In November last year, amid great uncertainty regarding the pandemic, in the pensions industry a small but significant announcement was made by the Pensions Regulator (TPR).
Clara Pensions, the UK’s first commercial consolidator of defined benefit (DB) pension schemes, received regulatory approval, clearing it to begin taking on its first clients.
More than 12 months on, that all-important first scheme has yet to be announced. After a summer of unprecedented turbulence in government bond markets, the resulting shift in DB funding positions has proven to be something of a setback for Clara.
“We got our assessment at the end of last year and we’ve been working with a number of schemes that couldn’t afford buyout,” says Ashu Bhargava, chief origination officer at Clara Pensions. He explains a number of the schemes his company has been working with, since its TPR assessment, moved significantly closer to buyout following the September “mini-Budget”.
As gilt yields rose sharply in this aftermath, pension fund liabilities fell – meaning, for many schemes, their overall funding positions improved. DB schemes attached to FTSE 350 companies had an aggregate accounting surplus of £29bn at the end of October, according to Mercer.
For Clara, this meant its immediate target market has shifted. However, Bhargava says the months of work his team has carried out with these initial schemes has helped to speed up the process for the clients it is now working with. “It’s a bit of a setback, but we’ve got a lot of the processing documents in place now, which means that we can move faster,” he explains.
The commercial players
Despite these difficulties, Bhargava remains confident that the first schemes to take their step into commercial consolidation will be finalised in the next few months.
“The schemes and sponsors waiting to transfer want to do this sooner rather than later,” says Bhargava. “We take a lot of comfort from that.
“It has taken a while, but the industry has got comfortable with the concept. The regulator has spent a lot of time looking over superfunds and has set stringent requirements. That’s why we are working with schemes that are much bigger than we initially expected.”
As Owen McCrossan, senior solutions director for pensions at abrdn, points out: “There is a continuous spectrum of solvency positions for pension schemes. There are schemes that have seen improvements over the year, some that will be fairly neutral, but others that will unfortunately have seen a reduction in funding levels as a result of the LDI stress.
“However, broadly, over the year, there has been a shift upwards which may have lifted some out of the target market for different consolidators but at the same time introduced other schemes into their market.”
The insurance path
The gold standard for DB pension funds when seeking to secure member benefits remains insurance. In 2021, the combined volume of buy-in and buy-out transactions totalled £27.7bn, according to Hymans Robertson, and in the first half of this year, total volume reached £12bn.
The dramatic shifts in government bond pricing in September resulted in many schemes improving their funding levels, in spite of the doom-laden headlines that dominated the national press in the immediate aftermath of then-chancellor Kwasi Kwarteng’s mini-Budget.
This means next year could see even more activity, according to Pension Insurance Corporation (PIC), the UK’s largest specialist pension insurer. In November the company reported a short-term pipeline of new business worth £10bn in assets under management, as well as “an immediately addressable market of new business of an additional £20bn” covering up to a quarter of a million members.
LCP partner Catherine Hopper explains that insurers are growing “more selective” regarding the schemes they work with. “While insurers are building their teams to meet the expected higher levels of demand, this will take time and is not a problem that is going to be solved quickly,” she says. “Schemes should look to begin their preparations in earnest at least six to 12 months before going to market for a quote.”
Abrdn’s McCrossan adds that he has seen schemes forming “an orderly queue” for insurance transactions after having “unexpectedly found themselves in a financial position” to buyout but with other logistical hurdles to negotiate.
“They will want to avoid the risk of throwing away their newfound position and investment strategies will be adapted as a result,” he says. “Consolidators of various forms can still be a way forward for these schemes.”
However, as demand increases and pricing remains attractive, the main stress point for insurance transactions has shifted to capacity.
“Insurers are already very busy and are increasingly more selective in deciding which schemes to prioritise,” says Hopper. “While insurers are building their teams to meet the expected higher levels of demand, this will take time and is not a problem that is going to be solved quickly.”
Schemes should look to begin their preparations in earnest at least six to 12 months before going to market for a quote,” Hopper adds.
The alternatives
Consolidation can take many forms. In the months following the high-profile launches of PSF and Clara, several pension service providers came forward to highlight their own bundled offerings that effectively consolidated different parts of a scheme’s overall governance structure into one product.
Crucially, these options do not lose the link to the scheme’s sponsor. It means the corporate is still ultimately on the hook for any shortfall, but by streamlining operations in different ways – and in some cases injecting third-party capital – these arrangements can help trustees on their route to an insurance transaction.
Consultancy giant WTW launched OneDB in 2018, bringing together its actuarial, administration, and investment offerings through an integrated digital platform. It is designed to streamline traditionally siloed pension functions to give trustee boards more time to focus on strategic goals – usually, a buy-in or buy-out. This summer, OneDB brought on board two closed DB schemes connected to Yorkshire-based Cleveland Potash with £284m in assets under management.
