The PLSA's DB taskforce has suggested employers should be able to offload their DB scheme into merged 'superfunds'. James Phillips explores the idea.
Defined benefit (DB) consolidation has been harped as a potential solution to soaring deficits, with various models providing different benefits, particularly for smaller schemes.
The Pensions and Lifetime Savings Association's (PLSA) DB taskforce has suggested a ‘superfund' as the way forward, where sponsors can pay to have their scheme absorbed into a giant fund and shed their responsibility.
The superfund would see struggling schemes able to offload their DB funds for a cost lower than buyout, the taskforce says. Furthermore, that cost could be met through contributions, rather than upfront, as secured debt.
Altogether, the proposal could help struggling employers with a small amount of capital remove the onus for burgeoning deficits.
But the practicalities of this are more complex and the idea has provoked a mixed response from the industry. Nearly two-thirds (62%) of Pensions Buzz respondents rejected the idea.
The taskforce says this route would be open to schemes of all sizes, with each seeing some kind of benefit. But would large schemes want to consolidate, particularly considering the cost and administrative headache?
Hymans Robertson head of trustee consulting Calum Cooper says the cost may be too much.
"Moving into a merged superfund would mean schemes would cede control and influence over outcomes," he states. "The cost and risk exposure for larger schemes is too big for their trustees or sponsors to surrender control over influence and investment outcomes willingly."
Cardano head of innovation Stefan Lundbergh adds the very smallest schemes are the most likely to benefit from consolidation, and the larger the scheme gets, the availability to access its advantages is already there.
"It's been possible for smaller schemes to get better access to financial markets at a better price than in the past," he says. "A lot of the economies of scales have been taken by the providers who give something back to their clients.
"If you look at asset management firms, smaller funds can get a better deal than they could 10 years ago. However, for the really small funds, there is a case for consolidation one way or another."
The report adds schemes moving into a superfund would need to conduct actuarial conversions and accept the terms of the superfund's existing rules. This could see benefits moved from the Retail Prices Index (RPI) to the generally lower Consumer Prices Index (CPI).
Aegon head of pensions Kate Smith says the proposal could see many members disadvantaged.
"The only way DB schemes could be consolidated efficiently is to simplify benefit structures across all members, creating many losers," she argues. "DB schemes can be complex arrangements with different membership categories as well as different pension increases."
However, if this is done on bulk by employers without complete consent, then they could open themselves up to legal challenge. Cooper says: "If this were to happen it could be subject to legal challenge, as well as going against the pension minister's comments about pensions being deferred pay and a promise that must be kept."
The superfund model would require some legislative change to allow a move with just majority consent - or only partial moves will be possible.
Lundbergh adds this whole process becomes a lot trickier because of the need to change contracts.
"A strong argument for the superfund would be that if you standardise the pension contracts, then you can merge things, but you're going to need legislative help," he states. "But a change of contract is quite complex and needs to be agreed by members."
Nevertheless, with employers paying to dump their scheme, the sponsor backing is gone, leaving the superfund to pick up any downside. This could risk members' benefits, so how can a superfund be sure that it will not fail?
Smith argues the funds would need to have strong financial frameworks to ensure this does not happen.
"Allowing employers to walk away from their DB schemes creates a moral hazard and needs to be treated very carefully," she says. "Removing the link with a sponsoring employer also removes a financial back-up plan, and could weaken members' positions.
"It's absolutely fundamental that the funding and solvency of any superfund is robust with clear rules on who makes up the shortfall."
Strong measures are currently on the way for defined contribution master trusts, with new rules requiring them to hold adequate capital to ensure they can pay members if something goes wrong, much like the rules insurers are bound to. Perhaps this could be something a superfund would also be required to comply with.
Association of Consulting Actuaries chairman Bob Scott welcomes the superfund idea, but argues there would need to be sufficient safeguards like this in place.
"This raises the issue of who should bear the risk of the superfund failing to meet its obligations," he says. "Insurance companies have to hold regulatory capital and are subject to strict financial supervision; ordinary pension schemes have an employer to fund them.
"Superfunds would have less capital than insurance companies and no sponsoring employers and so, if the available capital is not adequate, they will fall back on the Pension Protection Fund."
Lincoln Pensions chief executive officer Darren Redmayne likes the superfund idea but adds the entry fee should be set at a level to ensure the fund has adequate capital.
"What's critical here is that the covenant isn't cashed in for too low a price," he states. "The covenant has been a huge sacrosanct concept that sits behind these pension schemes and it's easy to undervalue sponsoring employers."
Nevertheless, the best approach would be to ensure that a superfund would not get close to failure, and is proactive in identifying risks it faces.
Cardano's Lundbergh says the funds may end up facing problems if they do not manage their risk properly.
"A lot of DB schemes are in a problem because risk has not been managed in a good way," he argues. "A lot have interest rate exposure. That's led to the current problem with underfunding.
"If you don't manage your risk properly and the world doesn't turn out as nice as we'd hoped, we might end up having a problem with the superfunds as well."
The taskforce's idea has elicited a wide range of views on this, with some supportive but cautious of the practicalities. In particular, many are worried how the superfund would cope in times of financial hardship.
Nevertheless, the taskforce has recognised more work needs to be done to develop the proposal further and so the industry should look out for more details over the next year.
• Employers pay a fee to reduce scheme underfunding and remove their obligation to their DB scheme(s)
• Following a consultation with members and trustee agreement, the scheme and its assets and liabilities would be transferred
• Benefits would be revalued after negotiations on actuarial conversion between the trustees, sponsor and superfund
• The superfund would be authorised and supervised by TPR
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