The PLSA's DB taskforce has released more details about its suggested scheme consolidation route, but questions remain about how it would work in practice. James Phillips reports
Bigger is better, especially for pension schemes, according to many in the industry. Not least, a bigger fund provides better access to a wider range of asset types, varying models of investment mandates, and general benefits of economies of scale.
Yet, with nearly 5,800 defined benefit (DB) schemes in the private sector, and the difficulties seen arising from multi-employer schemes, moves to consolidate have been slow and cautious.
Indeed, although there does exist a number of DB master trusts, many schemes have refrained from merging their assets. This can be for a variety of reasons; perhaps the scheme is large enough that there would be no benefits from consolidation; or trustees may feel a sense of obligation to their scheme's liabilities.
This has been a common theme through work carried out by the Pensions and Lifetime Savings Association's (PLSA) the DB taskforce's work, since it launched its first report last October - stating the system was too fragmented - and its second report in February.
This latter report suggested the idea of superfunds: where employers could sever their ties to their pension scheme, and see it absorbed into a giant aggregator for a price cheaper than buyout.
The taskforce has spent the last six months working on the fine details, and last week launched its final report, stating that superfunds could give members greater security. This is particularly important given the trade body estimates that three million savers have just a 50/50 chance of receiving their full pension.
The superfund model, according to the DB taskforce, would aim to pay full benefits 90% of the time, with the Pension Protection Fund (PPF) available as a back-up in the worst-case scenario.
There would also be strict rules on when superfunds could accept new transfers, depending on its funding level. For example, it would only be able to accept new transfers if it has a funding level over 100%, the trade body said, while The Pensions Regulator (TPR) would have the power to wind up or merge at levels above PPF benefits if the fund's ratio fell below 90%.
Taskforce chair Ashok Gupta says it is vital to consider this kind of model in an environment of high covenant risk.
"More than 11 million people rely on DB pension schemes for some or all of their retirement income, but there is a real possibility that without change we will see more high-profile company failures such as BHS or Tata Steel," he said. "It is vital that action is taken to address covenant risk, underfunding and the current lack of scale in the majority of schemes.
"Our proposals have the potential to transform the industry - helping to ensure more members get their full benefits, reducing sector inefficiency, addressing the issue of stressed schemes and enabling sponsors to concentrate on growing their businesses. The industry and government need to grasp this opportunity and tackle serious flaws that threaten the security of people's retirement."
The big question that remains, however, is how such a superfund could be funded, particularly if there are such stringent rules on how well-funded a scheme needs to be to accept further transfers.
The PLSA taskforce suggests that each superfund would have just one sponsor - independent from trustees and the schemes' original sponsors - as well as one set of trustees, asset managers, advisers and administrators, setting it apart from other consolidator models which can have a mix of governance structures.
These sponsors would have a "significant role" in investment decision-making, with the fund backed by investors who would enable it both to be set up and have a capital buffer.
The taskforce said it would be important for the superfund to be "commercially appealing" and deliver return to investors, arguing that return could be delivered based on agreed funding targets and refunds of capital if the superfund was in surplus.
Some funding would, of course, come from the transferring schemes - as all assets and liabilities would be transferred into the superfunds, as well as the sponsor having to pay for its obligations to be removed.
This cost to the sponsor, however, could vary - the taskforce envisages a competitive arena, rather than just one all-encompassing scheme.
Therefore, it is highly likely that each superfund will have its own entry requirements, influenced by the investor backers and the regulator in its authorisation regime.
The PLSA taskforce therefore modelled the entry cost on a number of scenarios: pure gilts, gilts plus 0.25%, and gilts plus 0.5%, and then applied that to various covenant grades TPR awards schemes. Based on gilts plus 0.25%, and a number of other assumptions including investment outperformance of 0.5%, the PLSA believes payments will be paid out in full in 90% of cases.
Lincoln Pensions chief executive Darren Redmayne says, however, firms will need to be diligent that schemes are not being under-sold.
"The idea of exchanging covenant for funding is at a nascent time. What is being proposed is that the covenant of stressed schemes is 'sold' for money into the scheme without needing a regulatory process," he argues. "I think members would need some form of 'fairness opinion' from the covenant firm advising on the price to say that they believe selling for a particular amount of money is in the interests of the members.
"Covenant firms - and the wider pensions industry - will need to take responsibility for ensuring that the value paid doesn't turn out to be, in years to come, too cheap."
Of course, it is important that these funds cannot be set up too simply; this is something that we have seen in the master trust market, leading the government to bring in an authorisation regime, overseen by TPR, sometime next year.
For superfunds, therefore, the taskforce suggests something similar. Those wishing to set up a superfund would need to approach TPR with a business plan.
Much work would have to be done by government and TPR to enable this framework to take off, however. One of its biggest barriers is the ability to amend benefits; the last few years have taught the industry how difficult, sometimes impossible, it can be to switch indexation of future accrual from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI).
Royal London director of policy and former pensions minister Sir Steve Webb said the industry needs to give serious consideration to the report.
"This is a really valuable report whose recommendations deserve to be taken very seriously by policy makers," he said. "The report highlights the fact that millions of savers have only a 50/50 chance of having their pensions paid in full by their company pension scheme.
"High-profile cases such as BHS and Tata Steel are only the tip of the iceberg and the government needs to be more proactive to reduce the risk of more scheme members not getting their full pensions.
"If schemes can be consolidated in a way that provides better value for money, reduced pressure on employers and an increased chance of pensions being paid, this could be a real step forward."
Nevertheless, before there is any action, the industry will need to be convinced too. A PP poll, carried out after the PLSA first recommended superfunds, found almost two-thirds disagreed with the suggestion, with one describing it as "impractical and unrealistic".
And in response to this latest report, JLT Employee Benefits head of technical John Wilson says: "The PLSA has much work to do in terms of winning over hearts and minds."
"Proposals to exchange covenants for funding are controversial," he continues. "There will be concerns over security of members' benefits and scepticism that this will just end up being reduction of benefits 'through the backdoor'.
"There are also the issues of regulation and the ability to offer a cheap form of buyout without the reporting and reserving that applies to insurers."
Indeed, TPR is not convinced of the doomsday scenario the PLSA has painted for those three million savers that it says only have a 50/50 chance of receiving full benefits.
A spokesperson states: "While some DB schemes are facing significant challenges, as highlighted in the PLSA's report, over the longer term, most will be able to pay members their promised benefits. Our annual funding statement for 2017 showed that 85% to 90% of schemes currently preparing their valuations have employers with sufficient financial resilience to be able to afford to manage their deficits, and don't have a long-term sustainability challenge.
"However, we are clear that while the majority of DB schemes remain affordable, many should do more to tackle increased deficits and reduce risk to pensioners. We are prepared to use our powers where employers and trustees fail to tackle problems.
"We will continue to engage in discussions with government and industry in the months to come, including on how scheme consolidation can help protect member outcomes."
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