Skip to main content
The Actuary: The magazine of the Institute and Faculty of Actuaries - return to the homepage Logo of The Actuary website
  • Search
  • Visit The Actuary Magazine on Facebook
  • Visit The Actuary Magazine on LinkedIn
  • Visit @TheActuaryMag on Twitter
Visit the website of the Institute and Faculty of Actuaries Logo of the Institute and Faculty of Actuaries

Main navigation

  • News
  • Features
    • General Features
    • Interviews
    • Students
    • Opinion
  • Topics
  • Knowledge
    • Business Skills
    • Careers
    • Events
    • Predictions by The Actuary
    • Whitepapers
    • Webinars
    • Podcasts
  • Jobs
  • IFoA
    • CEO Comment
    • IFoA News
    • People & Social News
    • President Comment
  • Archive
Quick links:
  • Home
  • The Actuary Issues
  • May 2018
05
General Features
Topics

The case for consolidation

Open-access content Tuesday 8th May 2018 — updated 1.40pm, Wednesday 6th May 2020

John Herbert discusses the merits of consolidating defined benefit pension plans using a sectionalised master trust approach

2

The relationship between many defined benefit pension plans and their sponsors has changed significantly over the past 10 years. Very few current employees in the private sector continue to benefit from these arrangements, and they are now largely viewed as a financial legacy rather than part of current remuneration policy.

Existing structures and solutions appear to be under significant stress, with sponsors paying in substantial amounts of cash, yet, in some cases, members are still not getting their full benefits. Consequently, changes over the next 10 years may be even more significant as challenges emerge to deliver better solutions for both members and sponsors. 

The consensus view is that a process of 'consolidation', such that the number of defined benefit plans reduces significantly, may provide a suitable solution. However, there are diverging views on how this should be done and the timescale over which it can be achieved. 

A number of solutions have been proposed as summarised in the table below. Most aim to reduce both operational costs and financial risk. 

Figure 1

With the exception of superfunds, many of these solutions are already available, so why are they not being used more extensively? The main reasons are probably a reluctance to change, owing to either inertia, uncertainty or, possibly, the upfront transition costs.

In addition, the scale of the risks, both financial and reputational, are yet to fully emerge. Recent high-profile corporate failures have highlighted pension issues and the likely reduction to member benefits. Further ahead, the human resources required to continue to provide these services is likely to come under severe strain. 

Once the risks of maintaining the status quo and taking no action become clearer, these products and solutions are likely to become widely adopted by many pension plans. So the question is when rather than if, and whether one single option will prevail or whether there will be a range of solutions to choose from.

Smaller plans 

Typically, smaller plans have higher operational and management costs (compared to their asset size) and are likely to see the greatest savings from 'consolidation'. Increased scale may also lead to stronger governance and better risk management. 

Smaller plans also face other issues, such as access to insurance buyout solutions at a competitive price and possibly access to some specialist skills around investments. For very small plans, the issue of adequate service provision at an affordable price may already be starting to emerge.

Sectionalised master trust

The master trust solution has been widely adopted for defined contribution plans, providing economies of scale, access to a wider range of investments and stronger governance. These benefits can also be provided to defined benefit plans.

The defined benefit master trust is a medium/long-term consolidation solution that reduces both governance risks and operational cost for the sponsor. There are some upfront costs involved, but operational costs (both direct and indirect) should be greatly reduced. In most cases, the break-even point should be relatively short.

The sectionalised master trust ringfences assets and liabilities for each employer, so that there are no cross-subsidies and no risk that one employer may need to contribute towards the liabilities of any other employers. Each section has its own funding plan and investment strategy, so the employer retains overall strategic control of the pension plan. 

Unlike the non-sectionalised master trust, it remains very straightforward to move all the assets and liabilities to another consolidation solution without incurring significant exit penalties.

It should be viewed as a change of management (or governance) structure rather than a transfer of risk. In nearly all cases, these master trusts are run by professional independent trustees, who take on the responsibility for compliance, governance and management and use their expertise to find the most efficient solution for the participating employers. 

