US conglomerate Honeywell has gone ahead with proposals to merge three of its UK defined benefit schemes on a sectionalised basis, in a bid to lower costs and streamline governance.
Two legacy UK funds, the FKI Group Pension Scheme and the McKechnie Pension Plan, will be rolled into the company’s main plan, the Honeywell UK Pension Scheme.
Mergers enable trustees and employers with multiple DB schemes to benefit from economies of scale, and have become increasingly popular in recent years. Advisers, administration and trustee meetings can all be streamlined with one scheme and board, while a single big scheme is also likely to have better bargaining power with asset managers than a smaller pension fund.
You may not have something to offer them, and if you can’t do that, the only kind of merger you’re going to end up doing is a sectionalised one
Rosalind Connor, Arc Pensions Law
The Honeywell change comes amid continued government emphasis of the need to raise awareness of existing types of consolidation, in addition to its work on new consolidation options like superfunds.
The three schemes were combined in April on a sectionalised basis, meaning the schemes are amalgamated but assets and liabilities are ringfenced in different sections.
Admin efficiency accompanies cost savings
The Honeywell scheme’s trustees anticipate that moving to a single trustee board will boost the scheme’s net performance by reducing costs, while also delivering a better experience for members.
“The running of one scheme will mean a significant reduction in the time required to administer and manage pensions within Honeywell, ensuring that the resultant scheme is dealt with in the most efficient and cost-effective way,” a February member newsletter announcing the proposal explained.
The letter notes that legal, actuarial and covenant advice established that members could not see any detriment as a result of the change.
“Based on this advice, the trustee is satisfied that your benefits in HUKPS will be no less favourable than your existing benefits in the scheme and that Honeywell’s ability and commitment to provide ongoing financial support for FKI Scheme members, is not weakened as a result of the merger,” it states.
M&A led to proliferation of schemes
Honeywell’s previously fragmented stable of DB pension schemes was brought about by many years of mergers and acquisitions.
In 2015, the multinational bought the Elster electricity and water division of Melrose Industries. As part of the deal, in addition to the Elster DB pension plans, Honeywell assumed the FKI and McKechnie schemes.
Together, these pension plans had gross liabilities of £848.7m, gross assets of £736.8m and a net deficit of £111.9m at the date of disposal, according to Melrose’s 2015 annual report.
Honeywell’s shows total assets of $6.5bn (£5.1bn) for its non-US pension plans, which include schemes in the UK, Germany, Canada and the Netherlands.
Ringfenced sections keep assets separate
A Honeywell spokesperson says that the scheme merger has “enabled us to continue to manage the UK pension schemes equally and efficiently through a streamlined decision-making process with a single trustee board, actuarial valuation and a consistent funding approach”.
“Following consultation with respective trustee boards, a sectionalised approach was agreed as the best way forward due to differences between the schemes that needed to be retained,” the spokesperson adds.
The fund has taken pains to reassure members of the smaller schemes that they will remain in their own sections, rather than cross-subsidising each other.
“There will be no mixing of any existing HUKPS and FKI Scheme assets; they will remain separate and identifiable,” the newsletter stressed.
This may be because a full merger, where both assets and liabilities are combined, can have an impact on employer covenant, according to Matthew Harrison, managing director at Lincoln Pensions.
“Where the merger is sectionalised, it is likely that the existing covenant will be largely unchanged,” he notes. “However, trustees and sponsors should be cognisant that, where the covenant differs for each section, it may be appropriate to retain different investment and funding strategies – this may make it harder to obtain some of the cost and efficiency synergies which are often a driver behind a sectionalised scheme merger.”
Full mergers prove tricky
Where a scheme merger is not carried out on a sectionalised basis, understanding the impact on the covenant will be key, according to Mr Harrison.
This includes the impact on the funding level, scheme-employer relationships, scheme demographics and trustee powers.
“This will be essential for both the departing trustees who will want to be sure the scheme is going to a ‘good home’, and the receiving trustees, who will also want to be sure that the security of their existing members’ benefits is not adversely affected,” he says.
Stagecoach tightens governance reins with scheme merger
Stagecoach Group has merged one of its smaller pension plans with its £1.3bn DB scheme, but the company maintained a separate section for the smaller fund, keeping liabilities separate while potentially sharing some costs.
Rosalind Connor, a partner at Arc Pensions Law, says funding levels are a key first consideration: “If you’re a better funded scheme and you’re fully merging with a less well-funded scheme, then you have to have a good reason to do that – because otherwise you are just reducing the funding level for your members.”
She adds: “If your funding isn’t similar, you’ve got to either sit there and think, what is it you can give those trustees – what can make those trustees comfortable – and you may not have something to offer them, and if you can’t do that, the only kind of merger you’re going to end up doing is a sectionalised one.”
Mr Harrison says he has seen some instances where merging schemes with different funding levels has been justified, usually where there is a covenant benefit to the pension plan whose funding level is being diluted through the merger.
“This could include obtaining access to stronger employers, covenant augmentations provided as part of the scheme merger (eg guarantees), or ‘softer’ benefits such as improved negotiation leverage through being part of a larger scheme,” he notes. More often, he says, employers make an additional contribution to balance the two funding levels.
Are you ceding power to your employer?
If one scheme is asked to accept another’s trust deed and rules, trustees also need to consider whether they lose any of their previous powers, according to Ms Connor. “You might find that one scheme has a lot of discretion in the hands of the trustees – maybe the discretion about whether expenses are paid out of the scheme or directly by the employer, maybe discretion about increases to benefits, and the other scheme doesn’t.”
It is therefore quite common to carry out a ‘balance of powers’ analysis before agreeing to a scheme merger, she says, adding: “I’ve seen people look to amend the powers of the receiving scheme.”
