In response to the recent Government White Paper ‘Protecting Defined Benefit Schemes’ published in March 2018, TPT’s Head of Strategy & Business Development, Paul Murphy writes for
One of the central tenets concerns the merits of size, that larger schemes have better governance and this may result in better investment returns and lower costs.
As a result, says the white paper, larger schemes will probably have better engagement, with more frequent trustee meetings, and a more collegiate approach to working with the sponsor to execute an integrated risk management strategy that takes full account of the risks associated with the employer covenant, investment and funding.
It goes on to say that these qualities are not the be all and end all when it comes to managing the standard of governance achieved by a scheme. They will, however, give strong indication and on average, that bigger schemes are better regulated.
Lack of resources
There's nothing particularly contentious about any of those findings. We have known for years that smaller schemes struggle to find sufficient resources to be confident they are delivering the best possible service to members.
That's not to say they are not doing the best they possibly can. Many small schemes are well run and may be well resourced and even funded. But that doesn't mean a larger scheme would not be more efficient.
In the past, smaller schemes may have felt there was little option but to carry on regardless. Though consolidation has been spoken of for many years, it has been up to schemes to determine whether their members would be better off by joining with a larger partner.
The white paper makes it clear that a consolidator - such as a DB master trust operator - may be a better bet for smaller schemes.
It says: "…a potential consolidator, which would be a large scheme by nature, has a higher probability of being well governed. And we have some evidence that better governance leads to higher investment returns or lower costs."
This is an important point.
However, the aim of consolidation should not be seen as an opportunity to drive down costs, but to drive up the quality of governance across all schemes.
Better governance improves every aspect of a scheme's fabric, from the bottom up. That includes access to advice, better administration, better communication, and, as outlined by the white paper, better investment returns.
The creation of bigger schemes will allow those schemes to take a longer-term view of their investment strategy, allowing many smaller schemes access to alternative return streams, better diversification and reduced volatility for their growth assets.
They may also benefit from the ability to reduce risks through hedging instruments such as liability driven investment (LDI), which are more affordable for larger schemes.
The white paper speaks in terms of smaller schemes but doesn't place a figure on that. We consider small as any scheme with less than £1bn of assets as below this size it is difficult to achieve true economies of scale. We believe that many small to medium-sized schemes would benefit from the use of consolidators.
This may become more apparent with the introduction of a statement from the chair of trustees. Chairs of defined contribution schemes have been issuing these in recent years by way of an additional internal governance component forcing them to confirm the scheme continues to offer members good value for money.
Their introduction to DB schemes will be a powerful motivator for smaller schemes to look inwards and ask themselves whether they can say the same, and ask whether the trustee board has the right skillsets and whether the scheme is keeping up with the pace of changing regulation.
Help at hand
Though adoption of consolidation has been slow to date, this paper is proof that its time has finally come. It is likely to be a catalyst for smaller schemes to accept there is no shame in seeking help and that by joining with others they can be stronger and serve members better.
There should be no concerns about capacity in the consolidation market - there are plenty of providers to satisfy the potential demand.
Consolidators will be required to have expertise - beyond administration, in actuarial, investment, communication, fiduciary, and so on, far beyond the scope of an administrator.
Finding the right partner is important and selection must undergo the same rigorous due diligence, even for small schemes seeking to select a provider.
The additional hoops the regulator will expect master trusts to jump through should provide some additional comfort to trustees that these arrangements are well governed.