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Consolidation…The possibilities and the practicalities

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Darren Wateridge discusses the benefits of consolidation and the steps schemes can make now.

According to figures published in the PPF’s Purple Book 2018, 36% of schemes have fewer than 100 members and another 44% fewer than 1,000. Concerns continue to exist (rightly or wrongly) that not all small and medium sized schemes meet the governance standards expected by the Regulator and that smaller schemes lose out on the benefits of economies of scale that could lead to lower investment manager charges, lower administration costs per member, or schemes being able to gain access to beneficial investment opportunities or other products.

In the DWP’s White Paper published in March last year, the use of consolidation to improve the way that DB pension schemes operate was one of the big headlines, with much talk being around new forms of consolidation vehicles such as “Superfunds”, but also what steps can be taken now.
Trustees, employers and members could currently benefit from consolidation through:

• Using an investment platform - thereby enabling trustees to gain access to a wide range of funds, whilst benefiting from reduced costs that platforms can achieve due to their scale.

• Consolidating services, possibly across several schemes, with one provider to provide a cheaper, more
efficient service.

• Merging several schemes into one, thereby reducing ongoing fees although the initial cost of such exercises can be significant.

• Implementing a sole trustee, either to replace a full trustee board or to act as trustee across several schemes.
Buying out a scheme with an insurance company is also a form of consolidation although, as we know, the cost requirements of this are usually beyond the reach of most employers.

DB master trusts, under which the assets and liabilities of a scheme are transferred into a section of a larger DB Trust also exist.

Superfunds are the proposed new consolidation vehicle, a framework for which has previously been outlined by the PLSA’s Defined Benefit taskforce.

The main elements to the operation of a Superfund are as follows:

• Assets and liabilities are transferred to a Superfund along with the payment of either an additional one-off lump sum or a series of payments.

• The additional funding required would be lower than that of an insurance company for a buy-out, although higher than that for a pension scheme linked to an existing employer to be fully funded.

• Employers pass over their pension obligations to the Superfund and the payment of benefits is then dependent on the ongoing existence of the Superfund rather than the covenant of the employer.

• Additional capital would be required from external investors.

• Some Superfunds would prefer to operate such that benefits can be reshaped to simplify their administration process.

• It is unclear whether Superfunds would however be eligible for the PPF if they were to fail.
“The Pension Superfund”  was launched last year and agreed its first transaction with the Regulator in December.  A second consolidator, Clara Pensions, is also now out in the market.

Consolidation tales from overseas
Both Australia and the Netherlands have significantly reduced the number of DB pension schemes over the years through consolidation. The ability to simplify past benefits in both has been a major factor in achieving this.

In addition to this, in Australia, employers have used Master Trusts for many years making consolidating through this type of vehicle a more natural progression than is the case in the UK. In the Netherlands consolidation has been successfully encouraged by the regulator through highlighting the need to meet governance requirements which small schemes may feel unable to fulfil.

So, what’s next? On 1 February, the DWP closes its consultation on proposals for a legislative framework under which the new forms of consolidation vehicles (such as Superfunds) would operate, as well as a new accreditation scheme for existing forms of consolidation (such as Master Trusts). The DWP will also be working with the Regulator to raise awareness of the benefits of consolidation, so that’s another unit in the Toolkit for Trustees to look forward to!

Darren Wateridge, Senior Consultant and Actuary at Quantum Advisory