The options available for smaller DB schemes

The roundtable – chaired by PP editor Jonathan Stapleton and held in association with Russell Investments – challenged the perception that smaller schemes sometimes face more challenges than their larger counterparts and highlighted the fact that the number of services targeted specifically at smaller schemes had expanded significantly over recent years.

It also looked at models such as professional trusteeship, corporate sole trusteeship, fiduciary management and defined benefit (DB) master trusts as well as trying to understand the specific challenges and opportunities smaller DB schemes have when looking to de-risk and move towards endgame.

As well as this, the roundtable discussed DB consolidation options and the potential opportunities they might present for smaller schemes, as well as how the Pensions Schemes Bill and the Pensions Review might impact this part of the market.

Specific questions it discussed included:

• Are smaller schemes struggling to get access to insurers for buyout?
• Is there an issue with getting competitive quotes
• What challenges do smaller schemes face relative to their large counterparts when it comes to other endgame options?
• What are the advantages of professional corporate sole trustees when it comes to smaller schemes?
• Is fiduciary management a cost-effective option for smaller schemes?
• How do smaller scheme trustee boards and sponsors know about the options?
• Is the PPF, as a public consolidator, a potential solution for some smaller schemes?

Are smaller schemes struggling to get access to insurers for buyout?

Scott Pinder (Law Debenture): No. Based on the fact that it is going to be a bumper year for insurance transactions and we are told that around 80% of these will be sub-£100m then clearly this shows a distinct lack of struggle, at least currently.

Annabelle Hardiman (Independent Governance Group): It is a myth that small schemes are struggling to secure endgame options. There is no lack of traction with insurers. It is more about the quality of data and collaboration with the insurer, sponsor and trustees to ensure a smooth process, rather than the size of the scheme.

Sarah Leslie (ndapt): This year, we saw small schemes get competitive quotes from multiple insurers. Yet, small schemes don't always choose the cheapest. In some respects, they are more paternalistic. They often have more of a relationship with their members, so they want them to be looked after. There are no problems accessing insurers, and competition across multiple insurers gives people the chance to pick those with the right fit.

Adam Davis (K3 Advisory): Size is not the dominant factor insurers look at when deciding to quote. It is more to do with how certain it is that the scheme will transact, data and benefit preparation. At the very small end, we also see the ability to attract multiple insurers. There is some care needed to not over-engineer a process because fees can kill deals for small schemes. They do not have very many assets, so there is a place still for exclusive transactions, if run in the right way.

Sam Burden (Zedra): I have an employer with three schemes, one of which is a £2m scheme fully funded and ready to buyout, but we need to wait for the other two so we can take them to market as a whole.

Paul Tinslay (Dalriada Trustees): The efficiencies are important. The market volatility in the autumn of 2022 left a benefit for small schemes that had previously decided not to go for liability-driven investment hedging because it was too expensive and their scheme was too small. However, they also did not invest much in data cleansing, which has been the challenge.

If there's a platform where the data is ready and the same professional trustee and brokers are involved, you can easily stack schemes together. Then, the small scheme issue goes away as they effectively become categories of a single buyout arrangement.

Kevin Clark (Vidett): No, in the past 12 year I have seen four clients buyout with same insurer ranging from £0.6m to £4m, but their rates have hardened lately. It's a busy market and competing insurers quote when they have capacity. Also, one insurer potentially entering the buy-out market is interested at the small schemes market.

Are there differences when it comes to buyouts?

Lynn Pointon (Pi Partnership Group): As long as you have prepared thoroughly and have the right advisors and broker, schemes with a few millions of pounds of assets will be able to transact. However, micro-schemes with assets measured in hundreds of thousands of pounds and probably only a single-digit number of members are challenging to transact.

Kevin Clark: At the smaller end, you need a pragmatic lawyer who is not going to charge lots, a red flag report to cover the trustee for entering into the buyout policy transaction, as well as an advisor who normally transacts.

Small clients have had problems with different advisors who do not give them attention. It is not hard to switch to another advisor in your preparation who can give you the right attention to get this deal done.

Is there an issue with competitive quotes feeling reasonable value for smaller schemes?

Annabelle Hardiman: We might have expected insurer pricing to worsen because of the greater demand, but we have not seen that in practice. Pricing has steadied or improved in recent years, and that includes for small schemes.

We see greater pragmatism at the smaller end around the number of insurers to include in the broking process or whether to move straight to exclusivity. Provided trustees are comfortable with the insurer and receive advice that the price is reasonable in the current market, reducing the number of insurers involved in the broking process helps reduce costs for small schemes. There is also an expectation that smaller schemes will accept the standard terms offered by insurers, reducing costs in negotiating the contract and meaning insurers can offer better pricing terms.

