Weighing up your consolidation options
There has been a lot of talk about DB scheme consolidation over recent months, driven by the arrival in the market of two new consolidation vehicles, Clara and the Pensions Super Fund. But consolidation itself isn’t new. There are lots of ways to reap similar benefits. And consolidation itself is only one of a number of possible ‘endgames’ for pension schemes.
When I am journey planning with my clients, the first question I ask them is the most fundamental: where do you want to get to? This question inevitably triggers a good discussion around a number of ‘endgame’ options.
- Are you expecting to run on?
- For how long?
- Do you want to insure?
- When and how do you think that might become possible?
Every scheme answers these questions in a different way. Every destination they describe is different, sometimes only subtly. But once it’s clear where they’re going, it’s a lot easier to plan a route – and to allow for a few obstacles or changes of direction along the way.
Given that there is no single destination for a DB scheme, and no one ‘best route’ that works for everyone, then it follows that there is no single ‘best approach’ to consolidation either. So how should schemes weigh up their different options?
The first step is to consider the full range of options
Put simply, there are lots of different ways to consolidate. Each has its merits.
Sharing services or governance
Schemes can share services to gain cost efficiencies. It is common when several schemes are sponsored by a single employer: just because they are sponsoring three schemes, it doesn’t necessarily follow that they need three different actuaries. It also happens on an industry-wide basis, as with the railways pension schemes, which share administration and investment services.
As well as sharing services, schemes can share trustees too, either by becoming part of a DB master trust, or by asking a single, independent trustee to manage their governance.
Schemes also have the option of merging. As with sharing services, this can happen with schemes sponsored by a single employer, or across an industry. And mergers can be full or partial, meaning the new, larger scheme continues to run its constituent parts as segregated sections.
Schemes can be absorbed into the Pension Protection Fund (PPF). This isn’t normally thought of as a consolidation option. Yet that’s exactly what it is, albeit an option that’s only chosen when a sponsor becomes insolvent.
Then there are the insurance options. Bulk annuities – the buy-in or buy-out models – have been available for decades, with the market accelerating sharply over the last ten years. These options aren’t open to every scheme. Schemes need to be sufficiently attractive to interest the insurers. That is largely about the combined level of funding available from scheme and sponsor. For those with enough funding, insurance is often viewed as a ‘gold standard’ option, even if it isn’t quite a cast-iron guarantee.
All this brings us to the new ‘commercial consolidators’. Like all the options I have looked at so far, the benefits to schemes are clear. Services, costs and governance can be shared, which creates savings and efficiencies that aim to make the schemes financially stronger. There’s the promise of a different financial support structure – and specifically a ‘buffer’ from investors that may look attractive to schemes with weaker covenants, as long as the employer has enough cash for the required initial funding. As with DB master trusts, or the pension insurance companies though, that has to be offset against a cost – because all three types of consolidation vehicle exist to make a profit. And as with buy-outs and buy-ins, it’s going to require a complex advisory and decision process. Unlike those other options, no scheme has completed a transfer to a consolidator yet.
There’s a lot more to say about the differences between the two new market entrants, the likely changes in regulation that will affect how they operate, and the implications for schemes. There’s also the prospect that yet more new consolidators will come into the market. I’ll come back to all of that in future blogs.
The second step is to weigh up those options and decide what’s right for you
Once you’ve decided to consolidate, and you’ve widened your consideration set to include all of the suitable, different ways that can be achieved, then it’s time to make a choice.
That’s likely to involve a lot of parallel assessments of the options you’re considering.
If you’re breaking a link with your current sponsor, you’ll need to consider how strong your new covenant is likely to be. That might involve weighing up the covenant strengths of different consolidators, as well as that of your existing sponsor.
You’ll need to look at security too. How much capital will be available? What happens if funding dips too low?
If you’re looking at a third party, then you’ll want to look at how they’ll handle administration and governance, as well as their approach to investment. With the new consolidators, it will take time for a track record to materialise, so you’re likely to need to do some modelling and prediction in the meantime. You’ll also need to assess the likely timescales for implementation.
And with all these options, you’ll need to consider the impact on members. Each of these assessments merits a blog of its own, so again, I’ll return to these subjects another day.
In the meantime, my advice is what it always has been. Think about where you’re trying to get to. Consider the different ways you might get there. Plan some scenarios – which might include getting to your destination more quickly or more slowly. And take advice. Talk to your colleagues, your peers and your advisers, and talk to the different kinds of consolidator, so you’re sure you understand which options are open to you, and which will work best for your scheme and its members.
Note that the DWP has recently released a consultation paper on the potential regime for the new consolidators. This blog was written before that publication and I will return to that point in more detail in a future article.
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