14 November 2018
The possible attraction of DB consolidators from a corporate sponsor’s perspective is clear: a clean break from their DB pension promises at a cost that is (potentially) materially below the insured buy-out cost, particularly for less mature pension schemes. Consolidator vehicles may be particularly interesting for companies looking to make themselves more attractive to potential buyers, or for overseas companies that have little UK presence other than a subsidiary with a legacy DB pension plan. Trustees of schemes backed by sponsors with relatively weak covenants or uncertain outlooks may also be interested.
Too good to be true?
Well…Yes and no. You can interpret the lower cost as reflecting the weaker security of consolidator vehicles compared to a regulated insurance company. However if insured buy-out is not likely to be affordable in the short/medium term (if at all), then would an immediate transfer to a consolidator be a better solution for a number of pension schemes (and their members)? This really boils down to the question of member security, and hence covenant. The chart below illustrates how the position of the scheme would change following a move to a consolidator.
How do DB Consolidators make their money?
The consolidator vehicles in the market look to benefit from the economies of scale of consolidation. This is similar to how traditional buy-out insurers make their money but, as commercial consolidator vehicles sit outside the Solvency II insurance regime and are overseen by the Pensions Regulator, they are not subject to the same strict regulations and capital requirements as the buy-out insurers. However, a DWP consultation is expected very shortly on a possible new regulatory and accreditation regime for these vehicles.
So...Is this an appropriate solution for my scheme?
These solutions may not be a silver bullet for UK DB schemes; most will still need substantial cash contributions to reach the consolidator’s pricing levels, and the target market is acknowledged to be a relatively small subset of the overall DB market… although with total UK buyout liabilities of c.£3 trillion, this “small” subset is still of the order of £300bn!
As well as those schemes where a transfer to a consolidator may increase the likelihood of members getting paid their benefits in full, there may also be cases where a transfer to a consolidator is expected to ultimately result in better benefits for members than if their current scheme were eventually bought out with an insurer.
Although it is likely to be a difficult (and significant) decision for schemes to decide whether a consolidator is appropriate, that should not deter both sponsors and trustees taking a serious look at what these vehicles offer.
Okay I’m interested…but which consolidator?
An additional complexity is that there are currently two different vehicles with quite different propositions (with further entrants to the market expected.).
At a high level, the key structural difference between these two propositions is that one looks to run off liabilities and share any upside through an increase to member benefits (the Pension SuperFund), whilst the other targets buy-out and shares any upside by moving to buy-out sooner (Clara). Schemes may find either of these approaches more attractive than the other, and there will be other important factors to consider (not least the consolidator’s “premium” for the transfer, and the level of security for members’ benefits).
The Clara model presents an interesting proposition for schemes already on the journey to buy-out… i.e. if buy-out is expected to be achievable in, say, 10 years, but there is material covenant risk during that time, then would it be in the scheme’s (and members’) interest to transfer to a solution like Clara which offers something akin to a “bridge to buy-out”? Alternatively, where a scheme is on a path to self-sufficiency, the added possible benefit of an uplift to member benefits (above their full entitlements) may make the Pension SuperFund option attractive.
Whilst consolidation is clearly not going to be appropriate for all schemes, I for one will be keeping a close eye on how this market develops over the coming weeks and months, particularly when/if we see the first transfer to a consolidator occur. It will also be interesting to see whether other providers come into the market once it becomes clearer how such vehicles will be regulated. We expect the DWP to issue its consultation paper on consolidation later this month.
In the meantime, if you want to learn more about DB consolidators you can read about them in our Accounting for Pensions 2018 - Autumn report, (as well as other current issues that corporates should be considering now) or contact Gordon Watchorn, or myself Sam Jenkins.