Fellow consultancy Buck has a similar offering, Echelon, while several other consultancies have explored other ways of bundling services together under a single cost structure.
Elsewhere, Clara also offers a “connected covenant” proposition that is essentially the same as its central model but if the arrangement fails the sponsor picks up the bill, rather than the scheme falling straight into the Pension Protection Fund.
Capital-backed journey plans can help DB schemes on their paths to an ultimate insurance transaction. Investment company Aspinall Capital Partners and its subsidiary Portunes Capital entered into such an arrangement in 2020 with an unnamed pension scheme, and similar models are offered by Punter Southall and Legal & General.
Under such arrangements, the capital provider effectively underwrites a return to get the scheme to its endgame – either a set funding level or an insurance transaction. This gives the scheme added certainty in reaching its endgame, or making progress towards it, in a certain timeframe. In return, the provider works with the trustee board on the investment strategy, aiming to exceed the target return and keep any surplus generated.
In a similar way to commercial consolidators, capital-backed journey plans are at a very early stage of adoption. Consultancy group Hymans Robertson states in a recent report on the nascent sector that it expects to see “an increasing number of transactions in the coming years as trustees and sponsors become increasingly comfortable using these solutions to help meet their objectives”.
With TPR eager to ensure DB schemes have a clear path to an endgame, solutions such as commercial consolidation, streamlining and combining services, or capital-backed journey plans will become more important to trustee boards seeking to secure member benefits.
BOX: What DB consolidation means for DB funds
In recent years, the Pensions Regulator (TPR) has been putting pressure on trustees of small defined contribution (DC) schemes to consolidate into larger funds or justify the value members receive from being in a smaller offering. Since October last year, trustees of DC schemes with less than £100m in assets are required to compare their costs and returns to three larger plans.
Over the past 10 years, TPR data show that the occupational DC market has shrunk by almost 40 per cent in terms of the number of schemes available, even as membership and assets have grown significantly through auto-enrolment. This is largely down to the rapid expansion of master trusts and bulk transfers of single-employer DC schemes into them.
TPR executive director of policy, analysis, and advice, David Fairs, said in January when this data was published that “every saver deserves to be in a well-run scheme which offers good value for money”. Many smaller DC schemes are “poorly run”, according to Fairs, and consolidation is a key way in which the industry can raise overall standards of governance and trusteeship.
Often, pension scheme trustee boards will be responsible for both DC and defined benefit (DB) plans. This means that, when deciding on an endgame for the DB section, the implications for the DC section should be carefully considered.
When considering a buy-in or buy-out, trustees must decide whether they are going to put more time and resources towards their DC scheme once the DB scheme is off the books, or whether it is more cost-effective – and a better deal for members – to outsource the DC section to a master trust.
In rare cases, a closed DC scheme can be adapted to be included in an insurance transaction when it is part of a hybrid arrangement – but trustees need to be prepared to put in significant preparatory work to make this option feasible.
In April 2019, Pension Insurance Corporation (PIC) concluded a buy-in with the Dresdner Kleinwort Pension Plan, ultimately sponsored by investment bank Commerzbank. Unusually, the £1.2bn transaction included a £300m DC plan, to support members with hybrid retirement benefits.
Members were given the option to either transfer their DC pots to an alternative arrangement or convert to an annuity in line with DB members.
PIC’s head of origination structuring Uzma Nazir said at the time the deal was announced: “Given the unusual hybrid DC and DB benefit structure the trustees required flexibility from us to ensure that both sections of the plan were insured in line with their requirements.”
More often, however, it is a case of detaching the DB and DC elements ahead of any insurance transaction. How this is done will depend on how the DC section is structured. A trust-based scheme, for example, can be relatively easily transferred to a master trust arrangement and may be a preferable option if the DC scheme is still open to new members. This also allows trustees to outsource the whole scheme to one provider, significantly simplifying the governance structure and potentially lowering the overall cost relative to operating an in-house scheme.
Consolidation is not just for small schemes. While TPR is focused on making sure sub-£100m DC plans are regularly reviewing their value-for-money proposition, many master trusts have found their services in demand for much larger DC plans.
During the pandemic, Vodafone transferred its then-£1.4bn DC scheme to WTW’s LifeSight master trust, with more than 45,000 members affected – one of the largest DC scheme transfer exercises so far undertaken in the UK.
Speaking in 2020 following the announcement of the transfer, Kate Grant, head of pensions and benefits at Vodafone, said the move “was designed to give members greater control of their savings” as well as providing access to “strong financial wellbeing and savings consolidation tools”.
(Ian – can you add here the table Figure 9 from the master trust & GPP report 2022, but chop it off after Aon. All the others have zero transfers so leave them off.
