout requires further cash injection from the sponsor.

This isn’t just to meet the insurer’s premium – advisory fees also need to be paid to cover the costs of managing the entry process.

As many of these costs, especially the consulting and advisory fees, are fixed, the relative entry costs become far higher for a scheme of 1,000 members when compared with a scheme of 10,000.

The Pensions Regulator is clearly concerned that small schemes are not being managed as effectively as their larger counterparts.

If this is the case for even some of this population then it is likely to present an insurmountable barrier to achieving buyout.

Trustees should be aware of the importance of data quality, member engagement, benefit and legal assurance, assessment of other derisking options, as well as considering GMP reconciliation and equalisation, to the derisking strategy.

To achieve buyout without significant financial backing from the sponsor, highly focused effective management and governance is essential. There is a long list of progressive steps that need to be taken in order to gradually and persistently prepare a scheme for buyout.

Weak pricing for small schemes

In a maturing DB market, where only a small fraction of schemes have started to buy out, the plentiful number of opportunities involving large schemes continue to draw insurers’ focus.

Big deals are easier to transact because there is a more sophisticated advisory infrastructure around them. The underlying work can take the same amount of time, thus making small deals less appealing.

At this time, the insurance market simply isn’t interested in attracting small schemes, so they’re currently unlikely to get the best deals.

It may be that schemes are waiting for more cost-effective small-scale solutions to come on to the market, and are keeping an eye on emerging alternative solutions, such as consolidation.

Similarly, small schemes often lack the quality of advice and support they need.

Like insurers after the big deals, the largest advisers tend to focus their efforts on their top-tier client base and often have small clients on a reduced service, or a care and maintenance basis.

This means small schemes are the last in line for advice on designing a derisking and buyout strategy, or the solutions and service needed to deliver it.

A progressive journey

There are steps small clients can take to ease their derisking and buyout journey.

Executing a winding-up lump sum exercise can provide a cost saving compared with a buyout. To meet the insurer’s requirements for data, schemes might also reconcile guaranteed minimum pensions with HM Revenue & Customs – this may highlight additional unknown liabilities, which with further work can be significantly reduced.

One such scheme we have worked with along this path also carried out a GMP equalisation exercise, before the provision of data to the insurers marking the final stages of the buyout process.

This process demonstrates that buyout is not simply about transacting a deal on a given date when funding gradually improves, it is about a progressive set of tasks and actions that support the objective over the long term. To achieve this, schemes require careful ongoing management and support.

For many small schemes, the option to stick with the status quo has probably been the most desirable and certainly the easiest option on the table.

However, the pensions landscape never stands still. Yet more changes are on the horizon in the form of the pensions dashboards and the Institutions for Occupational Retirement Provision II directive, which will result in another layer of running costs for these schemes.

The question should be asked: should these schemes continue to pay to meet the compliance changes faced by the DB market, or bite the bullet and meet the costs of embarking on the journey to buyout?

Gillian Hickey is projects team manager at Trafalgar House