Research by Hymans Robertson predicts existing options could shrink the DB universe by four-fifths in 25 years' time. Stephanie Baxter explores its predictions
- There will be an increasing drive to reduce running costs and improve the security of members' benefits
- Solutions such as sole trusteeship, DB master trusts, and investment platforms will grow in popularity
- It estimates asset pooling could reduce investment fees by around £3bn per annum
Persistently high deficits and big insolvencies such as BHS and Carillion have raised questions over the sustainability of defined benefit (DB) schemes. As the industry awaits the government's forthcoming white paper following last year's green paper, there is renewed talk of consolidation.
A report published by Hymans Robertson, DB Scheme Consolidation - a better future for members and employers, explores how a number of factors are likely to accelerate consolidation in DB over the next 25 years. The firm makes a number of stark predictions, including that the universe could shrink by as much as four fifths to just 1,000 schemes from the current 5,500.
A shrinking universe
It predicts a 90% fall in benefit sections within schemes to just 4,000, and the number of trustees will reduce from around 30,000 to 2,000. Meanwhile, the firm estimates assets will be £700bn - around half of today's £1.5trn - and the combined solvency deficit could shrink by three quarters from circa £800bn in 2017 to £200bn by 2042.
This will be as a result of the increasing drive to reduce running costs, improve the security of members' benefits and manage risks more effectively. According to the firm's predictions, it costs around £6.5bn to £8.5bn each year to run the 5,500 schemes; this is comprised of £1.5bn in advisory and administration fees, and £5bn to £7bn in asset management fees.
It estimates asset pooling could reduce investment fees by around £3bn per annum.
"We'll see more consolidation from here as sponsors will focus on value for money and make sure each pound spent on legacy DB goes as far as possible," according to Calum Cooper, a partner at Hymans Robertson.
"Now we're reaching that tipping point with 50% of legacy DB schemes no longer offering any DB accrual.
"Sponsors are likely to lead the charge of pushing for getting benefits of scale - whether that's investment efficiencies and opportunities, governance, access to good quality advice - ultimately reducing the cost per member for advice."
Superfunds have been proposed by the Pensions and Lifetime Savings Association as a new way to allow sponsors to remove their DB schemes from their balance sheet at a cost below buyout. While there are pros of setting up superfunds, such as reaching critical mass to have sophisticated investment strategies, the firm points out the operational costs of moving into one would be material.
Also, as DB superfunds would require regulatory and statutory change, the firm thinks it unlikely to happen.
Cooper doubts there is a political appetite to do anything more adventurous on consolidation in terms of mandating or actively encouraging small schemes. "They will say the governance standards need to be raised but that's as far as they will go."
The consultancy believes a healthy level of consolidation can be achieved without legislative change, and that solutions such as sole trusteeship, DB master trusts, and investment platforms will grow in popularity. Also, insurance bulk annuities and more transfers out of DB in response to Freedom & Choice will accelerate the changes.
Pressure on costs
"Ultimately these moves should improve the security of people's pensions as well as reduce costs for employers, according to Jon Hatchett, also a partner at the consultancy.
"We're reminded all too often that DB pensions are not ‘gold-plated' or ‘guaranteed', and there is a real risk for a significant minority that they won't receive their benefits in full. We have seen hundreds of schemes enter the Pension Protection Fund (PPF), with pain for scheme members, employees and shareholders alike. The plight of the Carillion pensioners is a recent high profile reminder of this.
From the perspective of employers, the cost of sponsoring DB schemes has been "eye-watering", he adds. "They've paid hundreds of billions of pounds in deficit contributions and on average seen deficits continue to rise. It's not hard to see why they'll be looking for a different approach to reducing costs and managing risks more effectively."
Hymans predicts around one million members could be consolidated into insurance or banks through transfers out, while another two million is expected to go to insurers through buyouts - which it dubs the "gold standard of consolidation vehicles" - as schemes mature and if funding conditions stabilise. Meanwhile, it predicts another 500,000 members will fall into the PPF as a result of corporate insolvency.
Other options for trustees and companies to consider include merging schemes within companies, which could lead to substantial cost savings. Corporate groups often sponsor multiple DB schemes; savings across cost and management time could be made by merging schemes into one, reducing the number of advisers.
Another way is to introduce sole trusteeship, which replaces full trustee boards with a single entity that acts as trustee to the scheme - typically a professional trustee firm, which has become more commonplace.
DB master trusts are another option; although there are a few in existence, they have not yet had a lot of traction but that is set to change amid rising pressures to reduce costs and improve governance. Hymans predicts around one million members will go into DB master trusts over the next 25 years.
"Many sponsors want to keep close influence over their investment and funding strategy, and do so by having their own trustee boards," says Cooper. "But as funding improves and risks become less material, then they will be much more comfortable about a lighter form of governance and less time spent on DB, and there will be more interest in good quality investment delivered at scale.
"When you get to that tipping point, many more will migrate from relatively small schemes to one scheme housing many small schemes and do it really cost-effectively but still manage risks well."
Investment platforms offer one-stop-shop access to a wide range of pooled funds run by different asset managers, typically using a life insurance company.
Cooper is not yet convinced they are harnessing their wholesale buying power to really drive down costs of asset management, however. "But when they do, that will make them very compelling, and then we'll see much higher assets going to DB platforms much like we've seen in the defined contribution world."
As the report shows, there are clearly various options already available for sponsors and trustees without having to wait for legislative changes and the creation of DB superfunds.
Cooper hopes there will be a steer to get trustee bodies to think about why current governance and advisory approach is good value for money relative to the alternatives, but not actively encourage consolidation.
He adds: "This should make people think about what's out there and if they are spending their money as wisely as possible."
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