DB Scheme Consolidation : Government’s plan for the PPF to become a consolidator of small pension schemes

DB Scheme Consolidation : Government’s plan for the PPF to become a consolidator of small pension schemes

The DWP’s consultation on DB schemes proposes a public sector consolidator by 2026, managed by PPF, targeting unattractive schemes. Key concerns include scheme eligibility criteria and benefit standardization, aiming to simplify costs and administration for smaller schemes considering buyout or superfunds.

In its latest consultation, ‘Options for Defined Benefit schemes’, the Department for Work and Pensions (DWP) confirmed that the government is committed to establishing a public sector consolidator by 2026, administered by the Pension Protection Fund (PPF) board and targeted at schemes “unattractive” to commercial providers of insurance and superfunds.

The PPF has published initial views on the consultation to “support an effective debate” on the topic and believes the potential market could include around 2,400 schemes with around £120bn in assets.

The DWP wants to introduce a statutory objective for the new consolidator to offer consolidation to “eligible” defined benefit (DB) schemes and suggests that entry could be subject to the scheme demonstrating an inability to join a commercial consolidator or secure insurance buyout.

While broad and in keeping with the desired aims, this begs the question as to how much work – and cost – would be required for schemes to demonstrate this. Setting the bar too high could undermine the ability of some schemes to take up this new option.

The PPF appears to have similar concerns and considers that the better approach would be to allow scheme trustees freedom to choose the right solution for their scheme and members. This means the consolidator would be required to accept any scheme that can accept its terms.

Unsegregated fund

A key structural question is whether such a consolidator should operate with multiple segregated sections – with ring-fenced assets and liabilities – or as a single, pooled fund.

The DWP favours an unsegregated structure to enable the consolidator to benefit from economies of scale, and the PPF appears to support this approach.

The DWP also expects that the consolidator would need to meet the same funding standards of commercial consolidators to ensure a high level of protection for member benefits and put the PSC on a level playing field with commercial consolidators.

However, this would require some form of underwriting from third party capital and the consultation considers ways in which underwriting could be provided – whether by the government, PPF reserves or something else.

There will be challenges to overcome with either option, but the PPF believes there is a clear case for the government to provide the buffer – albeit at a capped, finite amount – given the consolidator is being designed to achieve government objectives.

Link between scheme and employer

The link between employer and scheme is proposed to be severed when the scheme transfers into the consolidator, enabling a “clean break”. However, for any underfunded schemes, the employer would be contractually required to pay off the deficit over time.

In the unfortunate scenario that the employer becomes insolvent before fully paying off all the instalments, it is proposed that the relevant group of members would have their benefits reduced in line with the proportion of instalments made. Depending on the amount owing at the relevant time, this could mean affected members transferring into the “lifeboat” arm of the PPF.

This is complex and will need careful consideration. However, the ability for underfunded schemes to enter the consolidator has already faced some industry criticism and concerns have been raised about potential market distortion. Therefore this particular feature may not make the final cut.

Benefit structure

Unlike with insurance buyout and superfunds, where scheme benefit structures are broadly replicated, there would be a small number of standardised benefit structures on offer from the consolidator. The PPF’s discussion paper includes some initial views on this and a proposed “benefit choice menu”.

The rationale here is that the DWP thinks the cost of benefit replication is a particular challenge for small schemes looking at buyout or a superfund. The PPF has noted that it would also support lower administration costs and could make benefits easier for members to understand.

This would require careful consideration by transferring trustees. While scheme benefits before and after transfer would have to be actuarially equivalent in value, they will not be the same and there will be winners and losers. Trustees will need to understand the extent of this for their own scheme and will want to understand potential residual risks following transfer.

There are clearly several tricky issues to work through and it will be interesting to see how this unfolds, particularly given the desire to establish the consolidator by 2026 and with a general election looming.