Having your pensions cake and eating it

Innovation in the defined benefit pensions market is enabling employers to reduce the costs of their pension schemes through consolidation—but without losing control

The pensions industry has long grappled with a cost problem: the smaller a pension scheme is, the higher the per member costs of running the scheme.

“There’s a whole range of costs across a pension scheme, although investment management charges were probably the lightbulb moment for us,” says Mark McClintock, a partner in Deloitte’s pensions consulting business. “Why should a pension scheme with £10m of assets pay a higher annual management charge than a pension scheme with £100m of assets with the same fund manager in the same fund?”

That uneven backdrop is driving consolidation across the pensions industry in an effort to level the playing field for small and medium-sized pension schemes. The aim is to reduce their costs and enable them to benefit from the same economies of scale that larger pension schemes enjoy.

One potential snag is that consolidation has traditionally meant employers and trustees have been forced to relinquish control of their schemes in order to merge their assets with a consolidated fund.

“To access a vehicle that allows you to consolidate, you typically have to give up something—and that, if you’re an employer, is essentially loss of control,” says McClintock. “That matters because employers will have a trustee board that oversees their pension fund and they will know them and understand how they act; there are no surprises.”

Under that relationship, employers maintain influence over the scheme’s investment and funding strategy - and therefore have more control over how fast the scheme progresses to a fully-funded status.

“If you go into a consolidation vehicle, you don’t control who the trustee is and you lose the ability to have your own autonomous plan,” says McClintock.

That structural impediment, which has traditionally deterred smaller schemes from consolidating, was the catalyst for Deloitte creating the Deloitte Pensions Master Plan (DPMP). This is a pension plan that allows defined benefit (DB) schemes to pool their assets without ceding control.

“The key design feature we came up with was allowing pension funds to lift and drop into our plan with a scheme’s existing trustee in place,” says McClintock. “That means there is no loss of control, which is a unique proposition in the market. We believe no other DB master trust has this feature - you get the trustee that attaches to that consolidation vehicle. That’s a big barrier for a lot of small and mid-size pension schemes.”

DPMP solves this by having each scheme that ‘drops’ into the fund remaining as a separate entity with its own trustee board. That means trustees maintain their existing powers, including investment discretion. There is also a central professional trustee sitting at the core of the Master Plan who is responsible for oversight of the fund as a whole and can be called on if needed, for instance if a scheme’s trustee is facing a particularly difficult decision and they want a second opinion from an experienced practitioner, says McClintock.

Aside from maintaining control, the other main benefit of this structure is that it can drive down costs for small and medium-sized pension schemes by pooling all of the schemes’ assets without breaking the segregation of each individual scheme section. Deloitte kick-started the plan by pooling the assets of its own defined benefit scheme, giving the Master Plan sufficient scale to immediately help member schemes reduce their costs. Initially, typical reductions in investment costs were around 30% but that has since risen to more than 50%, McClintock says.

“As the Master Plan gets bigger, the ability to drive down those costs continues to grow, so it becomes a club where the people who are already in it benefit as others join,” he says. “And, of course, the more you reduce the cost, the more money stays in the fund and so that drives better funding over time and better outcomes for members.”

Robert Hughes, chairman of Hughes Electrical and one of the DPMP’s members, says the cost savings of a DB master trust and the ability to retain its existing trustee board and manage its own investment strategy were the chief motivations for joining the plan. Other companies have also signed up to diversify their workplace pension schemes.

“Working with Deloitte, we developed and launched the BT Hybrid Scheme, a blended defined benefit and defined contribution scheme, based on the DPMP. We’re delighted with the scheme: for members, it provides greater income certainty and is easy to use; and for BT it’s cost effective and reduces risk,” says Kerry Shiels, pensions director at BT Group.

The DPMP will typically benefit all small and mid-sized DB schemes. That could be anything up to £500m of assets, especially if those assets are split across several investment managers where the scheme would quickly lose the benefit of scale. The size of the potential market in the UK for DB schemes that fall under this umbrella is around 3,000.
“We’re finding that even getting to several hundred million of assets, the cost savings are really quite significant, particularly on the investment side,” says McClintock.

The drive for more innovation in the pensions industry comes as the Department for Work and Pensions (DWP) seeks to encourage the consolidation of DB pension schemes where it can benefit the schemes by reducing costs, enabling more effective investment strategies and improving governance. The introduction of the DB master trust self-certification regime, for instance, enables employers that are considering consolidation to compare schemes through self-certificates hosted on the Pensions and Lifetime Savings Association website.

“The pensions industry has had relatively little innovation in the past, so when something new comes along that seems to move the goalposts quite substantially people are naturally sceptical. But one of the benefits of the self-certificates is to have more information available and make this feel a bit more real for employers,” McClintock says.

DWP’s support for the creation of self-certificates, and the information they provide to employers and trustees, will be critical in helping build trust when companies are weighing up new ways of managing their pension schemes and maximising the benefits of consolidation.

For more information about the Deloitte Pensions Master Plan please visit dpmp.co.uk

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