Paul Murphy, head of strategy and business development at TPT Retirement Solutions, discusses the future of defined benefit pension schemes
The government’s recent Green Paper, Security and Sustainability in Defined Benefit Pension Schemes, has reignited the debate on the future direction of defined benefit (DB) pension schemes.
The section on consolidation of schemes has, in particular, generated immense interest. Of the 5,800 DB schemes in the UK, the majority have less than £1 billion in assets, while three quarters have fewer than 1,000 members and one third have fewer than 100 members.
This is a major concern because smaller schemes face significantly increased costs per member and tend to have less effective governance. Money spent on running schemes is money that could be used to pay down deficits and secure member benefits.
Similarly, poor governance can lead to poor decision making across the whole gambit of funding, benefits and investment, which could significantly increase the cost of financing a scheme.
High costs and low levels of governance should be avoided wherever possible, and this is where the consolidation debate has gained some traction.
Schemes that are sub-scale cannot afford to access investment instruments that optimise the management of risks and returns, or otherwise find it difficult to install appropriate governance structures run by trustees with the necessary experience.
Not all small schemes are poorly run, but it is harder to operate in an ever-more challenging regulatory regime and increasingly complex investment and funding environment if an organization does not have sufficient scale.
Need for consolidation
The green paper suggests some form of consolidation is desirable. Key potential benefits of consolidation are; economies of scale leading to reduced costs; access to more sophisticated funding and investment strategies; improved governance.
These factors combined will improve the likelihood that the member will receive their benefits in full.
DB consolidation is also favoured by The Pensions Regulator (TPR), but could give rise to a number of challenges.
Money could be saved by pooling, such as administration, actuarial, legal, and covenant costs, but this only goes so far.
Bringing the management of schemes together under one set of trustees allows organisations to take advantage of a more professional approach and save on cost and time.
Some DB home truths
It’s well-known that DB schemes can be frustrating for employers, but employees are increasingly viewing defined contribution as the norm.
Some employers may not see any difference in a scheme being run by trustees and their advisers or a third party group that calls itself a Master Trust. However, there are several big differences.
Studies show that consolidation can save an employer a lot of money and research has found that it is possible to achieve more than 30% savings on the running costs of a DB scheme through consolidation.
That’s around £250,000 a year for a medium-sized scheme of around £200 million. For a smaller scheme of about £25 million, that saving can be as high as £100,000. And that’s per year.
These cost savings release resources that can be used to reduce an organisation’s DB recovery period and it’s possible the average scheme could reduce this period by three years.
That’s not just three years less contributions, but three years without the additional costs of investment managers, advisers and lawyers.
It may not seem possible, but an FD can spend at least half a day a week overseeing their firm’s responsibilities for the DB scheme.
That’s 10% of an FD’s time spent acting as a pensions manager rather than managing the business’s bottom line. In real terms, that’s over 20 days a year that could be reclaimed.
It’s not just your time
A DB scheme uses up a lot of resources. Finance ends up dealing with member matters and a cottage industry springs up around the FD just to deal with advisers and ensure VAT reclamation and other processes are executed correctly.
If something goes wrong with the DB scheme, the liability lies with the trustees. However, maintaining a trustee board can be difficult.
It is becoming harder and harder to recruit member nominated trustees (MNTs) and legislation makes their role ever less appealing.
This is only going to get worse. In the last couple of years alone, at least 100 changes have been made to DB rules and regulations.
Consolidation offers the business the comfort that these matters become the responsibility of the Master Trust trustees.
Don’t fear change – embrace it
Unlike other consolidation structures suggested by the Green Paper, there is no cross-subsidy.
Each separate scheme section retains its own benefit structure, scheme-specific asset allocation and agrees its own funding strategy on the basis of its own covenant.
These are also important considerations when it comes to looking at consolidation.
Many employers would prefer a more robust and efficient solution for the execution of their DB pension fund, but some – more paternal firms – fear that moving to a master trust is somehow an abdication of their duties. This couldn’t be further from the truth.
Choosing a DB Master Trust will maintain the benefits that employees currently enjoy, while making it easier for the employer to manage costs, access scale, investment expertise, robust end to end administration and drive up governance standards across the board.
Paul Murphy is head of strategy and business development at TPT Retirement Solutions.