Journey planning is an increasingly important issue for trustees and employers. Up to now, the ultimate destination for schemes has been a buy-out – securing members' benefits with a regulated insurer. Soon there might be an alternative in the way of a new style of defined benefit (DB) consolidator (DB Consolidators).

The promise of the new DB Consolidators (also called "superfunds") to employers is that they offer the benefit of buying out benefits by way of a release of obligations to the scheme but at a lower cost. DB Consolidators do raise complicated issues though – and industry, the government and regulators have spent the last few years working through them. In particular, what legislative and regulatory framework should be put around the new DB consolidators to make them acceptable to all stakeholders? While we are still waiting for draft legislation, The Pensions Regulator (TPR) has now published new interim guidance on superfunds.

Following publication of TPR's guidance we expect the first schemes will start to transfer to the new superfunds soon – and as trustees and employers increasingly consider the long term plan for their schemes many may give some thought to whether a superfund would be right for them. We are also likely to see the arrival of new DB Consolidators leading to greater consideration of other types of DB consolidation, whether through existing or new DB master trusts, new insurance products coming to market, sole professional trustees, or consolidated adviser platforms.

What is a consolidator?

Pension scheme consolidators bring together two or more existing pension schemes in a single scheme by accepting transfers of members and their liabilities from other schemes. The theory is that as consolidators operate on a bigger scale they benefit from efficiencies (from administration to investment) which are not available to smaller schemes.

There have been forms of pension scheme consolidation for many years – schemes have merged together to form larger schemes (often following corporate mergers) and there are DB Master Trusts which bring together schemes with unconnected employers.

How are the new DB consolidators different?

Like traditional consolidators, the new DB Consolidators are set up as occupational pension schemes which can take transfers from other schemes. Unlike a traditional occupational pension scheme, though, the new DB Consolidators do not have a significant employer that supports the scheme but instead have a capital "buffer". The capital buffer sits outside the scheme but can be called on to support the scheme if necessary (like the employer covenant).

The new DB Consolidators accept schemes if they are able to transfer enough assets to be fully funded on the DB Consolidator's (prudent) funding basis, and if a further contribution is made to the capital buffer. On the transfer to the DB Consolidator, the transferring scheme's employers have no obligation to the DB Consolidator (beyond any contribution needed to reach the required funding level).

By dividing up these benefits of scale, all the stakeholders benefit from a transfer to a new DB Consolidator – the employer clears its contingent liability to its pension scheme, trustees obtain a more secure benefit for their members (because the additional contributions and capital buffer outweigh the employer covenant being given up) and the superfund's backers (who commit additional capital to the buffer) can make a return. The cost to the employer is less than the other route to clearing its liability – a buy-out with an insurer – although the question that leaves is whether the security for members is also less.

For this reason new DB Consolidators are not without controversy – the severing of the employer link without the security for members of a regulated insurance company has attracted criticism, in particular from both unions and insurers. Grappling with the nature of the legal and regulatory framework to put around the new DB Consolidators has kept government and TPR busy over these past months.

A brief history of the new DB consolidators

Interest in new forms of consolidation has been growing since the Pensions and Lifetime Savings Association DB taskforce (which was looking at how closed DB schemes could run off more efficiently and secure member benefits) suggested a consolidator model could deliver materially better outcomes for members. Shortly after this, the Government issued its Green Paper (Security and Sustainability in Defined Benefit Pension Schemes) which included a number of questions on new forms of consolidator for consultation.

That consultation led to the Government's White Paper in March 2018 (Protecting Defined Benefit Pension Schemes). The Government was "convinced of the significant benefits that consolidation can bring if legislative and regulatory frameworks are designed properly and risks mitigated".

While the White Paper suggested a new legislative and regulatory framework would be necessary, and set out a number of areas for further consultation on what such a framework would look like, this was a significant step forward. Following the White Paper, in the summer of 2018, two new DB Consolidators launched – the Pension SuperFund and Clara-Pensions.

