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Article | Pensions Briefing

Transferring schemes to commercial consolidators

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By Costas Yiasoumi | October 2019

Commercial consolidators, like Clara Pensions and The Pension SuperFund, are offering their solutions within a regulatory environment that is still going through consultation. Costas Yiasoumi outlines some of the challenges commonly raised by trustees about transferring their pension scheme members’ entitlements to a commercial consolidation vehicle, and how the corporate can develop a proposal that addresses both the technical and emotional concerns of the trustees and facilitate a smoother engagement.

What is commercial consolidation?

Government policy to develop a regime to facilitate commercial consolidators was confirmed in a March 2018 White Paper. The Department of Work and Pensions followed up with a consultation document in December 2018.

A commercial consolidator is an entity to which other defined benefit pension schemes can transfer. After the transfer the sponsoring employer has no further liability. Sponsoring employers will normally be expected to make a final payment which serves to replace their covenant, in effect a severance payment. The expectation is that commercial consolidators will aggregate multiple schemes resulting in lower running costs and more sophisticated asset strategies that may generate higher returns than schemes could achieve on their own.

The White Paper stated that commercial consolidators might be able to allow employers to exit their pension liabilities at a cost of only 85% of buyout, presumably for deferred pensioner heavy schemes for which buyout cost is highest versus best estimate liabilities. However, whether such pricing will be achievable in practice as a norm remains to be seen.

Commercial consolidators put up capital to increase security for transferred schemes, much like an insurer does to back a bulk annuity, but at a lower level than insurers. The intention is that commercial consolidators will have a high likelihood of delivering member benefits in full. However, by design, commercial consolidators will not be as secure as bulk annuity insurers for which the likelihood of default is remote.

Two commercial consolidators have launched so far, Clara Pensions and The Pensions SuperFund, and others are waiting on the side-lines to enter. We have advised a number of clients considering transfers. The Pensions Regulator has issued preliminary guidance and has been engaged by both consolidators in relation to their first proposed transactions.

So what’s the problem?

A transfer to a commercial consolidator would only happen if it was in members’ interests and met various legal requirements – trustees would be extensively advised. It would seem that this solution is not going to work where the employer covenant is very strong or where the trustees are confident that they will be able to buyout with an insurer. So what are the problems trustees might raise?

“People shouldn’t make money out of pensioners”: As the name suggests, commercial consolidators are for-profit enterprises – they aim to make a return on the capital they put up. However, insurers make profit on bulk annuities and nobody raises that as an issue. Perhaps the real issue is that commercial consolidators don’t offer the guarantee that insurers offer? We suggest the primary focus should be on whether members are better off.

It’s for corporates to help demonstrate and provide covenant information to trustees to illustrate that alternative end game strategies are unaffordable or not in members’ best interests.

“This is just a way for an employer to escape its pension liabilities on the cheap”: That’s certainly true if the employer could have afforded to pay more than the severance payment and/or has a covenant sufficiently strong to support the scheme. It’s for corporates to help demonstrate and provide covenant information to trustees to illustrate that alternative end game strategies are unaffordable or not in members’ best interests.

“Consolidators are taking a gamble with our scheme assets”: Consolidators may only put up capital of , say, around £10 for every £100 of scheme assets and employer severance contribution received. So trustees may feel consolidators get access to a lot of upside in return for their capital. Trustees should be encouraged to look in detail at how the consolidator will invest the assets, manage risk, withdraw profit and run down its capital, such that they can get comfortable with the approach. Consolidators will have to show they are operating on prudent principles.

“The legislation hasn’t been passed yet”: That’s true, but transfers can take place under the existing regulatory regime and The Pensions Regulator has issued interim guidance. Supporting legislation will give the commercial consolidators a credibility boost but it is not a pre-requisite for schemes for which a transfer makes sense at present. However, the discomfort created by the unconcluded consultation is real, but not insurmountable, where trustees need to make decisions today.

“We can achieve better without a transfer”: if this is truly the case the trustees will not make the transfer to the consolidator. Corporates should explore the alternatives as part of their feasibility, including whether a journey plan can be developed to self-manage to buyout within a reasonable time period without excessive risk on the way. However, trustees need to consider downside scenarios associated with their current strategy too.

“We just don’t like the concept”: It might be useful to express this as follows – which of these options would the trustees prefer assuming funding of exactly 90% of buyout is on the table taking into account the employer severance payment offer?

  • Option A: Transfer members to a commercial consolidator that will aim to meet benefits in full with a high probability.
  • Option B: Wind up the scheme and secure a buyout worth 90% of full benefits – to members this may look like full benefits but with scaled back future indexation.
  • Option C: Reject the immediate severance payment from the employer and carry on as normal.

The answer … it will depend!

Whilst the issues for trustees and employers are not straightforward, the good news is these issues can be anticipated in advance and so efficiently navigated. Regardless of whether the outcome is a transfer to a commercial consolidator or not, the resulting clarity in planning a scheme end game means that the corporate can focus its efforts in engaging the trustees to efficiently reach that goal.

Contact

Costas Yiasoumi
Senior Director, Transactions

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