Let's stick together
DB scheme consolidation is this year’s hot topic. But can the pensions industry find sufficient harmony to make it happen?
When the Pensions Regulator, DWP, PPF, PLSA and representatives from some of the UK’s biggest pension schemes sit together on a conference stage, you know there is a problem.
That problem is the parlous state of defined benefit (DB) schemes in the UK. The PLSA’s DB Taskforce launched the results of its investigation, The Case for Consolidation at its Investment Conference last week. In his introduction, chair of the taskforce, Ashok Gupta, referred to ‘systemic failure’ of DB provision. While others on the stage (including the Pensions Regulator) contested the ‘systemic’ element, in the wake of the BHS scandal it is impossible to argue that there has been ‘failure’.
The report follows hot on the heels of the DWP’s green paper Security and Sustainability in Defined Benefit Pension Schemes. “The green paper put out a complacent message that there isn’t too much of a problem,” said Kevin Wesbroom of Aon and a member of the taskforce. “But the taskforce’s conclusion is that a lot of people could lose a lot of their pension.”
At present, there is no straightforward alternative to the worst-case scenario of a member being hit with a substantial benefit cut as a result of a fund falling into the PPF, other than buyout (expensive) or genuine self-sufficiency (increasingly rare). Given that 42% of defined benefit member promises are in schemes with only a 50/50 chance of paying those pensions in full, there is clearly room for new thinking.
Enter the superfund. Or rather, superfunds. The DB Taskforce sees these as solutions that could be run by private or public-sector entities alike.
The rules are as follows: trustees, following consultation with members, must agree to transfer the scheme and its assets into the superfund. Employers pay a fee to the superfund to reduce the underfunding of that scheme and discharge themselves from responsibility. In return, the new structures will provide consolidated administration and governance, and manage pooled assets. There would also be a single, standardised benefit structure for members, and the fund would be managed to carefully prescribed capital levels to ensure its viability. Members would get paid, if not in full by their original scheme rules, then certainly above PPF levels. Superfunds would have sufficient scale to invest in ‘real economy’ projects benefitting the UK as a whole. Employers would be free from the millstone of legacy DB, enabling them to concentrate on the proverbial widget-making. What’s standing in the way?
“There is a mindset in the sector that consolidation is really difficult to do. Unless there is a catalyst to break that mindset, nothing will change,” said Gupta.
Pie in the sky?
There is justification in the sentiment that it is difficult to do - but when the impetus is there, the collective pensions industry is perfectly capable of tackling ‘difficult’. A fair and consistent mechanism for harmonising benefits, political and regulatory commitment, and substantial cultural change are all required to make consolidation a success.
But those three things will not happen overnight. There are genuine technical and regulatory challenges. At first glance, the actuarial acrobatics needed to harmonise benefits could make GMP equalisation look like The Times’ quick crossword. But Wesbroom of Aon is undaunted, describing it as a “giant PIE [pensions increase exchange] exercise”.
‘Giant PIE’ could be one hurdle off the list. Next up, regulation. Perhaps learning from the DC mastertrust experience, the Pensions Regulator Lesley Titcomb is rightly insistent that any superfund regime must be fully-formed from day one. She also cautions that it could look “more prudential than conduct”. That opens up a further consideration: to the untutored eye, without sponsors to underwrite them, superfunds start to look suspiciously like insurance products. One obvious point of difference would be for the PPF to maintain a safety net for superfunds. Even the Taskforce acknowledges that the relationship with the PPF is still far from clear.
Getting regulation right is about sufficient political commitment, time, intellect, research and detail (and of course the cost associated with those) - it is not simple, but neither is it an impossible task. And, ultimately, the regulator could be in the position of looking after a smaller number of well-run consolidated schemes, rather than the jumble of governance standards that it currently encounters.
So. Equalisation. Check. Regulation. Check (probably). Cultural change and industry adoption?
“There is desire for consolidation and clear advantages from benefits of scale. Why are we not seeing this anyway?” asked Charlotte Clark, director for private pensions and stewardship at the DWP. Why indeed. There are DB master trusts out there already (albeit not with all the features of a superfund) but take up is very low. Anecdotally, the reasons are varied. A lack of genuine cost savings has deterred some, as has turkeys-don’t-vote-for-Christmas reticence from consultants loathe to recommend a solution that loses them a client to a consolidated scheme.
Then there are buyout providers, who might argue that they are already superfunds of a sort. Some have evolved their offerings to help schemes that are less than 100% funded move towards buyout. Will the cost differential be sufficient to make superfunds a genuinely affordable alternative?
And then there are the schemes themselves. Trustees, members and sponsors must agree to the move into a superfund, relinquishing their involvement with the scheme. Some trustees may feel that they have delivered for their scheme through tough times, and feel that they want to finish the job, whether self-sufficiency or buyout.
This is not about consultants, commercial providers or even trustees, however. It is about members. The current binary scenario where individuals either receive 100% of their benefits through a healthy scheme, or risk losing as much as a quarter of their expected pension when their fund goes into the PPF is clearly unacceptable. That is the point from which all other discussions must start.
It remains to be seen whether superfunds will be the answer to the problem of ensuring members see as much of their pension as possible. The DB Taskforce itself admits there is much work still to do in even understanding if this will work. But it has at the very least initiated debate - and that could be just the catalyst that Gupta wanted.