When it comes to pensions, Jeremy Hunt believes big is beautiful.
The Chancellor wants to consolidate. The UK's broad portfolio of pension schemes is divided into a smaller number of larger banks with the financial firepower to invest in high-growth assets. The idea is to maximize retirees' income while boosting the British economy.
But with more than 30,000 personal pension schemes currently operating in the UK, Hunt has his work cut out for him.
Not only will he have to overcome the reluctance of trustees, who are happy to carry on with business as usual, but he will also have to overcome the insurance lobby, which is trying to portray the idea of “super funds” as a risky move that could shortchange pensioners. /p>
The idea of winding down pension schemes was first floated several years ago in a document published by the Department for Work and Pensions.
It said: “Clearly there can be economies of scale with potentially lower costs per participant, and scale can also bring benefits by delivering better returns on investment.”
That was six years ago, and with little has changed since then.
Baroness Altmann, who was Pensions Minister before the report was published, says there were two reasons why the project failed to get off the ground.
“First of all, it’s damn hard,” she says. “When you combine two schemes, you can't just standardize benefits. Every scheme has to preserve all the little nuances and flaws.”
Vested interests also played a role.
“Each of our DB schemes (defined benefit pensions that promise pensioners a certain income level) must have its own actuary, its own lawyer, its own auditors and its own professional consultants. If you have 5,000 schemes now and you cut them down to 100, that's 4,900 professional firms that are losing business.”
And then there's the structure itself.
A sweeping change in legislation following the death of British media tycoon Robert Maxwell, who stole hundreds of millions of pounds from his companies' pensions, has forced pension funds to move away from stocks and towards bonds, which offer more predictable but lower returns.
As a result, many pension funds ended up with huge deficits in an era of low interest rates. The merger will simply leave the funds with more unfunded liabilities.
For those in a stronger position, the preferred ending is now the so-called buyout.
In this scenario, rather than relying on investment returns for pension benefits, the schemes pay an insurance company to take on the responsibility of paying participants' pensions upon retirement.
These types of deals are known as “bulk annuity” sales, and in the first six months of this year alone the market was valued at around £25 billion.
It's a neat way of doing it, though. reduces the risks of individual pension schemes, it does little to encourage investment in growing assets.
Naseeb Ahmed of UBS says: “Insurance companies want securities and bonds as payment [in the buyout process]. Some will also take on infrastructure assets, but even these will eventually be redeveloped when they come on the balance sheet. So it's mainly bonds, government bonds and corporate bonds.”
Official figures show that pension schemes with assets of more than £1 billion currently have less than 5% invested in UK shares. In contrast, schemes with assets under £10 million hold around a third of their assets in shares.
While higher interest rates have helped most schemes improve their funding position, thousands of companies are still far from redemption.
Enter the commercial super fund. Modeled after systems in Australia and Canada, these mega-pension banks can pool small funds and invest their assets in high-growth opportunities.
Clara Pensions became the first and only so-called super consolidator to receive permission from the Pensions Regulator in 2021. Clara chief executive Simon True, who previously worked as chief actuary at insurance giant Phoenix, oversaw its first deal last month, taking over Sears' £600 million pension scheme.
UBS says super funds can offer pension risk reduction at a price that is “at least 10%” cheaper than insurers, partly because regulation is less onerous.
Hunt wants to see more Clara-style schemes . However, not everyone shares his enthusiasm.
The insurance industry has been a vocal opponent of super funds since the idea was first floated. Tracey Blackwell, chief executive of the Pension Insurance Corporation (PIC), described the growth of super funds in 2019 as “appalling”.
She questions whether super funds actually make it more likely that pensioners will be able to enjoy their “full benefits” and argues that the structures pose a “moral hazard” resulting in trustees selling to super funds simply because they are cheaper.
Blackwell adds: “The final question is how to prevent these under-regulated organizations, riven by conflicts of interest, from becoming systemic risks. We saw what happened during the LDI crisis and this risk needs to be managed very carefully.”
However, Clara believes that regulation is much tighter than insurers assume.
He said: “There was a corresponding challenge from the insurance industry… so it seemed like there was a vacuum. This vacuum has now been filled and the TPR [Pensions Regulator] has stepped up significantly.”
Clara believes she can increase her assets to at least £2 billion in the next few years and hopes super funds will eventually control £200 billion of the £1.5 trillion market. Scale is the key to success.
“We benefit from scale because we can invest time and effort into exploring niche assets [and] we can invest in larger, more ambitious infrastructure projects. We're already seeing the benefits of this.”
Hunt is also keen to strengthen the role of the Pension Protection Fund, the government-backed lifeboat for the industry that rescues schemes in trouble.
Its market-beating returns, averaging more than 9% since 2011, and its world-class in-house investment team have attracted the attention of policymakers.
Strong profits have allowed the company to accumulate £12.1 billion on a rainy day. funds, and invest in a range of diverse assets, from forests in Tasmania to office buildings in Bristol. A fifth of its assets are invested in UK production finance.
This winter the Treasury will launch a consultation on how PPF “can act as a consolidator for schemes that are unattractive to commercial providers” that are “not served by the market”.
Barry Kennett, chief investment officer of PPF and a former Morgan Stanley banker, says he is ready to take on a wider role: “The new mechanism could help DB schemes achieve their ultimate goal of providing benefits to their members, as well as providing more investment in assets, which support the UK economy.”
Insurers are already expressing their concerns.
Kunal Sood, managing director of Standard Life, part of FTSE 100 insurer Phoenix, said: “Any changes must be carefully considered to ensure that scheme participants and ultimately the taxpayers who benefit from , may have to pay bills in case of losses.”
Senior Treasury sources say they are determined to make a difference.
“I think it's smart and right that we give small pension funds a choice, so there's not just an insurance route, there's a PPF route, there's a route super funds. I think the market will have to decide.
“What won't happen is that they will simply continue to do business the way they have always done it, because that will result in lower income for retirees and less capitalization of our rapidly growing business than we really need.”
Be that as it may, Clara's business model is still based on entering into a full buyout deal with the insurance company over five to 10 years, which limits her investment options.
TPR rules are also aimed at obtaining DB schemes eligible for buyout, which limits the amount of money that can be pooled into a super fund.
For now, consolidation can only be “considered if the scheme cannot access redemption now” and “does not have a realistic prospect of redemption in the foreseeable future.”
John Kay, lead economist who led the government review UK stock market ten years ago, believes the TPR rules need to be reformed.
Speaking more generally about the impact of regulation on investment, he says: “We have seen how harmful regulation can be when you are people who have no idea what they're doing and who are spreading unnecessary regulation.”
He adds: “What actually happened in terms of buyouts is that we supposedly introduced this regulation of funds, which reduces risk, which makes them quite expensive.”
Lady Altmann says: “The whole idea of capitalism is based on the idea that you take risks and, on average, in the long run you will be rewarded for it.
“There's no guarantee that some people won't fail, but if you don't take risks, everything you do will cost a lot more money.”
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