In December 2018 the The Department for Work and Pensions (DWP) launched the consultation anticipated by the White Paper. The consultation looked at how new DB Consolidators could be supervised, how to ensure each had a viable business model and is financially sustainable, that they are well governed and, crucially, that a new DB Consolidator could be expected to pay members benefits as they fall due. Although the consultation closed over a year ago (on 1 February 2019) the DWP has still not issued a response to the consultation.

In the meantime, though, the PPF has set out the way it would approach setting a levy for a new DB Consolidator and TPR has set out its approach to regulation. TPR has stated its expectations of those running new DB Consolidators and how it will address the areas identified by the consultation – TPR's guidance anticipates schemes transferring to new DB Consolidators before legislation is introduced to regulate new DB Consolidators (but only if TPR has assessed the new DB Consolidator against its stated criteria). See our separate Insight for more detail on TPR's latest guidance.

TPR expects trustees to justify their decision that a transfer to a new DB Consolidators was in the interests of members. TPR has issued brief guidance to employers – the key point of which is that TPR expects any employer transferring a scheme to a new DB Consolidator to apply for clearance from TPR first; a point re-enforced in TPR's latest guidance.

In October 2019 the Government published the Pensions Bill, which is now making its way through Parliament (and is expected to become law in the autumn). While the Bill addressed most of the issues covered in the Green and White Papers, it did not include any provisions for the regulation of superfunds.

The new DB consolidators

Two new DB Consolidators launched in 2018 – The Pension SuperFund and Clara-Pensions. They have some significant differences and they will therefore need to be compared and contrasted when considering the pros and cons of a DB consolidator.

Clara-Pensions describes itself as a "bridge to buyout". Schemes are transferred into separate sections of the Clara scheme, so different schemes remain separate from each other. As each scheme reaches a funding level that allows benefits to be secured with an insurer, the scheme benefits are bought out (and capital is returned to Clara's investors). Clara is therefore not pitched as an alternative to an insured buy-out, but a structured step on the way.

The Pension SuperFund, on the other hand, is intended to provide benefits to scheme members in the long term – and so is pitching itself as an alternative to buy-out. Schemes transferring into The Pension SuperFund do not therefore need to be kept formally separate from each other.

The market evolves

The launch of Clara and The Pension Superfund has generated interest, discussion and debate. While some have questioned whether the new DB Consolidators will effectively meet the needs of large numbers of trustees, employers and members, it's been generally acknowledged that schemes would benefit from a wider range of options.

Legal & General have been one of the first into the market with an alternative to the new DB Consolidators. Their "Insured Self- Sufficiency" (ISS) product offers schemes a reduction in their risk (based on insurance principles) but retains the link to the sponsoring employer. L&G estimate that the ISS solution would be 10%-15% cheaper than bulk annuities – L&G estimate that the risks a scheme would remain exposed to (compared with a full buyout) would be the investment risks associated with a very severe market shock (L&G estimate that the ISS would cover risk up to a 1 in 200 year event) and some employer insolvency risk.

More recently Aspinall Capital Partners have completed their first Capital-Backed Journey Plan transaction. This structure sees the pension scheme benefit from the security of an additional capital buffer until buy-out is secured, while maintaining the link with its sponsoring employer.

Should I be thinking about a superfund?

Superfunds are unlikely to be relevant to the best funded schemes as it would be difficult to justify a transfer to a superfund when a buy out with an insurer was possible in the near future (indeed it may be legally impossible to do so in such circumstances). In addition, the employer of such schemes may consider that it can deliver member's benefits securely on its own and in its own time.

At the other end of the spectrum, schemes which are significantly underfunded and only have a weak employer are likely to have other priorities and the employer may not be able to find the initial sum required to meet the superfund's up front deal price in any event.

Trustees and employers should be giving thought to their long-term funding objectives – and for many schemes between these funding levels, superfunds provide a welcome additional option when considering how best to secure members' benefits.