Following the Government’s white paper in 2018, several commercial consolidators have entered the market, to try and provide an alternative option to an insurance buy-out for DB Pension Schemes.
What is the commercial consolidation model?
In essence this can be viewed as a DB Master Trust, where the employer is replaced by a conglomerate of pension schemes with a combined strong covenant.
The main difference from the current regime is that Consolidation allows the sponsoring employer to separate from its pension scheme in exchange for a value related to its covenant. Although akin to a buy-out of liabilities, the new vehicle would fall outside the insurance regime and therefore not be subject to the capital requirements of the Solvency II Directive. The theory is therefore that it will be more affordable than an insurance buyout, however, this will be at the cost of a lower degree of benefit security.
HOW THE COMMERCIAL CONSOLIDATION MODEL OPERATES:
- A private company sets up a new DB pension arrangement.
- It will take over the responsibility for meeting the liabilities of the admitted pension schemes in exchange for a one-off payment or structured payments from the previous sponsoring employers.
- The private company will then act as the ‘sponsor’ for these consolidated schemes with a new board of trustees responsible for the overall scheme governance.
- The covenant is initially provided by additional capital supplied by external investors who expect a return for their investment.
WHAT TYPE OF SCHEMES ARE THE COMMERCIAL CONSOLIDATORS 3TARGETING?
- Closed to future accrual.
- Member data is of a high standard.
- Are relatively immature with a proportion of at least 20%+ of non-pensioner members.
- The sponsor covenant is rated as less than strong, or there are uncertainties about the long-term covenant of the sponsor.
- Are reasonably well funded, so any cash top-up is potentially affordable to the sponsor (but buy-out with an insurer is not affordable).
It is recognised that only a small proportion of DB pension schemes will be able to consider commercial consolidation. However, even 10% of UK DB schemes represents a very significant volume of pension schemes and some £200bn liability.
I set out below what the key considerations should be for a trustee, in deciding whether it is suitable to engage with a consolidator:
- The duty to fully satisfy themselves that the funding level of and security in, the consolidator sufficiently matches the ongoing support provided by the original sponsor.
- How it would improve member outcomes alongside considering what other options are there?
- Would it be better to remain with the sponsor long term and waiting for a possible buyout?
- How member security may change over time in the context of the structure of the consolidator, its mechanism for returning capital to investors and how investment decisions are made in the consolidated scheme.
- Compare the likelihood of receiving potential future contributions from the sponsor against the “bird in the hand” of an immediate contribution and additional physical capital.
- Consideration of non-financial factors such as the views of the membership.
Clearly, trustees will need to seek detailed legal, actuarial and covenant advice to be able to fully assess all of the above.
It will be interesting to see the outcome of the Department of Work and Pensions’ consultation that commenced earlier this year, looking at the regulatory framework for these new operating models and when it is debated by Parliament.
The Pensions Regulator will need to provide regulatory clearance to a sponsor/trustee of a DB scheme looking to move to a consolidator and it will be interesting to see how it does and what the outcome is. We all will be keeping a watching brief!