The Pensions and Lifetime Savings Association today (Monday) released the second report by its Defined Benefit (DB) Taskforce, ‘The Case for Consolidation’. The report outlines how consolidation into new superfunds could tackle the issues which place an unacceptable, and mostly unrecognised, risk on scheme members.
In its first report the DB Taskforce identified that members of schemes with the weakest employers – schemes which hold 42% of liabilities of schemes in deficit – have just a 50:50 chance of seeing those benefits paid in full. These schemes are stuck with a choice between trying to manage this risk through heavy reliance on struggling sponsors or hoping to reach buy-out levels of funding which few can afford. There is a clear and pressing need for an alternative option.
‘The Case for Consolidation’ examines four models that offer trustees an additional option that would alleviate the level of risk carried by scheme members.
1. Shared services: combining administrative functions across schemes achieving cost savings through economies of scale. Especially beneficial to small and medium schemes and brings an estimated aggregate saving for schemes of £0.6 billion per year.
2. Asset pooling: different schemes’ assets are pooled and managed centrally while individual schemes retain responsibility for their governance, administration, back office functions and most advisory services. Especially beneficial to small and medium schemes and brings an estimated aggregate saving for schemes of £0.25 billion per year.
3. Single governance: different schemes’ assets are consolidated into a single asset pool; governance, administration and back office functions are also combined. Estimated aggregate saving for schemes of £1.2 billion per year; comprised of savings from shared services (£0.6 billion), asset pooling (£0.25 billion) and single governance cost-benefits (£0.36 billion).
Options one to three present valuable savings but do not materially reduce the risk faced by members of DB schemes. The DB Taskforce’s report outlines a further potential option – the superfund.
4. Superfund, full merger: designed to absorb and replace existing schemes. Employers and trustees are discharged from their obligations for future benefit payments which would be paid from the superfund. According to modelling for the DB Taskforce, a consolidator like this could improve security for savers in CG41 schemes – reducing the probability of seeing their scheme fail from 65% to close to 10% or even less.
Ashok Gupta, Chair of the Defined Benefit Taskforce, commented:
"There's a general assumption that 100% of DB scheme members are guaranteed 100% of their benefits. That is the intention but it will not be the reality. The reality is that savers in weaker schemes have a 50:50 chance of seeing their benefits paid in full. The Taskforce wants to find ways to improve those odds and building on its first report looked at four models of consolidation.
"We think the biggest gains lie in the merger of schemes, into what we have called superfunds. We believe superfunds have the potential to offer great benefits to members, employers, the regulator, the industry and the economy.
“Members get a better chance of more pension benefits being paid. Employers get a lower cost alternative to a buy-out. The regulator gets a sector with better managed risks. The economy benefits from improved investment by superfunds and employers are freed from onerous DB burdens."
Graham Vidler, Director of External Affairs, Pensions and Lifetime Savings Association, said:
"The Taskforce was asked to think about solutions and it has - including the new and bold idea of superfunds. There’s work to be done on developing the superfund idea and the Taskforce will be analysing it in detail over the coming months so we can contribute fully to the Government's Green Paper consultation."
'The Case for Consolidation' can we found on our website here.
We have provided a set of Q&A to answer any initial queries you may have – please see Notes to Editors.
Ashok Gupta will present ‘The Case for Consolidation’ on 9 March at the PLSA Investment Conference in Edinburgh. The session will be web-streamed live and available to view by registering here.
NOTES TO EDITORS
We’re the Pensions and Lifetime Savings Association; the national association with a ninety year history of helping pension professionals run better pension schemes. Our members include over 1,300 pension schemes with 20 million members and £1 trillion in assets, and over 400 businesses. They make us the voice for pensions and lifetime savings in Westminster, Whitehall and Brussels.
Our purpose is simple: to help everyone to achieve a better income in retirement. We work to get more money into retirement savings, to get more value out of those savings and to build the confidence and understanding of savers.
QUESTIONS & ANSWERS
What is the DB Taskforce recommending?
We want to see a more efficient DB sector, more likely to pay out members’ benefits. To achieve this we think trustees should be considering consolidation each year. This might be consolidation of some or all scheme services or it might be full merger of the scheme into a new type of ‘superfund’.
We’re calling on the Government to make it easier for consolidation to happen and to introduce a new requirement for trustees of DB schemes to demonstrate to members and the Pensions Regulator that the scheme is being run effectively and, if not, what steps they are taking to fix it.
Do your proposals bring a reduction in benefits for members?
No. Currently scheme trustees have only two options: limp on and attempt to reach full funding or try to fund an expensive buyout. Failure brings a marked cut to member benefits and buyout is often too expensive for schemes. Consolidation into a superfund provides trustees with another option to secure their members’ best interests.
We recognise that there is a broader discussion about the affordability of benefit levels, including in the Government’s Green Paper. Our next phase of work on superfunds will look at whether, and in what circumstances, it might be desirable to allow trustees to accept benefit reductions as a means of opening up the benefits of superfunds to more members.
Will poorly funded schemes be able to afford to buy into a superfund?