Adam Davis: You are running a one-round process, so you are not playing insurers off against each other on price. If you get a couple of prices, there is a chance that you end up with a better price, but sometimes if you want to hit the target, you are better talking to one insurer.

Buyout is not the only option. What challenges do smaller schemes face relative to their large counterparts when it comes to other endgame options?

Aqib Merchant (Russell Investments): The key challenge for a small scheme is that the cost of running the scheme does not get lower as the scheme matures, so when you think about value for money per member, the amount of money spent on actuaries, consultants and advisors can quickly add up. Is it worth running that scheme on or running that scheme off? Without the advantage of scale to spread these costs, evaluating the most viable endgame option becomes a significant challenge for trustee boards.

Simon Partridge (Russell Investments): Smaller schemes are able to react to market conditions, and there is an increasing number of options available to them beyond buyout including run-on, mastertrusts, consolidators and capital-backed journey plans; it is important to be able to be flexible. We have clients who want to run on for the foreseeable future, waiting for when the buyout market looks more attractive, but they want to be able to change their mind. It's important to watch the market and opportunities for changing your endgame target – professional advisors can help trustees to understand the dynamics of the market. Even when a buyout objective is agreed, moving the portfolio to being insurer-ready and facilitating that entire process through the endgame to buyout is complex.

Sam Burden: There is the ongoing governance to-do list. At the small scheme end, it is challenging, particularly in relation to the code of practice. Sole trusteeship comes into its own around the code of practice, but there are other issues, such as section 37, that you have to work through, irrespective of scheme size.

Kevin Clark: There is increased competition from advisers who love delivering small scheme solutions.

What are the advantages of professional corporate sole trustees when it comes to smaller schemes?

Sarah Leslie: The professional corporate sole trustee model is often quicker and more efficient than the traditional trustee board. It is important though to maintain diversity of thought. In addition to having multiple trustees feeding into any solution, we engage with ex-member nominated trustees or ex-‑company reps.

Annabelle Hardiman: A big part for smaller schemes, is timing. Having a sole trustee gives you flexibility to respond quickly when there are pricing opportunities that can be captured. This is largely due to the existing knowledge and experience of the trustees and being able to make decisions quickly.

Scott Pinder: A lot of schemes can work in real time, but some really struggle. The value of a corporate sole trustee is that you can nudge things along at your own pace with ease. For example, there are opportunities for smaller schemes to take targeted actions that make the most difference in a really nimble way whether that be on data or idiosyncratic risks like concentration of liabilities. Corporate sole trustee enables this being done in a mindful, ‘clean as you go' way. Corporate sole trustee also fits well with the General Code requirements since you are able to streamline across schemes and not reinvent the wheel; this can be helpful for smaller schemes.

Kevin Clark: The sponsor is looking for somebody experienced, rather than the lay trustees who were there when the scheme got fully funded and ready. That experience will get the deal done while avoiding the pitfalls, on budget and on time.

Lynn Pointon: Smaller schemes often have a history of spikes of activity around trustee meetings and then things fizzling out for several months. A professional trustee, whether it is sole or co, can keep that momentum going.

Paul Tinslay: There are benefits of having a professional trustee versus the cost. For example, very recently, for a small scheme of less than £100 million, I have saved £750,000 a year on the Fiduciary Management fees. This level of saving makes the cost of a professional trustee fairly negligible.

Professional trustees can also look across schemes horizontally rather than vertically, particularly with their sole trustee arrangement. If you have the same actuary and fiduciary model across a group of schemes, you get benefits of scale.

Sarah Leslie: Cost control is important. However, this is not about getting the cheapest option, it is about getting the right value and spending the money in the right places to get the right outcomes.

Simon Partridge: When we look at pricing a fiduciary mandate, we consider whether we have an existing relationship with the scheme's other advisers and trustees in particular. If a sole trustee is in place, there tend to be fewer meetings and these are often focused on a particular topic – which may be discussed across multiple schemes, and therefore the cost shared – which makes those relationships different to traditional fiduciary mandates. Large trustee boards typically involve a range of experience, requiring more training and meeting attendance, increasing the cost of service.

Is fiduciary management a cost-effective option for smaller schemes?

Aqib Merchant: It is a cost-effective solution if you think of it holistically. A traditional consultant model often begins with standard fees, but quickly incurs additional costs for strategy reviews, manager selections, implementation statements and other add-ons. These extras can accumulate, making the overall approach significantly more expensive than the fiduciary model where all these are included.

Kevin Clark: Small schemes can access sophisticated investment solutions to mitigate risk now via pooled funds developed by competing managers.

Cost is an issue that consolidation could help mitigate. What are the broad options for consolidation for schemes, particularly those at the smaller end of the market?

