Running a smaller defined benefit (DB) pension scheme can be expensive. Moreover, cost pressures often limit the help and support members receive.
That’s why the Department for Work and Pensions (DWP) introduced measures to support the consolidation of DB pension schemes, giving the green light to superfunds and other innovations.
There are significant diseconomies of scale involved in running a DB scheme. Many tasks that need to be performed, like undertaking triennial actuarial valuations, or preparing annual accounts, give rise to a significant amount of ‘fixed cost’. This affects smaller DB schemes disproportionately to larger ones. As a result, smaller DB schemes often struggle to run effectively or efficiently on their own.
Smaller DB schemes with less than 1,000 members typically spend well over £1,000 per member each year. In the context of paying an average annual pension of around £5,000, that is shockingly inefficient. Employers must meet these costs for every member, even those not yet in receipt of a pension, some of whom may not see a penny from the scheme for another 20 years or more.
Meanwhile, large DB schemes, with more than 5,000 members, spend less than £200 per member each year on average. They are able to spread their fixed costs over a much larger number of members, so they benefit from vast economies of scale relative to their much smaller counterparts.
Running to stand still
Whilst a strong governance framework is necessary and appropriate – to protect members’ retirements – it places a very heavy burden on smaller DB schemes.
The Covid-19 pandemic has placed additional pressures on trustees and employers already struggling to keep up with new rules and regulations.
Large DB schemes are more likely to have the scale and resources to tackle these issues than smaller DB schemes.
Leveraging size to help members
DB schemes can be such a headache for trustees and employers, it’s sometimes easy to forget their original purpose – to provide a guaranteed retirement income for life to members.
When Freedom and Choice was introduced in 2015, the additional flexibility for members of DB schemes was widely welcomed. However, choice introduces new problems, presenting members with complex decisions and opening the door to potential scams.
If DB schemes can provide members with access to the right information and support, they will make better financial decisions and safeguard against pension scams. Whilst trustees and employers want to do the best for members, cost pressures often restrict what is delivered, leaving members in many smaller DB schemes, in particular, to go it alone.
Pressure is mounting for trustees and employers to do more, both from within the industry and from members themselves. A recent survey found that 47% of respondents want more support on what options are available to them, with just 21% believing that they already have an adequate level of support, according to consultant Hymans Robertson.
Large DB schemes can leverage their size to provide additional services to members. Some have their own websites, providing members access to information on scheme benefits, options on when and what form they can take their benefits in, and secure portals where personal information can be viewed and amended.
It was recently reported that member engagement rates increased to between 30% and 40% when members were provided with online, real-time access to their scheme benefits, compared to the industry average engagement rate of around 10%, according to consultants Buck. A tripling or quadrupling of the level of member engagement really demonstrates the value of such services and highlights the gulf that can exist between large and smaller DB schemes.
The wider benefits of consolidation
By bringing schemes together, consolidators can spread fixed running costs over a much larger number of members. They can also embrace technology and engage communications specialists to educate and inform their members, facilitating better decision making and helping to guard against pension scams.
Consolidation can bring other cost savings and risk reductions too. By adopting best practice governance standards, larger schemes can generate additional investment returns – the DWP’s 2018 White Paper cited several academic studies which showed that good governance through effective investment can add between 1 and 2% per annum to returns.
Some consolidators also expect to generate endgame buy-out savings by securing benefits in bulk rather than individually for each of the smaller DB schemes that join them.
The number of consolidation options in the market and the range of benefits they offer is growing. Any trustees and employers considering consolidation as a way of cutting costs and reducing risk will need to carefully weigh up all the options before making their move.
Chris Parlour is head of employer engagement at Stoneport Pensions