More work is needed to understand the affordability of superfunds to sponsoring employers. There is clearly a trade-off between the price of entry to sponsoring employers and the level of members’ benefit secured, that any potential superfund provider would consider.
The majority of employers in the regulator’s categories CG3 (tending to weak) and CG4 (weak) are unable to afford full buy-out in the current market. However, many of these employers would like to secure the interests of their pension scheme members and also release the company from its pension scheme obligations and the risks these can pose to the business. We believe a superfund could allow sponsors to raise capital from markets or creditors to enable a transfer to a superfund.
Is this just an easy option for sponsors who want to be rid of their DB pension scheme?
No. Employers will have to pay to enter a superfund and entry will be subject to a three-way agreement between employer, superfund and trustees. We would want to see an extremely robust regulatory framework around this, including a requirement for trustees to consult with their membership.
Are there clear benefits of entry into a superfund for scheme members, trustees and sponsors?
Yes. For schemes with employer covenant strength rated by the Pensions Regulator to be CG3 (tending to weak) or CG4 (weak) it is clear that joining a superfund could provide significant benefits – although some schemes might be so poorly funded that entry in to the PPF might be inevitable. The majority of schemes in these categories are currently unable to afford buy-out on the insurance market.
Some of these schemes’ sponsors may wish to make a clean break from their ongoing pension obligations (including the risks those pose to the viability of their business) and the superfund provides an option to do this.
The role of the trustees does not change – they must act in the best interest of the scheme members. Trustees will only accept the transfer if they believe it offers a better deal for the membership as a whole.
We would expect trustees to be instrumental in communicating to members the benefits provided by entry into a superfund. It is important to remember that savers in weaker schemes have a 50:50 chance of seeing their benefits paid in full and a 20% plus reduction in benefits if they go into the PPF; entry into a superfund is likely to offer them greater certainty and an improved outcome.
What protection would scheme members have?
Common standards for member consent would be required before a scheme enters into a superfund. Trustees would need to provide members with clear guidance so that members are fully aware of any risk to benefits in their existing scheme and the potential effect on those benefits if the scheme goes into a superfund. We would expect the process to be overseen by the Pensions Regulator with each step in the process carrying its own regulatory requirements.
What would happen if a superfund failed?
A superfund will be eligible for entry into the PPF and would pay a levy as other schemes do.
How do the financial benefits of consolidation arise?
They are a combination of:
- Schemes entering the superfund with a good level of funding which, in many cases, will require an upfront payment or commitment from the employer;
- Efficiency gained by economies of scale and high quality governance; and,
- A strong asset allocation strategy.
Did the Taskforce consider other solutions, such as conditional indexation alone or partial transfers?
No. Based on the evidence in its interim report the Taskforce focussed this stage of its work on consolidation. However, we do recognise the need to consider many of the broader issues which the Government is consulting on in its Green Paper; these include conditional indexation and a switch in indexation from RPI to CPI. We will consider the impact of these on consolidation in our next report later this year.
What does the separation of sponsor and scheme mean for public understanding of, and confidence in, workplace pensions?
The separation of scheme and sponsor is not a new development. Under the buy-out arrangements available today the scheme is permanently separated from the sponsor. The superfund would carry out the role of both scheme and the sponsor, similar to the situation in a buy-out.
Does your analysis differ from Government’s view outlined in its recent Green Paper?
We had the same starting point: people need to be able to plan for their retirement and that confidence in the pensions system is a vital to allowing that to happen. We also share an understanding that there is significant (over £400bn) deficit in the DB pensions system and that millions of people are relying on these schemes for their comfort in retirement. As a result, we agree that an informed discussion about the future of DB pensions is necessary.
Our approach differed from the Government’s in that: we have considered the strain that schemes’ sponsoring employers are under; and, have not assumed that sponsors’ deficit recovery contributions are entirely sustainable indefinitely. Sponsoring employers can, and do, go bust. If they do so before the scheme’s deficit is filled members will typically be transferred to the PPF; superfunds provide a way of removing this risk and offering members a higher benefit level than the PPF.
What is the role for the Government?
The Government should bring forward legislation that removes barriers to consolidation. It should work to build a regulatory framework for the creation, authorisation and supervision of superfunds. We would be very glad to collaborate with the Government on this and to work towards building the necessary consensus to make it happen.
Do you expect this to have an impact on the buy-out market?
Superfunds will complement the buy-out market. Trustees will retain the option to choose buy-out and this will be the right option for some schemes. However, the additional choice provided by superfunds may well have the beneficial effect of reinvigorating the buyout market by encouraging greater competition and choice.
What is the basis for assuming the market will respond by offering superfunds?
DB schemes currently have £1, 4672bn assets under management – the opportunity to manage some of this is inherently attractive. Furthermore, a superfund offered by an insurer should not require them to hold the same level of capital they currently need to under Solvency II requirements for a buy-out.
1. The Pensions Regulator uses four broad categories to rank employers from strong to weak according to how well they are able to support the scheme. In brief, these are: covenant grade 1 (CG1) – strong; covenant grade 2 (CG2) – tending to strong; covenant grade 3 (CG3) – tending to weak; and, covenant grade 4 (CG4) weak. Further details can be found on the Pensions Regulator’s website.
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