In recent years, there has been an increasing discussion around pensions consolidation. At his recent Mansion House speech, the Chancellor of the Exchequer, Jeremy Hunt, again highlighted the fragmentation of the UK DB pensions landscape and confirmed a new regulatory regime for “superfunds”.
The Department for Work and Pensions (DWP) has also launched a call for evidence around how DB pension schemes could increase the amount invested in productive asset classes. The ‘Mansion House Compact’ will see the UK’s largest DC pension providers agreeing to the objective of allocating 5% of assets in their default funds to unlisted equities by 2030. There will also be a roadmap to encourage Collective DC funds.
Additional choice that seeks to secure the best possible outcomes for pension savers is a very good thing, and we believe consolidation could play an important role to help DB schemes reach their chosen endgame. However, consolidation may not always be appropriate or an option for small schemes and their ultimate endgame could still be a buy-in with an insurance company. K3 has advised three schemes, each with less than £3m in assets, to secure buy-in contracts over the past couple of months alone.
But, to do that, they must be prepared and there are several key factors for small DB schemes to bear in mind to increase the likelihood of securing a buy-in with an insurer in this market.
Matching assets with liabilities
Smaller schemes are, in many cases, better funded than their larger counterparts. On average, they have seen a much bigger improvement in funding levels over the past 12 to 18 months as gilt yields have risen, because they are much less likely to have had liability hedging in place. Some small schemes have remained in arrangements such as with-profits policies where, in return for a capital guarantee, the trustees have no influence on the investment strategy.
The primary objective of a buy-in is to match a specific portion (or all) of the scheme's pension liabilities with an annuity policy. Consequently, the ideal investment strategy should focus on assets that most closely reflect insurance pricing, for example using a portfolio of gilts and corporate bonds of appropriate duration. If scheme assets move differently to the way insurer pricing moves, this can pose a major risk to the transaction. Where this is the case and the risk is understood and accepted (for example, where it is not cost-effective for a small scheme to review its investment strategy), there are two main options:
- Fix the insurer’s premium ASAP (i.e. on signing the contract). This fixes one element of the transaction but leaves the scheme exposed to movements in the value of assets until they are liquidated.
- Fix the insurer’s premium at the point the assets liquidate. This leaves both assets and liabilities moving for longer, which could improve or worsen the funding position.
Data and benefits
Preparation is always paramount. This is particularly true for small schemes with a limited governance budget.
It is critical to ensure that the scheme's data is accurate and up to date. For small schemes, it should be easier to collect postcodes and marital information, especially if focusing only on a small number of members that might represent a large proportion of the premium. This information should be collected (via a member write-out or tracing agency) to produce the most accurate premium, but it can be possible to instead pay a slightly higher premium for the insurer to accept the risk of inaccurate or missing data.
Another essential step on the road to a buy-in – especially for small schemes that might not have had regular legal advice – is to have a legally reviewed benefit specification in an “insurer friendly” format. This should be reviewed for consistency with administration practice.
Planning and governance
Taking professional advice from a specialist bulk annuity adviser and other trustee advisers is crucial for a small scheme to make informed choices. A clear project plan will ensure that momentum is maintained and any unusual issues faced by a small scheme (e.g. opening a trustee bank account where members have been paid by a with-profits insurer) are resolved in good time.
Wider pensions consolidation is a theme that will, undoubtedly, continue to develop but insurance remains the gold standard for UK DB pension schemes to secure members’ benefits. Our recent experience reiterates that insurance is available to even the smallest DB pension schemes if well prepared and assisted by an experienced adviser.
Mark Foster, Deal Lead at K3 Advisory
