Many employers are keen to get their defined benefit (DB) pension scheme liabilities off their books. That's a given. And has been for some time. But that imperative has come into even sharper focus as a result of the pandemic with scheme costs and an increase in governance requirements becoming ever more onerous. So, as employers seek to reduce their costs and improve their funding, while also securing the best possible outcomes for members, the pull of DB scheme consolidators becomes ever stronger. However, with a growing number of very different options available - from tried and trusted DB master trusts and the much-talked-about (but as yet untested) superfunds to the promised land of insurer buy-out - it's by no means a straightforward decision.
Being clear on your endgame - or long-term funding target - represents the starting point and ultimately that's going to involve either self-sufficiency or buy-out. In either case, a DB master trust represents an ideal route to success. In this article we take a look at the whys and wherefores of this vehicle, including why it could be the consolidation solution for most of the DB schemes which are still out there.
The future is consolidation
Consolidators hold the future for most DB schemes; it's a truism acknowledged not only by those who have already opted for this route and are reaping the rewards, but also by the government. The latest DB consultation paper 1. highlighted the "benefits of scale" and the "wider and potentially more innovative mix of investment opportunities" they offer.
Consolidation affords the opportunity to best secure member outcomes, while keeping pace with regulation, maintaining a robust governance structure, reducing costs and giving schemes access to affordable investment opportunities.
It's a market that has grown steadily in the UK over the years but, according to commentators at the conference, if the current interest is anything to go by, it's a market that is set for a seismic shift.
This shift is already being seen in Australia and the Netherlands in particular 2. The total number of corporate DB plans in Australia fell from 4,188 in 1997 to 30 in 2016. In the Netherlands, there were more than 1,000 pension funds a decade ago, falling to around 230 currently.
In comparison, the UK has seen only a relatively modest appetite for consolidation but the The Pensions Regulator (TPR) is keen to see this move up a gear over the next few years, particularly amongst schemes which have £1bn or less in assets under management, representing almost 90% of the DB market.
So, what's the best way to do it?
The traditional buy-out model is considered the ultimate endgame for many and it's easy to see why; the scheme's liabilities are transferred to the insurer, removing all future employer obligations while guaranteeing member security. However, it's probably only a realistic option for a small number of very well funded schemes right now with the cost for most schemes still being prohibitive.
An alternative is a consolidation vehicle that provides a different proposition; an interim step on the path to buy-out, or simply to reach - and remain at - self-sufficiency.
A DB master trust, like TPT's DB Complete, provides the framework to enjoy all the benefits of consolidation and Trustees or employers don't have the worry of having to seek any special authorisation from the TPR. It is already a pension scheme fully regulated by the TPR (no need to seek any special clearance), each scheme has its own separate section with assets and liabilities ring-fenced. Existing scheme rules are adopted so member benefits remain unchanged as do the balance of powers. When it comes to valuation, assumption setting and investment strategy discussions, employers can have as much or as little involvement as they choose.
Market research has shown that a DB master trust can, on average, reduce a scheme's costs by as much as a third. These significant savings can be used to reinvest in the scheme and improve funding or used to support and maintain a viable employer. Schemes which reach self-sufficiency can have confidence in the strength and size of the DB master trust to run off the scheme with very little (if any) further involvement from the employer.
Unlike a superfund model, the employer link is not severed in a DB master trust. Severing this link comes at a hefty premium and, whilst this may be less than the cost of a buy-out, it is still substantial. Several commentators suggested that current superfunds could most probably serve a small niche market (c 500 schemes) of distressed schemes, but that they were not likely to be suitable for the vast majority of today's DB schemes.
A DB Master Trust provides economies of scale by pooling governance, legal, actuarial, administration and investment functions, saving the scheme and the employer time, money, and the worry of increased regulatory pressures on the scheme governance. (No more desperately searching for member-nominated trustees or the next chair).
The more recent Pension Schemes Act, a revised TPR Funding Code and the likely introduction by TPR for schemes to produce a comprehensive annual ‘Own Risk Assessment' make running a DB scheme ever more burdensome with costs continuing to spiral.
The economies of scale of a DB master trust provides:
- Access to investment expertise and attractive investment opportunities at competitive prices out of reach for most schemes.
- Removes current and future governance concerns.
- Creates scale to invest in the most up to date administration services.
- Significantly reduces costs.
- Saves significant company time.
- Gives the option of targeting buy-out but provides the scale to consider lower cost self-sufficiency as a viable alternative.
One thing's for sure, doing nothing is not an option. With 9.9 million members relying on DB schemes for a substantial portion of their expected retirement income, they remain of critical importance 3.. Consolidation is unquestionably the future. The only question then is how best to do it?
To listen to TPT's presentation, followed by audience Q&As, at the Professional Pensions DB Consolidation Conference (March 2021), please click here.
1. Source: DWP Protecting DB pension schemes - 2018, 2. Willis Towers Watson, 3. DWP Protecting DB pension schemes - 2018