The DB market is seeing significantly increased scrutiny from the Pensions Regulator, with a clear desire for consolidation of smaller schemes. But will the market actually see significant consolidation?
The two large consolidation businesses certainly hope so, although the broader consultancy market feels that much depends on how new regulations are structured.
Explaining the regulatory position, Sackers partner Eleanor Daplyn says: “A regulatory regime that should help to establish credibility is promised. But it is not yet in place and with only two players there’s a sense of “wait and see” in the industry. In terms of where the customers might come from, the DWP has proposed that in order to consolidate, firstly a scheme must not be in a position to wind up and buy-out or be likely to be within five years and secondly, trustees must be satisfied that members’ benefits stand a better chance of being met in the consolidator. These conditions effectively exclude very well-funded schemes and those with a strong employer covenant.
At the other end of the scale, sponsors with a particularly poorly funded scheme and with limited prospects of improving will not have the money to make a superfund consolidation.”
The two consolidators themselves are unsurprisingly bullish, although they differ a little on their approach to smaller schemes.
The Pension SuperFund chief executive Luke Webster says: “Small DB schemes stand proportionately to gain most from consolidation structures like The Pension SuperFund, which offer levels of governance, resilience and economy of scale that are unavailable to smaller funds.
“For the time being, we are focussed on larger schemes in order to achieve the critical mass necessary to defray our substantial governance overheads and achieve well-diversified liabilities. The latter point is a key strength of our ‘unsectionalised’ approach: as the number of members in the scheme grows, the impact of idiosyncratic risks is diluted, and the overall cash flow profile becomes more stable. Smaller schemes can then be absorbed without having a significant impact on the overall asset liability management approach for the scheme.”
He says that the scheme will seek to achieve scale of around £5bn, then will be open to accept transfers from smaller schemes which meet its entry funding requirements.
He adds: “One of the matters our recent consultation response to Department for Work and Pensions raised was the need for Government, the industry and its regulators to ensure that the requirements placed on trustees of smaller schemes considering transfer to a consolidator are not so costly and time consuming as to be prohibitive.
“We hope that the forthcoming regulatory and authorisation regime will seek to ensure that consolidators are transparent and ‘do what they say on the tin’, reducing the need for different groups of trustees to duplicate the same covenant or legal analysis time and again, consuming resources that might otherwise be funding member benefits. Further debate around simplification of benefits may also be relevant, since the costs of maintaining different structures are proportionately more burdensome for collections of smaller schemes.”
Clara Pensions chief executive Adam Saron says: “We are agnostic on scheme size actually. We also recognise that the relative benefit of consolidation is higher for smaller schemes. We think consolidation offers the promise of material improvement. We are interested in working with the smaller schemes, their advisers and the regulator in finding ways to create a more streamlined approach to access solutions generally. This is an issue that is much wider than Clara. Even well-funded small schemes could have issues in the buyout market as it has become more concentrated and increasingly dominated by the larger schemes making it harder for small and even medium-sized schemes.”
He says Clara needs to be realistic. “Is Clara open to large scale transactions? Yes. But we need to ask ‘in what order will the business come?’ If you look at history of the insured market, they didn’t start doing £4bn schemes. It came after a decade of very hard work. We need to prove ourselves. That may well be starting at the smaller end and that is fine.”
In terms of the importance of regulation, he says: “I think the regulator wants to get to the position where they are making it easier for small schemes. I don’t think it is about cutting corners. It is everyone working together. The way a small scheme approaches this is a little different. You have to be much more targeted, make a lot more of the decisions upfront and be more prepared. It has been incredibly interesting that we have seen specialist advisers who advise on small schemes only.”
He also suggests that rather than the finalising of regulations, the next big landmark event will be when the first consolidation happens.
Andrew Ward, partner and head of journey planning at Mercer discussing consolidation in broad terms, said: “The question has shifted from can consolidation happen to when will it happen. I would caution equating consolidation only with superfunds. The question is broader when you look at the aims – better decision-making, better access to investments, and lower costs. Yes. The superfunds offer benefits of pooling, but they want to offer an exit in ways cheaper than a bulk annuity.
We have already seen fiduciary management taking off, we have seen independent trustees. You can package that up and get something like a DB Mastertrust. There is a push in what has been a sleepy market.
“The superfunds and insurers are consolidators and I think we will see dramatic changes in the coming years and decades. It is interesting to look at the superfunds. They are very different models – Clara is bridge to buy out, The Pension SuperFunds is a long term run-off model. Trustees and corporates have different perceptions. Will those be the only two models? I don’t think so. We will see others enter and those two refine their models. We will see change as they learn, clients learn and consultants learn what works in different situations.”
Some point out that there is big business being transacted in the small end of the market.
