For Defined Benefit (DB) schemes, one method of consolidation is to transfer into a DB Master Trust.
There are a number of DB Master Trusts, and each one will have its own approach. A common approach is to combine functions - administration, trusteeship, actuarial, legal, investment, accounting, covenant assessment and member communications. The aim is to achieve the benefits to which the Regulator has referred.
The consolidation options
Many DB pension schemes have now closed, both to new members and to further benefit accrual. Where this is the case, the employer and the trustees will be considering what the future holds for the scheme.
For those schemes which are well-funded enough, the employer will often wish to remove the scheme from its balance sheet by buying out the benefits with an insurance company. The Department of Work and Pension’s (DWP) White Paper on the sustainability of DB pension schemes commented that, even when schemes are well-funded, the cost of insurance provision means that it is unlikely that many will be able to buyout the benefits in full. It said that new consolidation vehicles could therefore offer a more affordable option than insured buy-out.
Like an insurance buyout, transferring members to one of the new consolidation vehicles would be a way for the employer to remove the scheme from its balance sheet. For those employers who want to break the link with the pension scheme but cannot afford buyout, a commercial consolidator might be an option. Because the link with the employer is broken, the benefit of the employer’s financial support (covenant) is lost, so a cash injection will be
needed to compensate for that.
The Regulator has published guidance for employers who are considering transferring to a consolidation vehicle. It expects employers to seek clearance from it for any proposed transfer,
even if they consider that any detriment is mitigated.
As part of the clearance process, the Regulator will assess whether any detriment to the scheme has been adequately mitigated, and make sure that the scheme could not achieve a better outcome through other means.
The Regulator does not expect a transfer to go ahead if trustees already have the ability to buyout, or are on course to do so, within
the foreseeable future (for example in the next three to five years). Its guidance for trustees who are considering transferring to a consolidation vehicle says that the decision must be in the best interests of the members, and should further the purpose of paying the accrued scheme benefits.
Legislation governing consolidation vehicles is awaited and the Regulator has said that they will need to seek authorisation from it once the legislation has come into effect.
Defined Benefit Master Trusts
A DB Master Trust is a multi-employer pension scheme in which the employers need not be connected with one another. It is usual for each pension scheme which joins the DB Master Trust to have its own separate, ring-fenced section. Two of the main advantages of being part of a larger pension scheme like this are better
governance, and the greater opportunities which come with scale, including access to more efficient investment strategies.
When a pension scheme transfers into a DB Master Trust, the link to the sponsoring employer is not broken and the benefit of the
employer’s support (covenant) is not lost. So, there is no need for the employer to find a cash injection to compensate for that.
How do Defined Benefit Master Trusts work?
A common approach is for each pension scheme which joins the DB Master Trust to have its own separate, ring-fenced section, funded separately from the other sections.
It is also usual to combine functions such as administration, trusteeship, actuarial, legal, investment, accounting, covenant assessment and member communications - with the aim of
achieving the benefits to which the Regulator has referred.
A DB Master Trust can either continue to run the schemes which are transferred to it, or it can be used as a bridge to buyout. The funding levels and the employer’s aims for their scheme will be important factors in the decision-making. Crucially, unlike an insurance buyout or a transfer into one of the new consolidation vehicles, the decision to transfer into a DB master trust is not a once-and-for-all decision. The employer will retain an influence in what happens to its scheme in the future.
Cheviot’s aim is to manage the schemes to the point where they are fully funded on a cautious basis, reducing their dependence on the employer. This can be difficult for smaller schemes to achieve individually, because of the time and expertise which it requires.
Pension scheme consolidation has been on the government’s agenda for a while now, and the Regulator has said that people saving for their retirement are better served by big schemes
than by small ones. For Defined Benefit schemes, one method of consolidation is to transfer into a Defined Benefit Master Trust.
This article was featured in Pensions Aspects magazine May 2020 edition.
Last update: 19 January 2021