‘Make or break year’ for frustrated DB consolidators

Two vehicles so far, The Pension SuperFund and Clara Pensions, currently operating under an interim regime, are awaiting final approval from the Pensions Regulator.

Neither fund has yet transacted a deal after years of work, but consultants now see the threat of insolvencies as an imperative for trustees to make progress. One in four sub-investment-grade companies is not expected to make it to 2040, according to Hymans Robertson, the actuary for Clara.

The risk of being first is that no follow-on transactions occur and our members would then be subject to the higher overheads that apply to the current scheme. This could lead to a lower likelihood of members receiving their benefits in full

Charles Ward, Dalriada Trustees

“The risk of employer default before reaching full buyout funding is very real,” says Alistair Russell-Smith, the company’s head of corporate DB. “The solvency stresses and economic uncertainty through Covid-19 is only reaffirming the risk.”

Mr Russell-Smith says this fear may start to sway trustees in the new environment: “Where employer default is a realistic possibility on the journey to buyout, moving to a commercial consolidator starts to look a sensible way to protect against a haircut to members’ benefits on an employer default.”

Adolfo Aponte, managing director of Lincoln Pensions, says of the findings: “These statistics speak to averages when the reality facing schemes with weak covenants is much starker.” 

Deals in the offing

With the release of TPR’s interim regime, momentum does look to be building behind the DB consolidation sector. A third operator is understood to be waiting in the wings, insurers are busily developing competing products, and Finnish insurer Sampo has recently been revealed as a backer of The Pension SuperFund.

Companies are now eyeing a first transaction by December. Mike Smedley, partner at Isio, reveals his firm is “actively advising on live deals where the circumstances give trustees a reason to act now — and the balance is in favour of consolidation”.

He adds: “There could also be attractive pricing for the first movers — mirroring the early days of the specialist pensions insurers 10-15 years ago.”

Charles Ward, a professional trustee at Dalriada Trustees, is in talks with fellow trustees and scheme sponsors about consolidator options. Based on these, he expects “to see the first transactions announced this year”.

However, he sounds a note of caution: “The risk of being first is that no follow-on transactions occur and our members would then be subject to the higher overheads that apply to the current scheme. This could lead to a lower likelihood of members receiving their benefits in full.”

He warns of another danger: “One specific area that requires very careful management is conflicts of interest, particularly if the same trustee firm acts for both the ceding scheme and the consolidator fund.”

Nevertheless, the superfunds are bullish: Richard Williams, director of policy and communications at Clara-Pensions, says: “Our ambition is that Clara will consolidate at least £5bn in liabilities over the next five years. Given the need for consolidation, and the interest we are seeing in the market, we believe this is both reasonable and achievable.” 

Equally, Kieran Mistry, risk transfer consultant at Hymans Robertson, adds: “The Pension SuperFund aims to get to £5bn in the next year to achieve economies of scale under their model. Over the next five years, they hope to transfer at least £30bn and have the capital lined up to achieve this.

“In terms of pipeline, The Pension SuperFund has indicatively priced more than £25bn of transactions.”

Pie in the sky?

It might all be pie in the sky. Indeed, “2020 is likely to be the make or break year for consolidators”, says Sam Jenkins, partner at LCP.

“Assuming they are able to get their first transactions over the line and demonstrate that they are a viable solution for schemes, it would not be unreasonable to predict transfer volumes of £2bn-plus over the next 12 months, with that likely to increase over the next five years as these vehicles become a more established route for schemes… and we could potentially get to £10bn-plus of annual transfers in five years’ time,” he says. 

“At one extreme we could see half a dozen small deals and the consolidators failing to ever reach scale,” adds Mr Smedley.

“On the other hand, if the consolidators have early success and the regulator clears deals quickly, then they could become mainstream — 50 schemes a year is a plausible high figure and would represent less than 5 per cent of the pensions market over five years.”

Most trustees will hold off until the market is established, and worries remain over the lack of covenant in the consolidator model.

In the meantime, Jane Kola, partner at Arc Pensions Law, stresses: “The best thing all schemes can do is get their house in order by sorting out their benefits. Get the benefit specification drafted and legally signed off properly, and transfer your data into buyout standard quality.

“Then you are ready to move to buyout or a consolidator quickly depending on how your sponsor fares.”

Ms Kola adds: “By all means, keep a close eye on covenant and seek to improve funding as fast as your sponsor can manage. But to fail to be buyout-ready on the benefits side is like Nero fiddling as Rome burns.”