Running a smaller defined benefit pension scheme can be a real challenge and comes at a vast expense.
There have been more than 1,000 new pieces of pensions legislation since the turn of the millennium. Though a strong governance framework is entirely necessary and appropriate
– to protect members’ retirements – it places a very heavy burden on smaller schemes, which tend to have more limited resources.
This year has already seen the Pension Schemes Act become law, whilst a second consultation on the Pension Regulator’s new funding code is due in the Autumn. This comes on top of schemes needing to deal with ESG investment pressures, protect members from pension scams, safeguard member data and ensure good governance generally.
All this, in the face of a global pandemic, means that sponsors and trustees are under sustained and considerable pressure. It is no wonder that some smaller schemes struggle to satisfy the Pensions Regulator’s high expectations when it comes to good governance.
Meeting the regulatory and governance challenges schemes face comes at a cost. Schemes employ a host of advisers, including actuaries, administrators, investment consultants and lawyers, to help them navigate the increasingly complex pensions landscape.
There are significant diseconomies of scale when it comes to running a smaller scheme. Many of the tasks that schemes need to perform or new issues which they need to take advice on affect smaller schemes disproportionately to larger ones. For example, the cost of an actuarial valuation for a scheme with 20,000 members costs far less than the cost of 100 separate actuarial valuations for 100 schemes with 200 members each. That is why smaller schemes struggle to run effectively or efficiently on their own.
Just ‘keeping the lights on’ in terms of meeting the compliance burden typically costs smaller schemes with less than 1,000 members well over £1,000 per member each year. In the context of paying an average pension of around
£5,000 a year, that is staggeringly inefficient. Moreover, those annual costs apply to members not yet in receipt of a pension, as well as those that are, and the costs could be paid for 20 years or more before the member ever receives a penny from the scheme.
The picture can be very different for larger schemes however, with the scale to spread their fixed costs over a much larger pool of members. The USS, for example, which is the UK’s largest scheme, spent just £72 per member last year.
It should therefore come as no surprise that coming together through consolidation is widely considered a solution to many of the problems facing smaller schemes today.
Consolidation can reduce risk for both the members and the employer. Some of the newer solutions in the market, as well as the traditional insurance company buy-out option, also offer improved benefit security to members.
The Pensions Regulator recognises good governance as being the bedrock of a well-run scheme. Often a consolidator will have professional independent trustees, ensuring the highest standards of knowledge underpin their operation.
By bringing schemes together, consolidators should also be better able to embrace technology and engage with communications specialists to educate and inform their members, facilitating better decision making and helping to guard against pension scams.
Consolidation can provide additional financial benefits to the employer too. The DWP’s 2018 White Paper cited several academic studies which showed that good governance through effective investment can add between 1 and 2 per cent per annum to returns. Consolidation allows schemes to adopt best practice governance standards and to capture these extra returns, which smaller schemes operating alone could be missing out on.
Consolidation may also offer endgame buy- out savings if benefits are secured in bulk rather than for each of the smaller schemes individually. The range of consolidation options in the market is growing. The benefits discussed above do not apply equally to all, and some solutions come with their own unique considerations. Each scheme looking to consolidate will need to take advice and weigh up the options before deciding which is right for them.