2021 to be 'defining year' for defined benefit commercial consolidators

The Pensions Regulator is set to approve the two existing DB superfunds and clear the first transactions in the first half of 2021. As companies struggle with the financial fall-out from Covid-19, seek to reduce costs and offload their pension liabilities, the pull of consolidators becomes stronger.

Given the current economic outlook, it is likely the first superfund transactions will be focussed around 'PPF+' cases and schemes exiting the PPF assessment period. Arguably, in these cases, it is easier for trustees to transfer to a superfund because they do not have an employer covenant to compare with the superfund and can potentially secure higher benefits for members with a superfund than an insurer. With cash scarce, the on-boarding of schemes without the risk of employer insolvency looks to be second order in 2021.

But where employer cash is available, we are seeing renewed willingness from trustees to consider superfunds carefully. This is unsurprising – it would take a brave trustee not to consider the option thoroughly, particularly when faced with an employer covenant that looks increasingly uncertain and the superfund offering buy-out levels of funding with its capital buffer.

Turning to a broader overview of the consolidation market, we have seen DB superfunds, capital-backed special purpose vehicles and commercial DB master trusts enter the market in the last five years, offering alternative 'end-game' solutions for trustees and employers to the traditional buy-out model.

We expect regulatory approval of the DB superfunds to kick-start activity in other areas of consolidation. DB master trusts have been in existence for a long time with historic ties to certain industries, but we expect the emergence of commercial DB master trusts to give this market impetus. Mercer launched its commercial master trust last year and we expect new players in this market in 2021, to join household names such as TPT Retirement Solutions.

We have published a report (31-page / 5MB PDF) to assist employers and trustees in preparing for a transaction to a commercial consolidator in the year ahead.

Towards a combined consolidation model

To avoid saturation in a competitive market, the new DB master trusts may choose to differentiate themselves by marketing specific solutions, such as buy-out as an end-game solution; or by targeting certain types and sizes of scheme. We see the potential for commercial trusts to partner with authorised defined contribution (DC) master trusts, or to seek DC master trust authorisation of their own. This would allow them to offer a complete solution to employers and trustees of 'hybrid' schemes with more complex benefit structures, where it may not be possible to transfer certain DC benefits to a traditional DC master trust.

Once the superfunds establish themselves, we anticipate further convergence in the industry, with new models emerging which combine the consolidation concepts. Superfunds may seek to adopt a master trust like structure for an interim period, allowing trustees to retain the employer link; while master trusts may seek injections of capital and regulatory approval to convert certain sections to a superfund structure.

What is a DB superfund?

A DB superfund is a pension scheme consolidation model which allows an employer to offload DB pension liabilities from its balance sheet in return for a premium-like payment. This model severs the employer link. The transferring employer is replaced by a special purpose vehicle employer in the superfund, and the employer covenant is replaced with a capital buffer consisting of capital from external investors and an upfront employer payment, depending on the consolidator structure and the funding level of the transferring scheme.

A DB superfund is an occupational pension scheme providing a 99% probability that members' benefits will be paid in full, without the certainty of a buy-out by an insurer.

What is a DB master trust?

DB master trusts are also occupational pension schemes for unconnected employers, providing economies of scale by pooling governance, administration and investment functions. They require a bulk transfer of assets and liabilities, but do not sever the employer link. With scale, master trusts can assist schemes accelerate their end-game solution, whether self-sufficiency or a buy-out.

DB Commercial Consolidators (31-page / 5MB PDF)