• Premature derisking of pension schemes could be costing the UK economy 20 to 25 years of productive investment.

• Pension consolidation, through the creation of large DB Superfunds, has the potential to increase productive investment.

• The Government must use the forthcoming Pensions Scheme Bill to operate Superfunds like pensions funds under pensions regulation rather than insurance institutions under the Solvency UK regime.

• To enhance the resilience of the system and generate more productive capital, insurers should be allowed to set up Superfunds outside their Solvency UK ringfences.

• The disparities between different official data sources make it impossible for the government to assess systemic risk and the overall health of the pension system; the health of the UK economy requires this to be addressed.

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Numerous calls for consolidation of pension schemes from think-tanks such as the Tony Blair Institute, Resolution Foundation and others, have all helped to put the issue back on the Government's agenda. The DB Taskforce set up by the PLSA in 2017 (chaired by the author) originally called for consolidation of DB schemes on the grounds of risk to members benefits, cost efficiency, investment competency and inflexibility of scheme resolution.

Until now, the Superfund initiative had been substantially delayed because of failure to get agreement between DWP, The Bank of England, the Treasury and insurers, most significantly on the prudential solvency basis for Superfunds. This is despite significant support from DWP and tPR who implemented a non-statutory Superfund regime. With an anticipated Pensions Schemes Bill coming soon that will set out a statutory basis for the authorisation and regulation of Superfunds, revisiting the focus for consolidation is timely.

What are the assets involved?

New Capital Consensus's "The Trillion Pound Question" report quantifies occupational pension system assets at just over £2.2 trillion. 78% resides in DB and 22% in DC. Of the £1.7 trillion in DB schemes, £1.2 trillion is in private sector schemes and just over £0.5 trillion in LGPS and other central government schemes.

DC is growing faster than DB, but DB continues to hold the majority of pension assets. Private sector DB schemes would be even more dominant if not for a 36% loss in assets (circa £650 billion) due to the LDI crisis. These losses may not matter for individual schemes targeting buyout as liability values may have shrunk equivalently, but losing 10% of investment capital is clearly damaging to the UK economy's growth potential. DB pensioners may not be affected as individual savers but the loss to the UK economy is tangible and real. It’s difficult to identify a body responsible for preventing this happening.

LGPS and other government schemes are in a considerably healthier position, having avoided such losses. They also invest more effectively, being still open and supported by government covenant.

Defined Benefit

While 5,500 different individual DB schemes exist, they behave more like one giant scheme due to high levels of herding. A report by the Bank of England Working Party on Procyclicality in 2014 quantified herding at more than 50%, and this is likely now significantly higher after the LDI crisis.

These schemes have invested heavily in gilts and LDI, driven by accounting and regulatory pressures to derisk. The LDI crisis demonstrated that government securities are far from risk-free.

Consolidating the entire DB pension system into the insurance sector through buyouts would create enormous systemic risk. Demand for matching assets and instruments attractive to life insurers would far exceed supply.

Even more damaging is derisking pension schemes well before their natural risk-bearing tenure. This removes investment capital from the economy and generates poor returns. Schemes typically start derisking 5-10 years before buyout, typically when members are around age 50. Individuals managing their own retirement funds should realistically start derisking between 70-75. The economy could thus be losing 20-25 years of productive investment. Importantly, derisking primarily mitigates potential costs to corporate balance sheets, not to benefit members.

This points to a private sector DB system lacking resilience and needing urgent attention - not only for cost efficiency and investment effectiveness, but for system resilience (preventing another LDI crisis) and stimulating economic growth.

Public sector DB schemes would also benefit from further consolidation. Today they comprise 8 asset pools in England/Wales (probably falling to 6 in light of recent Government decisions) but are governed by approximately 86 local authorities. Further consolidation would reduce governance overheads and enable building bigger collective risk-bearing investment pools capable of greater real asset investment, generating higher returns.

Backed by Government and not subject to accounting standards perversities, public sector schemes have been demonstrably better at bearing risk and remain open. The 2011 Hutton Review was meant to set the framework for a "generation," so as we approach 2030/31, another review is due. Any future review should question whether the near wholesale private sector DB scheme closures have benefitted members and society.

Defined Contribution

NCC’s first report, entitled “Reviving UK Investment Flows” identified significant consolidation has already occurred in the DC trust-based pension sector, reducing from nearly 3,700 schemes in 2012 to about 1,200 in 2023, with many consolidating into Mastertrust arrangements. Projections show trust-based schemes potentially falling to just 500 by 2030. While small trust-based schemes could be consolidated, the market is already concentrated into about 20 large schemes. Government policy on Value for Money and the Pensions Schemes Bill are expected to accelerate DC consolidation.

System fragility and productivity

While many reasons for consolidation identified in 2017 remain, the biggest current problem is lack of system resilience, primarily in private DB - representing the biggest reason for consolidation. Combined with premature derisking, this makes private DB the sector for Government to focus on to create more productive capital supporting its growth agenda, through the creations of Superfunds

Superfunds must operate under pension scheme regulation to have the investment freedom needed to generate productive capital, diversify system risk, and provide adequate returns and be able to work for all stakeholders. This was the key sticking point for insurers and the Bank of England which led to the long delay in action.

NCC believes that insurers should be allowed to set up Superfunds outside their Solvency UK ringfences. They are natural Superfund providers alongside existing large DB schemes, having the skills, competency and potential ability to raise capital. Without allowing them to compete, they could obstruct DB consolidation.

The Bank of England's past reasons for opposition remain unclear. In June 2020, the Governor reportedly wrote to Therese Coffey, the then Work and Pensions Secretary, expressing concern that Superfunds could create systemic risk - a view that might differ today following the LDI crisis losses.

Regulatory approaches to investment risk between private sector DB, LGPS, and insurance products have implications beyond meeting member benefits. The UK economy, housing markets, infrastructure, capital markets and the investment system more broadly, all benefit from large DB capital pools. These benefits risk being lost if DB allocation freedom is swapped for Solvency 2 restrictions.

Given the current Government's appetite for pensions consolidation and concern about pensions as the primary source of private investment capital for UK growth, it's timely to put private DB consolidation and risk-bearing back on the agenda.

A footnote on data quality

The NCC report identifies poor pension system oversight, partly driven by confused responsibilities between government departments. It also highlights poor data in measuring scheme health. The PLSA DB Taskforce deliberately avoided using deficits to assess scheme health, focusing instead on probability of pensions being paid in full.

The current health of the DB system varies wildly - 127% solvency using tPR data versus 100% using ONS data, which as our research with the University of Leeds found, is more reliable as it captures derivatives, repo, and gives a more up-to-date snapshot of scheme assets. While trustees understand their individual schemes' health, the disparity between data sources makes it impossible for the Government to assess systemic risk and overall pension system health - an issue that needs addressing given the sector's importance to the UK economy.