Shelly Beard, senior director in Willis Towers Watson’s pensions derisking team says: “Buy-ins and buyouts for large pension schemes tend to be the ones that hit the headlines but in the background, there is a steady flow of deals for smaller schemes. For example, in 2018, of the over 160 deals written, 75 per cent of these were under £100m and there were over 50 deals under £10m. While there is less competitive tension between insurers at this end of the market, the economics of the deal are often more compelling when the ongoing running costs of the scheme and the governance time for the sponsor are taken into account.”
Others remain circumspect. Broadstone Corporate Benefits technical director David Brooks says: “The small schemes are not on the radar of the commercial consolidators yet. They will want at least one big scheme, so they are not the great saviour of small schemes.
“The bigger impact the consolidators have had is that they are making the insurers look at pricing a bit more keenly. Schemes looking to buy out may benefit.”
He says the regulator may struggle to impose something on the market.
“If you were looking at a consolidator and it was going to cost you 105 per cent of your current liabilities compared with a buy out which was going to cost 110 per cent, why would you go to the superfund when you could have L&G? L&G’s covenant is going to be infinitely bigger than the superfund and for 5 per cent more for the premium. You might say let’s wait a couple of years or hope the assets go the right way or perhaps the company does some borrowing. The trustees would say I don’t want the superfund. What if it went bust? L&G is not going to go bust unless we end up in something worse than a 2008 world.”
There are, however, some more enthusiastic supporters including Adam Davis, managing director of one of those new specialist consultancies, K3 Advisory.
He says: “I set up at the end of last year, with a view to helping pension schemes exit in a controlled way. I see a growing difficulty with small schemes struggling to get traction from the insurance market.
“Insurance companies don’t get excited by small schemes. We want to make the process simpler. The consolidator market could provide much needed capacity to smaller schemes. However, the DWP suggests that if you can achieve buyout, you can’t use the consolidator route.
“It is all very well and good basing figures around theoretical numbers. If small schemes can’t get a quote, then they can’t do anything at all. You have to be careful that they aren’t barred from accessing either market.
“There are all sorts of providers that will offer low cost structures to run your scheme pooling with others. The problem for finance directors is they would prefer not to have a DB pension scheme on their balance sheet. We should give schemes more options in a way that is not detrimental to members. “Until the consolidator schemes emerged last year, your two options were run on and hope for the best while financial consolidation would only happen with the PPF or a buyout if you could afford it. “We need to improve how we get schemes to get to insurance. Small schemes are not exciting but if trustees can run simpler processes so the schemes end up transacting then that is much better. We want to create a middle ground for schemes who can’t legitimately access the insurance market. It is niche but otherwise it could be the PPF.”
PTL managing director Richard Butcher says that the legislative framework hasn’t been fully described yet and we don’t know the level of funding that will be required.
“The higher up the scale it is, the less attractive it is going to be to employers. The lower down the less attractive it will be to the regulator. The critical piece is that description. Once that is described trustees will have to decide how they will want to extinguish their liabilities. The only way they can get a discharge under law currently is a buyout. If trustees don’t get a statutory discharge it could all come back on the trustees or the employer. That has a bearing on how attractive consolidation is going to be. Assuming consolidation is not going to be equal in terms of statutory buy-out, the trustees and employers are going to have get over that emotional barrier.”
There have been suggestions EBCs may enter the market in significant numbers. Davis is a little cynical about this. “I hear rumours that they may launch their own superfunds, but I see conflicts of interest.”
Daplyn adds: “It would be a bold stroke for an EBC to launch a consolidator in the sense of a superfund, but much less so with a DB master trust particularly given that several already operate DC master trusts and if that were the case there might well be a new trend.
“In terms of regulation, there doesn’t seem to be any reason that an EBC-led consolidator would call for a different regulatory regime to any other. So for traditional DB master trusts they would be subject to the existing occupational pension scheme regulatory regime, and if it were a superfund the proposed authorisation regime.”
What are DB schemes alternatives?
Eleanor Daplyn, partner at Sackers suggests some options.
“Is there any scope for streamlining governance within the wider corporate group? Small legacy pension schemes within big groups can get left behind particularly when there is no or limited in-house pensions expertise. Such schemes might be able to take the initiative and suggest efficiencies to the sponsor.
Get your advisers and providers to work better for you. Make it clear you expect them to be proactive both in terms of liaising with you and with each other. Trustees or sponsors have to pay for professional advice anyway so make sure you are leveraging off their expertise. It may feel like this will cost more, but if you can engage your advisers in helping you prevent issues arising it will probably be less costly than paying them to help you sort problems out later.
Think about trustee board membership and structure. Is your board the right size and does it have the right people? Are your lay trustees, whether employer or member-nominated, contributing, or just passengers? Do you have a professional trustee – if so, are they providing value? If not, is it money well spent?”