In this webinar, panellists discuss some of the key questions around defined benefit consolidation, including what it is trying to achieve and the suitability of various models
Roundtable from www.professionalpensions.com
Discussion answers from Luke Webster, Co-founder and chief executive, The Pension SuperFund
Q. What are defined benefit (DB) consolidators and what do they aim to achieve?
It is about achieving better member outcomes within the pensions regime. Looking at the DB landscape in the UK, there are a great many schemes that would potentially be denied the benefits of consolidation because of the current high affordability hurdle of insurance. We’re looking to provide a solution for those schemes and their members where insurance is not a realistic option.
We’re acknowledging there is risk within the pension system. Currently that’s distributed in a way that is not transparent and is confusing, particularly from a member perspective.
We have the situation where members of a scheme – if they have any deficit whatsoever – are wholly depending on their sponsor’s success to maintain full benefits. If things go wrong, they’re likely to be looking at a haircut either through a PPF-plus buyout or entry into the PPF itself.
Similarly, there are many sponsored schemes that are relatively large compared to the operating business. Therefore, the scheme deficit provides a present risk to the going concern of those sponsors.
We are trying to separate the investment and asset and liability management risk, and keep that within the pensions regime, leaving businesses to flourish and manage business risks. That provides a mechanism to achieve a transfer of funds into the pension system on day one by achieving a sponsor top-up to our entry criteria and attracting new investor capital to reduce the overall risk.
It is about working with the risks of the pension regime, getting external capital in to achieve a net reduction and managing things in a resilient and professional way in the long term.
Q. Are superfunds attractive where there is a risk of employers defaulting on their promise?
Definitely. Consolidators are for any scheme for which other forms of endgame are not necessarily viable options. That encompasses a range of different circumstances: for instance, a situation where a scheme is in a good funding position and the sponsor is a strong business but the scheme is very large compared to the sponsor. Even though the sponsor has a strong business, it would never have the wherewithal to make a material dent in a large deficit.
Situations where the sponsor covenant is obviously weak would be our core market: where the sponsors are on the brink of insolvency because the scheme is not funded sufficiently to achieve a buyout. The alternatives for that scheme would be a PPF-plus buyout or the PPF itself. In either case this is likely to lead to some reduction in what the members had previously expected to be their full benefits.
A consolidator operating with slightly less capital and with somewhat more risk could offer a potentially higher level of base benefits. As long as risk is trans- parent, that’s a legitimate consideration for scheme members and their trustees.
Models such as ours – where there’s potential share for members in any outperformance – could enable those members to get closer or exceed their original promised benefits. That distressed state is an interesting sector for us.
Q. What’s in it for the providers of the capital? What are their return expectations? How do these capital providers make their returns?
If capital providers are putting their capital at risk, they will expect a return. Both of our solutions – Clara Pensions and The Pension SuperFund – have extremely conservative and low risk asset and liability management approaches. Massive outperformance is not really what we’re about. Modest but consistent outperformance is more than sufficient to generate attractive returns for investors and, in our case, enhanced benefits for members.
There are only a limited number of ways you can structure the capital buffer into which external investors inject their funds. Within a given risk and reward structure for the whole scheme, that can be adjusted for individual parts.
It is possible that some consolidators will have high returns and high risk for investors. Others may have lower returns and lower risk for investors. In either case, you would expect the whole portfolio to be managed in a very low-risk way, seeking to achieve security and certainty of outcome for members.
Q. What should people going down this route expect? What is involved in consolidation?
The legal pathway for a consolidation is the same as for a buyout. The only key difference is the pensions regime transfer. There are potentially some areas in terms of assets, for instance, that could be transferred where we can have a higher level of flexibility. We’re building up to scale. Issues such as data quality and so on are more significant with the initial transaction. It will be a very thorough and comprehensive onboarding process.
Q. Is there a minimum size scheme to accept into your superfund?
The structure we have in place is a heavy duty and resilient governance one in terms of the trustee board and its resources including the checks and balances that we need to maintain across the whole administration and asset and liability management.
We think about £5bn is our minimum operating scale. We want to get there as quickly as possible. That means in our triage of new opportunities, we will prioritise larger schemes. Once we’ve passed that rubicon, we’ll be much more flexible. It becomes a virtuous circle as scale increases because we’re a commingled fund. The potential impact of uncertainty – which is bigger in small schemes – becomes diluted overall.
Once we’re at scale, we hope to be able to offer a solution to much smaller schemes. At the moment we are prioritising large deals in order to hit that scale.
We welcome help from the government and The Pensions Regulator (TPR) as well as the advisory industry in making the process as painless as possible for smaller schemes. There are a lot of considerations for trustees. Smaller schemes potentially stand to benefit most from the economies of scale and improved governance that consolidation can bring. It is important the costs of getting to that point are not prohibitive.
We have seen some evidence of that being the case for small and well-funded schemes that could theoretically achieve buyout. They are not getting there because the cost of the transaction is too high.
Q. When do you expect to announce your first deals and when are they likely to be completed? What do you think the market demand will be for this solution?
Our original market study just over a year ago now seems extremely conservative given the level of interest in the conversations we’ve had. We’ll release details of ongoing transactions when it’s appropriate to do so.
I’m sure my experience is identical to Clara Pensions in terms of interaction with the regulator.
Q. What are your final comments?
Consolidation is a potentially huge opportunity for the pensions industry to organise itself in a more effective way, leading to better outcomes for members in the long term. I’m excited to be part of that.
This is an edited write up of a webinar held on 21 May. Listen to the discussion in full at: https://bit.ly/2LLxuSc