Published in the May 2008 edition of Pensions World:  Why is so much money chasing pensions?  Paternoster has accumulated pension assets of £1.5bn.  Edmund Truell’s PIC splashed out some £400m to buy Telent and further cash was spent acquiring Thorn and Thresher in order to “get their hands” on billions of pension scheme assets.  A string of other players are looking to enter the market as well.  When financially astute investors start chasing something that others are desperate to get rid of, it is worth asking yourself why?

Paternoster, the biggest new insurer on the block, recently announced that their total premium income to date is £1.54 billion, with 29 schemes now transferred to them including the £800 million P&O Scheme.  Others such as Lucida, Synesis and Tactica are also keen to get their hands on your pension scheme, not to mention the traditional players such as Prudential and Legal and General.

Most of the current owners of pension schemes, the sponsoring employers, would be happy to see the back of their schemes.  A typical FTSE350 company has pension liabilities of around a quarter of its market cap so FDs are taking an increasingly active interest in managing their schemes. 

Why the competition to take your pension problem off your hands?

There is a clear implication that there is latent value sitting in pension schemes, if only you know how to get at it.  All the new players think they have the special skills and knowledge to extract this value for their own profit – and they probably do!  It is estimated that there is around £1,000 billion of liabilities in private sector UK final salary schemes.  So, if you think you can extract just a fraction of this, the potential profits look huge.  However, could companies not extract this value for themselves?

As financial vehicles, pension schemes are managed, by and large, sub-optimally.  With the best will in the world, trustee boards simply cannot commit the time and resources to actively manage their pension schemes with the same rigour applied by major financial institutions.  With the possible exception of the largest pension schemes, most pension schemes are managed from one quarterly trustee meeting to the next with little action in between.  You wouldn’t run a business that way.

So what can companies do?

Many of the approaches used by the buy-out companies can be used by scheme sponsors themselves.  In this way, companies may be able to extract at least some of the value from their own pension scheme, rather than passing the problem – and the profits – on to someone else.  We would suggest approaching the task in hand using a four stage DIY process:

• Downsizing – reduce the rate at which future benefits accrue and control the growth in those already accumulated, e.g. by moving to career average benefits or by controlling pensionable pay growth.  Give members the option to transfer out at enhanced rates and thereby reduce the overall size of the problem.
• De-risking – a key pension scheme risk is investment risk from the mismatching of assets to liabilities.  The scale of this risk would be considered far too extreme in other areas of business.  Understand the risks and ensure you are being adequately rewarded with greater expected return.
• Risk transfer –another big risk is the future longevity of scheme members.  Some schemes have dealt with this by insuring pensioners liabilities, i.e. passing on both longevity and investment risks.  Less extreme, more innovative risk transfer solutions are now becoming available.
• Decommissioning – having reduced your liabilities and risks using the above process, the residual liabilities can in time be passed to an insurer and the scheme closed down.

Tailor-made solutions can be designed to solve a scheme’s particular problems, allowing the sponsor and scheme members to benefit from the removal of the risks.. In some cases it is absolutely appropriate for companies to pass the problem, and possible profit, onto someone else.  However, in the same way that selling an under-performing business is not the only option; companies can instead try to turn around their underperforming pension schemes themselves.