Kate Payne, Partner at ARC Pensions Law
It would be a shame if this was an impediment as the policy initiative was designed to improve the likely outcomes for members of defined benefit pension schemes. This is still true even if it is limited to the generally overlooked world of pension schemes whose funding level is sufficiently high that they have no prospect of benefitting from the Pension Protection Fund but not high enough yet to consider a buy-out.
Properly financed and regulated commercial consolidators can offer financial support, time and expertise to allow well-funded defined benefit liabilities to run off naturally. This is an alternative to the traditional way of securing members benefits by way of buying out with a traditional insurance company which many sponsors simply cannot afford now or in the reasonably foreseeable future.
The consolidator market needs regulation but there is a push and pull from interested parties as to which way it needs to go. The current consolidators argue it needs to be sufficiently different from the bulk annuity regulatory regime to give them a chance of success. Whereas the traditional insurers are arguing that the services offered by consolidators are similar to their services so need stringent financial sustainability criteria. This is going to be a tricky regulatory balance and getting it right will be key to achieving the Government’s stated policy.
It would seem that the current proposal for the long term sustainability of consolidator vehicles could mean the Government fails to meet its own objective as it is likely to result in a relatively restricted market place and leave more members of pension schemes with poor outcomes which could have been avoided.
Others will be better placed to comment on the financial sustainability aspects of the consultation but it does seem that if consolidation of defined benefit pension schemes is to be a viable and sustainable option to insurance there must be a difference in standards between the two. The natural difference would be in capital adequacy.
The area where consolidators should not have a competitive advantage is the benefits to be provided. Interestingly one of the biggest gaps in the consultation is the absence of any real focus on benefits. It is taken as read that “the same” benefits can be provided after transfer as before. There is an established mechanism for bulk transfers without consent but it is used in a different context. Under that route an actuary certifies that the benefits are broadly, no less favourable than the rights to be transferred, not “the same”. There can be winners and losers. For consolidation to be effective and financially sustainable as a way of discharging employers from their financial obligations and improving member outcomes there needs to be a material improvement in understanding and payment of members actual legal entitlements. Paying the right amount of pension to the right person is a trite definition of the duty of a trustee. Consolidators cannot be permitted to take on unknown liabilities which over time could undermine their viability.
In reality pension scheme benefits are complicated and often uncertain. They can change as a result of overriding legislation or case law, as happened recently in the Lloyds case with Guaranteed Minimum Pensions now having to be equalised. This matters less when there is a sponsor to pick up residual risks and manage them over the long term. If residual risks are to be shaved off on transfer to a consolidator, that becomes a member protection issue. It does happen on buyout but in exchange members get the certainty of an annuity policy.
Bulk annuity insurers are very familiar with the importance of understanding the precise benefits that members enjoy and making sure these are clearly stated in the policy. The risk of those secured benefits being incorrect remains with the sponsor and the trustees. Sometimes insurers take on latent risks of residual liabilities but at a price and the scope of this cover is pretty limited and not always available.
Unless the trustees and sponsor have been involved in a pensioner buy-in, where this due diligence around benefits is undertaken as a matter of routine, they are unlikely to have a legally signed off benefit specification of all benefits offered by the scheme (documented and undocumented). There may have been no formal check that the administration practices and calculation methodologies on which scheme benefits are based match those described in the governing rules of the scheme.
For consolidation to work, schemes need to re-focus some of their time and resources towards understanding and sorting out precisely what liabilities they are transferring. There is a lot of comment in the consultation about protecting members’ benefits but nothing about schemes using their resources to truly understand the legal entitlements that are to be protected. If there are any ambiguities in the governing rules of the schemes these need addressing and the risks associated with them should be considered and allocated. Like traditional insurers, consolidators will want certainty on the liabilities they are accepting. Who bears the risk of the full entitlement not having been properly secured with the consolidator? The employer or, more likely, the member? The consultation misses this point completely, but it is crucial to successful member outcomes.
The decision to move to a consolidator is unlikely to be an easy one for trustees and good member outcomes are key to making that decision. The consultation is a step in the right direction but capital requirements are not the only way to ensure that members receive their actual legal entitlements in full. That must surely be the aim.
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