The government has said it is against designing and running a defined benefit ‘superfund’ through an arms-length body but is open to supporting the industry create new ways of consolidation.

In the green paper, Security and Sustainability in Defined Benefit Pension Schemes, the government said there appears to be a “strong case” for supporting greater voluntary consolidation. This is because it recognises that data suggests small schemes have higher administrative costs, are unable to benefit from the economies of scale available to larger schemes, and tend to have less effective governance. However, it does not support compulsory consolidation.

There are around 6,000 pension schemes with approximately 11 million members. However, 10 per cent of these members are spread across 81 per cent of these, meaning there are many small schemes. About a third of all schemes, each consisting of one to 99 members, hold total assets worth just £14.2bn (about 1 per cent of total assets held by all DB schemes) as at 31 March 2016.

With regards to a superfund as a consolidation vehicle, the government said it has concluded that “it would not be appropriate to take this option forward”.

“We have asked whether it would be appropriate for government to provide some structures or incentives to encourage the pensions industry to innovate and to provide new consolidation vehicles,” it stated as an alternative option.

One idea for the superfund would be a vehicle targeted at smaller schemes which are at or close to 100 per cent funding on a buy-out basis. It could have a single benefit structure, and a single consolidated fund, rather than having assets allocated to individual schemes. It would then pursue a low risk investment strategy, allowing both employers and trustees to be discharged.

“This could provide a welcome additional route for smaller employers to remove the risks associated with running a DB scheme, providing greater certainty for members and employers. But there are a number of key questions that would need to be addressed before such an approach might be considered. These are private arrangements between companies and their employees, and the government does not think that there is a case for transferring any of the risk to the taxpayer,” it stated.

It said the options for risk bearing would be for the residual risk to be borne either by the employer, the member, or the Pension Protection Fund (PPF) levy payers. However, it noted that if the risk remains with the employer, then the employer could not be fully discharged, so that assets and liabilities would remain attributable to individual schemes. Therefore, a mechanism would have to remain to allow the employer to be called upon for additional funding if the funding level of its scheme were to reach a certain level. This would, however, undermine one of the main advantages of the model – that it provides a route for the employer to discharge their liability.

Alternatively, the risk could be wholly transferred to the members or be shared between the members and the PPF. Under the first approach members would fully bear the risks, with provisions for benefits to be reduced (potentially to zero) or increased above standard entitlements depending on the overall funding position of the consolidated vehicle, and with no facility to enter the PPF. In addition, there are potential conflicts of interest which could arise if the PPF were to manage the consolidation vehicle while also providing protection in the event that such management should lead to insufficient funding.

The second approach would allow the members to bear the risk up to a point, and to build in a safety valve allowing benefits to be reduced to a certain level if the funding level demanded it, but with an absolute floor of PPF compensation levels. However, this raises questions around whether it is appropriate for the risks to be transferred from sponsors to members and under what circumstances this should apply to prevent moral hazard issues and transfer of wealth from members to other creditors. Furthermore, the scheme as a whole would need to pay a levy to the PPF in order to be eligible for entry into the PPF should the scheme fail.

However, the government noted this would be a significant change in role for the PPF which would effectively be under-writing the investment risk of the consolidation vehicle. This would need amendments to supporting legislation and consideration given to ring-fencing this risk from the PPF’s current levy payers (rather than allowing any cross-subsidy) as well as potentially significant changes to legislation.

The consultation is open until 14 May 2017 and can be viewed here.

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