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Article | Pensions Briefing

Commercial consolidators – a new era in pension scheme de-risking?

A suitable destination for your pension scheme?

Pensions Corporate Consulting|Pension Board and Trustee Consulting|Pensions Risk Solutions
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By Suzanne Vaughan | January 21, 2019

Suzanne Vaughan examines what trustees should be considering in light of the rise of the commercial consolidators.

The Government’s White Paper in 2018 acted as a catalyst, with the first commercial consolidators quickly launching to market. But what exactly is commercial consolidation? Suzanne Vaughan examines this and the key considerations for trustees in light of this evolving alternative.

What is the commercial consolidation model?

This can be conceptualised as a DB master trust, where the employer covenant is replaced by a capital buffer.

It should be more affordable than an insurance buyout, albeit that this will be at the cost of a lower degree of benefit security

It differs from the current regime by allowing the sponsoring employer to separate from its pension scheme by putting a price on the value of its covenant.

This is similar to a buyout of liabilities, although the new vehicle would be outside the insurance regime and so not subject to the capital requirements of the Solvency II Directive. It should, therefore, be more affordable than an insurance buyout, albeit that this will be at the cost of a lower degree of benefit security.

Under the commercial consolidation model

  • A private company sets up a new DB pension scheme
  • It takes over the responsibility for meeting the liabilities of a pension scheme in exchange for a one-off payment or structured payments by the previous sponsoring employer
  • The private 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

The first commercial consolidators, Clara and The Pension SuperFund, launched to market with respective offerings following the Government’s White Paper last year. One of the most notable differences between these two is that Clara promotes itself as a “conduit” vehicle with the stated aim of transitioning liabilities to the insurance market over the medium term, say around 10 years. The Pension SuperFund on the other hand is more a “destination” vehicle, looking to hold assets and liabilities over the longer term, benefiting from economies of scale to drive down costs and drive up investment returns.

What are the key considerations for Trustees?

Consolidation comes in many forms – ranging from solutions such as OneDB through which schemes will consolidate their advisers to commercial consolidators. There is, therefore, much for trustees to weigh up when considering which route is right for their scheme.

There is a duty on trustees of the original scheme to satisfy themselves that the funding level of, and security in, the consolidator effectively covers the ongoing support otherwise expected from the original sponsor

In relation to transfers to commercial consolidators, there is a duty on trustees of the original scheme to satisfy themselves that the funding level of, and security in, the consolidator effectively covers the ongoing support otherwise expected from the original sponsor. Trustees weighing up a transfer are unlikely to find this straightforward because the costs and the long-stop protections of the alternative regimes are markedly different. Trustees will need to 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. If the cost of settlement through a commercial consolidator is only slightly different from a buyout with an insurer, it is difficult to see many trustees (or corporates) viewing them as attractive. If it is materially cheaper, trustees will need to consider the extent to which the likelihood of members receiving full benefits reduces – the fundamental trade-off is between cost and security. Detailed legal, actuarial and covenant advice will be needed.

Trustees may also wish to consider non-financially driven factors such as the likely views of the scheme’s membership, how the trustees view being a first mover in a new market and how the regulatory position may evolve. Views of the specific commercial consolidator business models are also likely to be of interest, I talked above about the different long term strategies of the two main providers, but in addition trustees will likely wish to understand and explore differences in their profit sharing/incentives of capital investors, investment strategy, governance structures and any offered commercial terms.

Who are the commercial consolidators targeting?

So what type of schemes are the commercial consolidators targeting? Well, both Clara and The Pension SuperFund acknowledge their propositions won’t suit all, but are most likely to appeal to those:

  • That are closed to future accrual
  • Have membership data in good order
  • Are relatively immature (say 20%+ proportion of non-pensioner members)
  • Have a sponsor covenant rated as less than strong, or the long-term covenant of the sponsor is uncertain
  • Are reasonably well funded, so any cash top-up is potentially affordable to the sponsor (but buy-out with an insurer not affordable)

It is acknowledged by the consolidators that their target market is a relatively small proportion of overall DB schemes, but even 10% of UK DB schemes represents a very significant volume of pension schemes and some £200bn liability.

What is 2019 likely to hold?

While the new commercial consolidator option is unlikely to be suitable for all, given potential concerns around security relative to the sponsor covenant, it is clear this model has its place in the settlement market, with many willing it to succeed as a viable destination for pension scheme provisions.

Regulatory clearance will play a key role in the first wave of such deals

2019 is sure to be a fascinating year in this regard as the outcome of the Department of Work and Pensions’ recent consultation into the regulatory framework for these new operating models becomes known and is debated by Parliament. Our expectation is that regulatory clearance will play a key role in the first wave of such deals as collectively trustees, sponsors and The Pensions Regulator get fully comfortable with the concept.

Author

Suzanne Vaughan
Director

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