Sam Burden: We have one scheme moving to a DB master trust to solve a particular technical problem. Even within that master trust space, there is a range of options and that can be particularly helpful solution for small schemes with administration issues.

However if your timescale is short, it is challenging. Does it make sense to go through the pain of moving administrators if you have a very short timescale? There are more options than just master trust, but that has been occupying my attention over the last few months.

Annabelle Hardiman: Master trusts are a form of operational consolidation. It is not in itself an endgame option because you go into a master trust with the aim of securing an endgame option, typically buyout, out of that. There is, however, the need to bulk transfer into a single scheme, which brings initial upfront cost and complexity. There are a few options for pure operational consolidation that does not require a bulk transfer.

IGG has recently launched one of these operational consolidators, IGGnite, which seeks to reduce operating costs for smaller schemes by streamlining and standardising services. This is achieved through consistency in trustees across multiple schemes, working with consistent advisors, and creating scale to reduce investment costs, but without losing the individuality of each scheme.

Paul Tinslay: IGGnite is similar to the Dalriada.Together model, in that it is a lift-and-drop model and does not require the existing scheme to be wound up, which is typically expensive. Whatever the end result is, you are on a treadmill first, so it is about what kind of treadmill you want to be on.

The lift-and-drop model offers a cost-effective transfer of a governance framework. Whether you use a DB master trust, a lift-and-drop platform proposition or a consolidator, it comes back to the specifics around the scheme requirements and the employer.

Kevin Clark: Clients can achieve the objective through their own scheme and retain control. There might be certain cases where a master trust works for them. We were involved in the PPF+ (Pension Protection Fund-plus) case that we placed with Clara, but most schemes should be able to control their budget better on their own, rather than involving a third party. There are, however, various master trusts that allow a professional trustee to get involved in. For the majority, own trust is the affordable solution for a client.

Annabelle Hardiman: There are lots of options already to meet every client's needs. Perhaps there is a lack of understanding of the different options in terms of what they are seeking to achieve and what type of client or scheme they suit best.

Lynn Pointon: Professional trustee firms all have slightly different operating models, but the principle we all share is that, because we can put in place solutions across our portfolios, it gives schemes access to economies of scale.

How do smaller scheme trustee boards and sponsors know about the options?

Sam Burden: Professional trustees are positioned to be the helpful voice and bring wider experience. However, the challenge is that small schemes are often limited in how much meeting time they have, so trustees cannot necessarily bring every idea in one go but need to be selective.

It is challenging just to make sure that other trustees are keeping up to date with the latest developments, understanding what is happening with their investments and new requirements such as the new funding code.

Paul Tinslay: It comes down to the level of knowledge and understanding of the trustee and the advisors. Even now, when I ask advisors to explain to me the differences between professional trustee firms, the level of knowledge and understanding can be a little frustrating.

Scott Pinder: It is our professional responsibility to show the spectrum of options and the advantages and disadvantages of all models and features transparently and be front-footed in doing so with schemes and advisers.

Sarah Leslie: It boils down to two things. There is a knowledge piece, where we use the term ‘consolidation', because it's easier for the trustees and MNTs to understand.

There is also an education point. For schemes without budgets to explore consolidation, or time, it is still important to go out and ask the questions. Whether it is professional trustees, fiduciaries or advisors, most people will offer a free discussion if you ask to increase knowledge and understanding for a trustee.

The flip side to asking for help educating the trustee is conflicts - and clearly understanding that if my advisor does not offer fiduciary, it is not in their interest to bring fiduciary as an option. If my professional trustee has an offering of their own, they are likely to bring that rather than get an advisor to do it.

Aqib Merchant: Trustee boards should understand what is and is not a proper option for them and understand those conflicts of interests that various advisers bring to the table.

Kevin Clark: Trustee boards can review case studies in the public domain to relate to their own situation. Sponsors will take advice from their corporate advisers on strategy and where a professional trustee can help develop and manage strategy.

Do you agree the PPF, as a public consolidator, is a potential solution for some smaller schemes?

Paul Tinslay: There is enough out there, so it would be another one in the pile. Is it necessary? It might aid competition in the marketplace, which would be a good thing.

Kevin Clark: The market may feel that a PPF extra vehicle could be easier to monitor and regulate, but it could be expensive for a small scheme to enter in terms of changing the benefit structure into a one-size-fits-all benefit structure, as you currently have to do for the PPF.

Adam Davis: A lot of the rationale behind PPF was based on myths and out-of-date information. As I understand it, there were three key objectives. One was using funds for productive finance, but it does not help productive finance to consolidate small schemes with few assets. The second was to support the gilt market, which for similar reasons it will not do. The third one was member security, which is already well covered by the UK insurance regime, so their rationale needs a rethink.