In summary, the sectionalised defined benefit master trust offers the following features:

Figure 2

Member perspective

While the benefits to sponsors are clear, what will be the likely impact on the members of a plan choosing to join a defined benefit master trust?

Overall, this should be very limited. There may be a new service provider and possibly some new contact details, but the member should not see too many changes. Potentially, service will improve as a result of being part of a larger pension plan with stronger governance and controls. 

Financial security will remain unaffected, with the same sponsor and covenant, while the funding level will also be unchanged because all the assets and liabilities will be transferred across. Lastly, the Pension Protection Fund (PPF) remains in place as a backstop if needed. 

Over the medium term, security for members would be expected to improve more quickly as a result of lower operational costs, so more of the contributions can be used to improve the funding level. Furthermore, economies of scale mean that the investments are likely to provide better risk-adjusted returns.

Experience in other countries

The UK has seen the number of defined benefit pension plans fall by around 20% over the past 20 years through mergers, insurance buyouts and entry into the PPF. This is fairly typical where there has been a passive approach and no positive action on consolidation.

In some countries, such as the Netherlands and Australia, where positive consolidation steps have been taken, the number of defined benefit pension plans has reduced by 70% or more. This has been achieved through master trusts, industry-wide schemes and buyout solutions, but changes to legislation and simplification of benefits have also played a significant role in the process. 

Why now?

The focus has moved very quickly on to the costs of managing legacy defined benefit pension plans and the additional financial burden this places on UK companies. For many sponsors, the cost of an insurance buyout is simply too high or does not represent efficient use of capital. 

Other solutions, such as full-service providers, are unlikely to make enough difference to costs to have a real impact. The superfunds approach will require fundamental changes to legislation and take significant time to deliver. 

The master trust can deliver the level of cost savings needed and really only needs confidence from employers (and trustees) to overcome the current inertia in the decision-making process. It still provides flexibility to take advantage of any simplification or harmonisation that may be available at a later date and may also accelerate the path towards a full settlement through an insurance buyout.

John Herbert is chief actuary at Premier

This article appeared in our May 2018 issue of The Actuary.
Click here to view this issue
Filed in:
05
Also filed in:
General Features
Topics
Topics:
Risk & ERM

You might also like...

Share
  • Twitter
  • Facebook
  • Linked in
  • Mail
  • Print

Latest Jobs

Senior Underwriting Risk Manager

London (Central)
£85K-£95K + Benefits
Reference
124386

Reserving Manager (Contract)

London (Central)
£1200 - £1400 per day
Reference
124385

Life Actuary - Contract - IFRS 17 Financial Impact

England, London / England, Bristol / North Yorkshire, England
£900 - £1150 per day
Reference
124384
See all jobs »
 
 

Today's top reads

 
 

Sign up to our newsletter

News, jobs and updates

Sign up

Subscribe to The Actuary

Receive the print edition straight to your door

Subscribe
Spread-iPad-slantB-june.png

Topics

  • Data Science
  • Investment
  • Risk & ERM
  • Pensions
  • Environment
  • Soft skills
  • General Insurance
  • Regulation Standards
  • Health care
  • Technology
  • Reinsurance
  • Global
  • Life insurance
​
FOLLOW US
The Actuary on LinkedIn
@TheActuaryMag on Twitter
Facebook: The Actuary Magazine
CONTACT US
The Actuary
Tel: (+44) 020 7880 6200
​

IFoA

About IFoA
Become an actuary
IFoA Events
About membership

Information

Privacy Policy
Terms & Conditions
Cookie Policy
Think Green

Get in touch

Contact us
Advertise with us
Subscribe to The Actuary Magazine
Contribute

The Actuary Jobs

Actuarial job search
Pensions jobs
General insurance jobs
Solvency II jobs

© 2022 The Actuary. The Actuary is published on behalf of the Institute and Faculty of Actuaries by Redactive Publishing Limited, 71-75 Shelton Street, London WC2H 9JQ. Tel: 020 7880 6200