In this uncertain world, could consolidators now be the best option for your members?

When I wrote my last blog back in February, I said that 2020 was promising to be another exciting year in the pensions world. Little did I know that a month or two later everyone’s worlds would be changed beyond recognition.

The current crisis

We all know that this is a challenging time for everyone and that many people’s priorities have changed. We’ve seen unprecedented market volatility and we’re starting to see the unfortunate impact of the Covid-19 pandemic on many successful businesses. One area that appears to have survived reasonably well is professional risk management, where stress tests that look a lot like current times are regularly carried out as a matter of course.

Impact on pension schemes and their sponsoring employers

For defined benefit pension schemes, there has been a lot for trustees and sponsoring employers to consider at this time, and the Pensions Regulator has introduced short-term easements to support sustainability where appropriate. There has been a range of impacts on pension scheme funding levels – with some seeing deficits increase markedly and others seeing little change because of the hedging they have in place.

We’ve also seen sponsoring employers affected in varying ways. A quarter of businesses have been shut down, and 1 in 5 of those businesses that remain open have furloughed their employees, evidence of the large shock this is having on the UK. The current crisis has reinforced the view that even the strongest businesses may not be around forever. We can all agree that there is a lot of uncertainty ahead, especially when it comes to employer support for pension schemes.

Covenant and consolidation

As a result, pension scheme trustees are thinking hard about how the current environment has impacted sponsor covenant, and this is one of the key considerations for trustees considering pension scheme consolidation. Quite reasonably, trustees will only agree to a transfer to one of these consolidators if they consider member security will be improved.

A consolidator is a defined benefit scheme into which pension scheme liabilities can be transferred and where the scheme’s sponsor covenant is replaced by capital, provided by investors. It is run by professional risk managers who will make sure they are prepared for adverse events like the current crisis, and who put their capital behind that commitment. For a scheme to move to a consolidator, a cash injection from the sponsor is likely to be needed, but at a lower cost than buy-out from an insurer.

These types of transactions may become more feasible over the coming months. That is because, over recent weeks, for many schemes the covenant of their sponsoring employer will have weakened somewhat, meaning that the financial covenant offered by a consolidator might now be a more attractive solution. Where previously a strong employer covenant would have meant that consolidators weren’t considered as an option by the scheme’s trustees, the deterioration in covenant is opening this up as a potential opportunity in cases where the funding level of the scheme has held up.

Schemes with failing employers

The PPF is the last option for failing employers - a great lifeboat for schemes - but if trustees and employers can secure better benefits than the PPF would provide with either an insurer, or a consolidator, the outcome is expected to be better for members. That remains the case even if all that can be provided are benefits that are above PPF, but below full scheme benefits.

Regulation

Whilst, in theory, consolidator transactions can proceed now, we are still awaiting the promised regulation to clarify the future regulation of the consolidator market. As transacting with a consolidator could provide better outcomes for members than they presently have and a cheaper solution for companies than insurer buy-out, at a time when we need a range of solutions, clarity over the regulation of consolidators can’t come soon enough.