Annabelle Hardiman: Part of the reason schemes aren't yet able to buyout is due to ongoing data cleansing work being needed. However, we have a lack of administrators in the industry to do the work. As part of the proposed design of the PPF consolidator, schemes would need to go through a lot of upfront data work to join. This may put additional strain on administration capacity, as well as increasing costs for small schemes.

Sarah Leslie: There must be a clear level of understanding of the PPF offering. If we were looking at a master trust or consolidation as options, I would want to understand what they are offering to my scheme and the performance. At the moment, they are taking on assets because those schemes have no other choice. That is very different to me actively deciding to put my assets with you, and you delivering a performance objective that is right for my scheme.

What are your key takeaways or concluding comments from this discussion?

Lynn Pointon: My takeaway from today is that I am quite heartened that, in general, there are options for small schemes. I still remain concerned about the tiny schemes, but, for small schemes, there are options. These will evolve and we will keep an open mind and work out what is best for our clients. In terms of changes, we have been very focused on DB today, but we have seen a lot of consolidation of DC schemes and there is going to be a lot more of that in the future.

Adam Davis: There are a lot more options coming to the table for smaller schemes than there have ever been, so it is generally a positive market. One of the key things, from a member perspective is that, with all of those options, whether it is buyout, whether it is Clara or whether it is a master trust, the member experience is down to the admin. We have mentioned the point about admin capacity, and the big challenge for the industry is to crack admin. Let us not forget that most schemes are closed, so we have a finite universe of about 8.5 million people who have DB benefits and who, each year, are one year older. Run that forward and, in the next five or six years, you are going to get a peak of deaths. Half of them are deferreds. You are going to get a peak in at‑retirement decisions, which are all going to be dealt with by this finite universe of administration, plus all the buyout work, the dashboard work and the other stuff. If we are not careful, that will be make for a very difficult environment for administrators.

Scott Pinder: I am going to go with a slightly positive tone. Come join the excitement club about smaller schemes. Let us not have any more Les Misérables on that. I would say that there are lots of options out there. If people are feeling anxious about small schemes, anxiety is the absence of a plan, so let us have a plan and some optimism about the majority of schemes. We have also heard from insurers that they really value approaches from schemes with professional trustees, be that corporate sole trustee or otherwise; they know the homework will be done and difficult questions already answered.

Simon Partridge: We have talked a lot today about options and challenges for smaller schemes, but I think there are lots of positive opportunities for these plans. There is lots of innovation and disruption in the market, whether it is because of the events of two years ago, or because of newer things that smaller schemes can look at now: sole trustee and bundled approaches, master trusts, broader consolidation, as well as an increased willingness and appetite by buyout providers to quote, especially given the new entrants to the market. These are exciting times and fiduciary management can help with any one of those options. It can give schemes of all sizes that ability to be flexible in their journey to whatever the end stage looks like.

Annabelle Hardiman: Whatever changes are made, regulators need to ensure these reflect the current landscape and what options are already available to small schemes, as well as taking a broader, more holistic and long-term view of what the objectives are and how those objectives can best be achieved.

Aqib Merchant: A key theme emerging from this discussion is the cost and governance challenges faced by small schemes, and how best to address them. Fiduciary management presents an excellent governance solution if you do not want to think about the day‑to‑day running of the scheme. By delegating to a fiduciary manager, schemes can benefit from cost-efficient expertise while focusing on achieving their long-term objectives.

Paul Tinslay: My takeaway from today is that, although solutions for small schemes are out there, they are probably not well recognised or understood, so there is a definite gap in the customer's understanding. Advisors also need to understand the full scope of options themselves in order to give the advice.

Sarah Leslie: My takeaway today is inquisitiveness. Try to understand exactly where you are trying to get to. Make the most of the free information that is available across the industry. Reach out to people. If you do not have answers, there will always be people out there who can help you and, a lot of the time, it will not cost you anything – just be mindful of conflicts as you go!

Sam Burden: I am going to do a bit of future-gazing. The first thing is that we will just see the industry get better at taking schemes through to buyout, the number of schemes going through the process will increase because it will become more commoditised and essentially everybody will just get better and more efficient at the whole process.

Second, going back to the Pensions Review. The government has come in and said it is absolutely focused on growth and improving productivity in the UK economy. Government is thinking about ways in which it can use pensions to generate growth. We have already seen that in a DC context, and that will be its priority for DB schemes, perhaps with the PPF as the consolidator.

Kevin Clark: Today's discussion highlights the numerous options available to DB scheme nearing their end game. Meanwhile, the Pensions Review is keenly awaited amid information that only a small percentage of members of auto-enrolment pension schemes are projected to achieve a moderate retirement income. Also, the value for member framework consultation will aim to provide better member outcomes from competing providers.

This roundtable was held on 3 October 2024 in association with Russell Investments