Create supertrusts to take on buyout insurers – DB Taskforce

The Government should legislate to create new DB supertrusts that can offer employers the chance to buy out their liabilities at rates lower than those offered by insurers, the DB Taskforce proposes.

Rebuilding trustThe proposal would see employers pay a premium to gain access to the superfund, to reflect the value of their covenant, after which their responsibility for benefits would cease to exist. This would deliver materially better outcomes for members, reducing risks to their benefits and the risks of their sponsor defaulting

The plan has sparked questions about who would ultimately guarantee the supertrusts, how much capital would be needed to establish them and whether members’ benefits could be changed.

Modelling for the PLSA-sponsored DB Taskforce indicates that such a consolidator could improve security for savers in weak schemes – reducing the probability of seeing their scheme fail from 65 per cent to close to 10 per cent or even less. It argues that moving into a superfund could be considerably less expensive than seeking to buy out, and more achievable for willing sponsors. But the taskforce accepts the concept is at an early stage and says further work will need to be done to establish a workable funding basis and level of benefits offered.

The response also argues than £1bn a year could be cut from DB schemes’ bills for asset management, asset services, governance and consultancy costs if private sector schemes were pooled together. It says £600m a year could be saved through combining admin functions across schemes, while asset pooling could save a further £250m a year. Combining governance costs under a single umbrella would save a further £360m a year, the DB Taskforce argues in its ‘The Case for Consolidation’ report.

The report says members of schemes with the weakest employers – schemes which hold 42 per cent of liabilities of schemes in deficit – have just a 50:50 chance of seeing those benefits paid in full, leaving them the choice of trying to manage this risk through heavy reliance on struggling sponsors or hoping to reach buy-out levels of funding which few can afford. While the savings made through combining admin functions, asset pooling and governance would be considerable, their impact on the risk of schemes failing would, unlike the launch of superfunds, be marginal at best, argues the DB Taskforce.

DB Taskforce chair Ashok Gupta says: “We think the biggest gains lie in the merger of schemes, into what we have called superfunds. We believe superfunds have the potential to offer great benefits to members, employers, the regulator, the industry and the economy.

“Members get a better chance of more pension benefits being paid. Employers get a lower cost alternative to a buy-out. The regulator gets a sector with better managed risks. The economy benefits from improved investment by superfunds and employers are freed from onerous DB burdens.”

PLSA director of external affairs Graham Vidler says: “There’s work to be done on developing the superfund idea and the Taskforce will be analysing it in detail over the coming months so we can contribute fully to the Government’s Green Paper consultation.”

KPMG UK pensions partner David Fairs says: “The economies achievable by simplifying benefits and consolidation are unarguable at the smaller end. And having 2,000 schemes run by one set of trustees is much better from a regulatory point of view. The political imperatives of delivering value for money to pension scheme members means consolidation will happen. Whether it happens in the shape the PLSA has set out, I have some doubts, but we are likely to see legislation that will facilitate some sort of pooling.

“Simplification of benefits is essential – I would do it before anything else. It should be done on the basis that members’ benefits under the new basis are at least equal to their benefits under the old regime. That gets rid of any arguments about member detriment, and the cost savings in administration are so great that they would wipe out the extra cost of benefits given to these members in a very short period of time.

“Creating superfunds with different reserving requirements to those of insurance companies is an interesting concept but will require significant risk capital to be put up by those running the funds.  The suggestion that the PPF should stand behind the superfunds begs the question of who will pay the levy to the PPF to support the arrangements? This is a particularly potent question as the PLSA is predicting that up to half of DB pension schemes might otherwise fail.”

Hymans Robertson head of trustee consulting Calum Cooper says: “The PLSA taskforce’s thinking is out of step with the DWP’s Green Paper on the sustainability of DB pensions issued just two weeks ago. The DWP concluded that DB pensions are affordable for the majority of employers. However, the PPF’s modelling suggests that in the worst 10 per cent of outcomes around 1,000 sponsors could be insolvent by 2030.

“For the DWP to say ‘affordability is fine’ seems to be answering a very narrow question. By the DWP’s own statistics DB scheme recovery plans are barely any shorter than they were 10 years ago, despite hundreds of billions of pounds being spent by companies.  And yet when sponsors fail members lose £50,000 on average.

“However, there are good reasons to question whether consolidating DB schemes to improve efficiency and investment returns represents the most effective means of addressing the issues. There’s an elegance to the theory but it feels vulnerable to be being hijacked by reality.

“Moving into a merged superfund would mean schemes would cede control and influence over outcomes. The cost and risk exposure for larger schemes – either in absolute terms or relative to their sponsor – is too big for their trustees or sponsors to surrender control and influence over funding and investment outcomes willingly.

“For smaller schemes it’s clear to see why voluntary consolidation could be attractive. A combination of relatively high fixed running costs and the prospect of achieving lower fees for investment management whilst accessing a wider range of investment opportunities could rightly trump the desire and value of retaining control and influence

“For closed schemes, finding a simpler and more cost effective route to moving members to a standardised benefit scale would generate real efficiencies for the industry, which alongside consolidation of assets, administration and governance could disproportionately benefit the thousands of small schemes.”

“If we look to the experience of the Local Government Pension Scheme (LGPS), here the Government opted for asset pooling over merger. All the evidence showed that pooling assets would deliver the same cost benefits, but faster, than fund merger.”

Association of Consulting Actuaries chairman Bob Scott says: “The ACA is broadly supportive of the concept of consolidation of some smaller schemes and we see conversion to a common benefit scale as an important precursor to that process.

“The PLSA proposes that the consolidator vehicle – the “superfund” – should be separate from the employers who formerly sponsored the schemes. This raises the issue of who should bear the risk of the superfund failing to meet its obligations. Insurance companies have to hold regulatory capital and are subject to strict financial supervision; ordinary pension schemes have an employer to fund them.  Superfunds would have less capital than insurance companies and no sponsoring employers and so, if the available capital is not adequate they will fall back on the PPF.

“The PLSA proposes that entry into a superfund should be a voluntary matter, decided by the trustees and employer following consultation with affected members. We support this structure, which means that smaller well-run schemes can continue to operate independently without being forced to join a consolidator scheme.”

Aegon head of pensions Kate Smith says: “The only way DB scheme could be consolidated efficiently is to simplify benefit structures across all members, creating many losers. DB schemes can be complex arrangements with different membership categories as well as different pension increases.  Allowing employers to walk away from their DB schemes, creates a moral hazard, and needs to be treated very carefully by government and regulators. Removing the link with a sponsoring employer also removes DB schemes financial back-up plan, and could weaken members’ position. It’s absolutely fundamental that the funding and solvency of any superfund is robust with clear rules on who makes up the shortfall.“