Some six months on from the publication of the Department for Work & Pensions paper CM9591, more snappily titled, Protecting Defined Benefit Schemes, we take a look at how the market for the effective management of legacy DB Schemes is moving on.
Just to recap, the White Paper finally confirmed what most of us knew all along; that when it comes to running pension schemes, bigger is better.
Some of the central tenets of the White Paper were around merits of size, that larger schemes have better governance and this may result in better investment returns and lower costs.
As a result, said 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 did say that whilst 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 a strong indication - and on average, bigger schemes are better regulated.
Motherhood and apple pie
There was nothing particularly contentious about any of those findings. We have known for years that small to medium size schemes struggle to find sufficient resources to be confident they are delivering the best possible service to members - these issues are not going to go away.
That’s not to say they are not doing the best they possibly can. Many smaller schemes are well-run and may be well-resourced and well-funded. But that doesn’t mean that a larger scheme would not be more efficient.
In the past, smaller to medium size schemes may have felt there was little option but to carry on regardless, appointing different sets of advisers and administrators - up to eight in some cases. 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 made it clear that a consolidator - such as a DB Master Trust operator - may be a better bet for smaller to medium size schemes.
…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.
Consolidation, consolidation, consolidation
The aim of consolidation should not just 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 spoke in terms of smaller schemes but doesn’t place a figure on that. We consider small as any scheme with less than £1 billion 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 (DC) 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 schemes to look inwards and ask themselves whether they can say the same, ask whether the Trustee Board has the right skillsets and whether the scheme is keeping up with the pace of changing regulation.
Help is at hand
Though adoption of consolidation has been slow to date, the pace is quickening.
Recent research which TPT has conducted amongst Finance Directors indicate they are looking more and more for alternative solutions to reduce cost and the time they and their employees and trustees spend on managing the pension scheme.
They also have concerns about whether scheme trustees can overcome the challenges of tightening and ever-increasing regulation. The increasing regulatory burden is likely to be a further catalyst for schemes to accept there is no shame in seeking help and that by joining with others they can be stronger and serve their members better.
Aside from achieving a better quality service, the cost savings achieved from a single organisation providing services under one roof can be massive - money which could be better spent on achieving better, more certain outcomes for members. TPT’s experience indicates that a typical saving might be in the region of 30% on adviser, administration and investment fees.
There should be no concerns about capacity in the consolidation market - there are plenty of providers to satisfy the potential demand - including the so-called Superfunds.
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 smaller schemes seeking to select a provider.
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