The Department for Work and Pensions (DWP) is to launch a consultation this year on the legislative framework and authorisation regime to enable the establishment of commercial consolidation vehicles for DB schemes, its Protecting Defined Benefit Pension Schemes white paper has revealed.
Under this model, a private company would set up a new defined benefit pension scheme and take over the responsibility for meeting the liabilities of other pension schemes in exchange for a one-off payment or structured payments by the previous sponsoring employer. The company then acts as the ‘sponsor’ with a new, board of trustees responsible for scheme governance. The covenant is provided by additional capital supplied by external investors who expect a return for their investment.
“Commercially-run consolidation vehicles would be a major shift in the defined benefit sector – but if designed properly we believe that they could both reduce some inefficiency within the system and have the potential to offer better long-term outcomes for certain scheme members whilst offering an alternative strategy for managing legacy defined benefit schemes … We are convinced of the significant benefits that consolidation can bring if legislative and regulatory frameworks are designed properly and risks mitigated,” the paper stated.
According to the white paper, its initial thinking is that these new consolidation vehicles would be authorised and supervised by The Pensions Regulator.
“At present, the regulator has no power to set the terms under which a defined benefit consolidator is established. An appropriate authorisation and supervisory process would therefore need to be established in legislation to ensure commercial consolidators meet all the framework requirements we put in place for the operation of such vehicles,” the paper stated.
The conditions required for a scheme to transfer, and the cost for doing so, would be determined by both the framework the DWP would put in place and market competition – much like the way the bulk annuity market operates – it added.
The relationship with the original sponsor and the consolidator in which the scheme enters into needs to be considered. While the PLSA’s DB Taskforce work presumes breakage of the sponsoring employer link in return for additional funding and capital investment in the consolidation structure, the market may also design other models where the consolidation vehicle retains some form of attachment to the sponsor of a scheme entering the consolidator vehicle, “for example in the form of an equity stake or debt repayment arrangements to fund any shortfall in assets transferred”.
Therefore the framework will need to be sufficiently flexible to cope with different models without allowing member security to be compromised, the DWP said.
The consultation would also look at the long-term funding objective for the consolidator, and the amount of capital buffer required.
The investment strategy consolidators should adopt will be consulted upon, with the DWP expecting a low-risk or cashflow-matching strategy to be implemented, with unrewarded risks hedged effectively. The level of funding in which the consolidator cannot fall below will need to be considered, as will the extent in which third-party capital providers can extract profit from the consolidation vehicle.
According to the paper, a key issue to be resolved is what would occur if a DB consolidation vehicle was to fail and whether it would be eligible for the PPF in that scenario. The reassurance of the PPF versus other security options, such as requiring consolidation schemes about to wind up to instead implement a buyout, are to be considered.
“Much depends on the wider funding requirements that are put in place, but consolidation of a large number of schemes into one sizeable consolidation vehicle would clearly pose a very different, concentrated risk to the PPF than the current position (where risks are dispersed across schemes with different employers and different investment strategies),” the paper stated. “The government will also need to decide whether it is appropriate for PPF members and levy payers to effectively underwrite a commercial, profit-making venture.”
The governance structure of DB consolidation vehicles, its regulatory framework, and the extent of levies charged against it will also need to be discussed, the paper added.
“There is a delicate balance to be struck. If the legislative framework is too restrictive, then the consolidator vehicles may not be commercially viable but if the vehicle is under-protective of members, then the risks to members’ benefits will be unacceptable,” it said.
The DWP also stated that member benefit simplification could be advantageous to schemes hoping to consolidate, but the department is “not yet convinced” that any legislative change that allowed trustees to simplify members’ benefits without consent, potentially overriding scheme provisions, is justified.
The paper also stated that there are already several different options available for DB schemes to consolidate, namely through shared administrative services, asset pooling, fiduciary management and DB master trusts.
However, there is a limited uptake of existing methods of consolidation, possibly due to an established practice of trusteeship and sponsorship wanting to retain full control of a scheme, regardless of the potential cost savings and increased security to members.
Therefore the DWP will be consulting this year on a new accreditation regime that could help build confidence and encourage existing forms of consolidation. It will also work with The Pensions Regulator to raise awareness of the benefits of consolidation with trustees and sponsoring employers, through, for example, the regulator’s Trustees Toolkit, and by updating guidance. In addition, the Chair’s Statement could require schemes to consider whether consolidation would be beneficial under certain circumstances.
Commenting on the DB consolidation proposals, Hargreaves Lansdown head of policy Tom McPhail stated that “if we can end up with fewer, bigger, better-un schemes then all stakeholders including members, regulators and employers are likely to benefit”.
The Pensions and Lifetime Savings Association director of external affairs, Graham Vidler, was pleased to see that the White Paper takes forward the work on consolidation developed by the PLSA’s DB Taskforce over the past two years. “There is a growing body of evidence that consolidation in its many guises could provide the benefits of scale for those schemes that choose to consolidate,” he added.
Broadstone technical director David Brooks noted that "the government has bought into the commercial consolidation idea in a big way with a good summary of some of the challenges to make an insurance scheme-lite framework.
However, "the challenges are clearly still significant and this solution is a few years aware from fruition", he added.
“While it is great that the government is planning to consult on a framework for consolidation, the reality is that we don’t need legislative change for more innovation to happen”, Hymans Robertson partner Calum Cooper said. “The creation of an accreditation regime will undoubtedly help to build confidence in consolidation as an option, encouraging more schemes to look for ways to benefit from scale.”
Echoing this sentiment, Redington managing director, integrated actuarial, Marian Elliot, highlighted that “flexibility to ‘reshape’ member benefits is helpful to consolidation but this was never the real barrier – clear benefit structures and well-defined member data have allowed consolidation even before the new powers were introduced”.
Creating a framework that allows capital to be injected in to pension schemes to increase the chances of paying pensions, whilst also generating returns for the capital providers, should result in a much higher change of members in ‘distressed schemes’ receiving their full pensions, she added. “This structure would only really be possible with sufficient scale – by aggregating several pension schemes – and so the consultation on these frameworks is welcome.”
However, a “significant barrier” will be the quality of scheme data and the systems on which the data is held, Elliot noted, along with the need for caution regarding potential issues of misuse and unintentional pressure to consolidate.
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