The last 20 years in pensions have been dominated by moving to DC and managing DB liabilities. As a result, DC innovation has flourished, particularly since auto-enrolment and TPR authorisation of Master Trusts. But DB has not been forgotten. DB risks continue to be managed by Trustees and Sponsors. Helpfully, DB innovation is out there in the form of Consolidators or Superfunds. Thanks to TPR’s recent interim guidance we could see the first transactions completing very shortly.
2019 was a record year for insurance buy-outs of DB liabilities. But for many schemes, the gold-standard of insurance buy-out is not an affordable option now or in the near future. Clearly an opportunity existed for a more affordable option for Trustees and Sponsors to improve benefit security for members. New solutions have come to the fore thanks to the likes of Clara Pensions and The Pensions Superfund. These provide a more affordable option to transfer covenant risk from the sponsor to a stable, financial covenant through consolidation – but what does this mean in practice?
What is a DB consolidator or superfund?
Essentially, a DB consolidator (also known as a superfund) is a model which transfers DB risk from the original sponsor to a replacement employer (who is supporting a consolidator scheme). Of course, that risk transfer does not come cost free and the consolidators are commercial. In return for the scheme assets plus a capital payment, sponsors can fulfil their pensions obligations and hand the reins over to their consolidation vehicle of choice. The consolidator provides a cash injection in the form of a ‘capital buffer’ to meet the liabilities as required.
The models and objectives of the providers differ slightly. One model ring-fences scheme assets, allowing ceding Trustees to identify their scheme’s assets post-transfer. The capital buffer for each scheme is also held separately, for the sole benefit of a particular scheme’s liabilities. Contrast this with the model where each scheme’s assets and liabilities are pooled, and the capital buffer is there for the liabilities of all schemes within the consolidator.
Ultimately the objective of the consolidator will be to secure the members’ benefits with an insurer. The intended timing of that journey to buy-out will differ by consolidator.
A consolidation vehicle can achieve economies of scale through shared advisors, Trustees and administration services. This scale also allows for investment de-risking and strong governance.
What types of scheme should consider consolidation?
Consolidation could suit any scheme where a full insurance buyout is not a reasonable option for the foreseeable future. This could be a well-funded scheme where the scheme is large in comparison to the size of the sponsor; or schemes for whom the employer covenant is considered weak. This was supported in TPR’s published guidance in mid-June. TPR stated that it would not support the use of a consolidator for schemes with a reasonable chance of buyout in three to five years.
At this stage it is unclear whether there is a minimum scheme size that consolidators will consider. Certainly, these providers will be looking to build scale quickly. As such, we expect to see larger schemes being prioritised at the outset, at least until such time as some economies of scale have been achieved.
With TPR now having taken a position on DB consolidators there are renewed calls for a not for profit consolidation solution as an option for smaller schemes. This proposal would see underfunded schemes with weak sponsors compulsorily transferred and certain other schemes able to transfer on a voluntary basis. This would allow weaker schemes to benefit from cost savings from economies of scale. The employer would maintain their link to the scheme and continue to be responsible for deficits.
Businesses and the economy have suffered through recent events. Employer covenants have weakened. According to the PPF, funding levels of DB schemes eligible for PPF entry have reduced from 99.4% at the end of December to 90.9% at the end of May (on a s179 valuation basis).
More businesses will be looking for ways to manage pension scheme costs and risk. The pricing of buy-out will continue to be unachievable for many and the cost of consolidation may be more palatable. For Trustees, the question is about replacing the existing employer covenant with a financial covenant with a known value, which has been funded up front.
TPR’s guidance and intended supervision framework recognises that consolidation can help reduce the burden on sponsors and improve security for members. Consolidators have welcomed TPR’s guidance but await the formal approval needed for them to complete that first all-important transaction.
Contact Tina Oversby at GO if you would like to discuss DB de-risking opportunities