Keeping other peoples’ promises: the FD’s perspective

During turbulent times like these, few would envy the prime minister their job. But if you thought that was the trickiest job in the country, you’d be wrong.

One of the hardest jobs faced by anyone in the uncertain economic waters being navigated by the good ship UK plc is that of Finance Directors (FDs). Not for their day job running company finances, but for a task they are expected to manage on the side. That is the small matter of keeping the promises made to generations of final salary or Defined Benefit (DB) pension scheme members by their businesses.

Can it really be so bad?

Many consider DB pensions schemes in the same vein as dinosaurs, Ceefax or Coffee Walnut Whips. Each has had their significant era, but one by one have become obsolete, discontinued or extinct and been consigned to the annals of history. This, too, would be a misconception. There are currently more than 5,400 DB schemes still in existence and they all require management and maintenance – not to forget, funding.

In most cases, their time has certainly passed and auto-enrolment (AE) means that DB is fast becoming a legacy issue. Defined Contribution (DC) has in fact overtaken DB saving. Employee contributions into DC schemes in 2018 was £4.1bn, a third more than the £3.2bn paid into DB. As AE continues to gather momentum, that gap will grow rapidly.

No longer the main plank of a strategy to attract, reward and motivate staff, DB is now a balance sheet issue of almost daily concern to many FDs.

Deficits, insurance and regulation

One of the biggest problems that FDs have with DB schemes is getting them off the books. They cannot easily exchange the benefits accrued by members for an insurance policy, because the premiums being asked require considerable commitment from the business to find the cash.

That is even if the scheme is not in deficit – and most are. This funding shortfall is a constant drain on company finances and new rules governing the funding of schemes may increase those deficits in the future.

The 2018 Pensions Purple Book (Pension Protection Fund) showed that only 13% of DB schemes are still open, while 44% are closed to new members, 42% to future accrual and 1% are winding up.

Research conducted by TPT in 2018*, indicated that the majority of FDs polled would like to get to the point where the scheme is no longer a concern for the business, but few saw any final solution in the near term. More than half (52%) expect to continue to manage the scheme in order to achieve self-sufficiency – reach an equilibrium where the scheme can self-fund without calling for more money from the business.

Fewer (14%) would like to de-risk the scheme through adopting a different investment strategy or through a buy-in or partial buy-out insurance contract.

Only 4% are looking at actually pulling the trigger on a buy-out, transferring the liabilities to an insurer through a bulk insurance policy.

As a result, DB scheme liabilities are set to persist for a considerable time and must therefore be managed.

Keeping an eye on the prize

Few of those who are choosing to runoff their scheme are confident about managing the risks. One in five said they’d love to spend less time looking after their DB pension scheme. However, though FDs spend an awful lot of time on their DB scheme, none had considered consolidation as a planning option.

In the case of DB pensions, there are not that many ways of skinning a cat. Buy-out is expensive – prohibitively so in most cases – but it is the end and passes the liabilities on to someone else.

A buy-in may secure some of the liabilities but leaves the rest of the fund to be managed on an ongoing basis. The transaction will affect the asset mix as the insurer will take the assets it finds best suit its strategies and it is likely that the volatility associated with the remaining assets would exceed the trustees’ risk appetite. This may require going back to the drawing board as far as the investment strategy is concerned – a prolonged and
potentially expensive process, and not without some risk.

A super alternative?

One recent innovation has been the arrival of the ‘superfund’. In essence, these businesses will take on schemes and the link with the employer is broken, as a third party (currently private equity houses) will provide additional capital to replace the employer covenant. There are currently only two providers, one model will take on schemes and run them off over the long-term, whilst the second aims to manage the scheme to buy-out over the medium term.

Neither of these options will be cheap and will only be suitable for a minority of schemes, as superfunds will have minimum funding requirements for schemes transferring into them. This may require businesses to provide additional monies at the outset to reach this threshold.

FDs wishing to pursue the potential for this approach will have to satisfy the trustees that their members are better protected by the superfund’s covenant rather than that of the employer’s. Until the benefits are secured through a buy-out, the business may remain on the hook should the superfund fail.

This is all rather academic, as these businesses don’t yet have a regulatory framework within which to operate. However, the Department of Work and Pensions has consulted on regulating superfunds and a response is due back this summer.

That just leaves…

The final option is to outsource the ongoing management of the scheme to a DB Master Trust. These entities are already regulated by The Pensions Regulator (TPR).

They have been proven to offer a comprehensive and flexible solution for all types of scheme. Master Trusts, such as TPT Retirement Solutions, don’t apply a one size fits all solution either. Each scheme will have its own different objectives and is treated as an
individual.

Why choose a Master Trust?

DB Master Trusts offer a proven, comprehensive and cost effective solution.

They specialise in running DB pension schemes and offer a safe harbour solution, robust governance, reduced operational costs, all without upfront costs while offering investment and risk management advantages, by offering employers a one-stop-shop for their schemes.

FDs would love to have the money to throw at the problem to make it go away, but they usually don’t, so have to find an alternative route.

The Master Trust will greatly strengthen the scheme’s governance through providing it with access to a professional trustee board, supported by an executive team, that provides it with continuous oversight.

Investment and risk management are integral components of any strategy today – and ones the TPR watches like a hawk. Consolidation even provides schemes with access to assets and strategies they didn’t have before, because they were deemed too complex for the governance budget, or simply too expensive. Economies of scale are generated by the use of shared services across multiple schemes.

It is these factors – governance, investment and risk management – that give businesses the greatest concerns when considering the future of their DB schemes. But they also choose DB Master Trusts because they receive great comfort from knowing their scheme will be effectively managed.

You’re not on your own

Political and regulatory momentum is building up fast behind pension scheme
consolidation. The Regulator understands that insurance is beyond the means of most businesses. They believe consolidation will improve governance and reduce operating costs, which ultimately better protects members’ benefits.

But it is not only small schemes or those in trouble that approach DB Master Trusts. The second largest Building Society in the UK, Coventry Building Society recently came to the conclusion that its £220 million scheme would secure better governance in the future and gain access to more diversified assets due to the £9 billion we already manage and significantly reduce running costs through being outsourced to TPT.

The Coventry Building Society, famous for putting the customer first, decided that outsourcing to a DB Master Trust would offer greater security to its scheme’s 1,800 members – or in this case, ‘customers’ – including 600 pensioners, into the future.

Easy when you know how

Outsourcing doesn’t only manage risk and reduce costs but also releases considerable executive time. Our research showed the average FD spent just under one day a week managing their company pension scheme in 2018. That’s a staggering 45 days a year and what’s worse is that some were spending twice as much time doing something that adds little or nothing to the business but uncertainty and risk.

Beyond the finance function, HR Directors can support the business by focusing on making sure the current suite of benefits offered to employees is doing what the business requires, instead of managing a legacy benefit few understand or have access to.

A DB Master Trust is a cost-effective way for employers to outsource the daily responsibilities of running their DB scheme. Leaving management to get on with doing what they do best – running the business.

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