Two defined benefit superfunds, Clara and the Pension SuperFund are poised to offer a new option for DB schemes and their members – at least as soon as The Pensions Regulator gives the go ahead. It has been a long process.
The Pensions and Lifetime Savings Association mooted superfunds as part of work begun in 2016 to address underfunded DB schemes, triggering 2018’s DWP consultation which has now passed the baton on to The Pensions Regulator.
Costas Yiasoumi, senior director with Willis Towers Watson’s UK pension de-risking transaction business, says: “The two superfunds that have come to market are still going through TPR’s process. I understand that is getting to its final stages and so would hope at some point this year TPR would complete that assessment process. Then each of the two superfunds will be able to go to TPR with specific transactions in mind for TPR to approve. They have been a long time in gestation, but it was important to get them right. We may be coming to the end of that process so we may see transactions in the first half of next year.”
The language from TPR guidance on the regulatory framework for superfunds published in June last year underlines this caution, suggesting that “some models may not get market support, may not achieve critical scale, may fail or may decide to exit the market. We want the investments held by the pension scheme and the capital buffer to be appropriate (and realisable or transferable for full value) to enable 100 per cent of members’ benefits to be protected to a high degree of certainty”.
Waiting game
Clara director of policy and communications Richard Williams says: “We are looking forward to progressing with our first transactions and welcoming our members once we have completed The Pensions Regulator’s assessment process, which is rightly a rigorous one.
“We hope to do so in the near future and be in a position to announce our first transactions after that. We have been working hard to ensure we are ready to transfer members to Clara – our team has already doubled in size this year and, together with our trustee, we’ve appointed Kempen Capital Management as our fiduciary manager.
“Clara offers members safer pensions, by providing a clear journey to the gold-standard of an insured buyout. We believe there is an urgent need in the DB market for consolidators who put members first and hope to be able to welcome our first members soon.”
Hymans Robertson senior risk transfer consultant Iain Pearce says: “Once the superfunds have had their names added to TPR’s website, schemes which have been waiting patiently in the wings can formally submit clearance applications for transfers.
“Given there appears to be strong Government support for the development of the DB superfund market it feels like a question of when, not if, for the first transfers. The more interesting question is whether the market snowballs or fizzles out.
“The addressable market of well-funded schemes with weaker sponsors is large and sustained, along with the ongoing pipeline linked to insolvency cases and M&A activity.”
Under pressure
This new market will therefore involve schemes under pressure. Pearce says: “The schemes willing to be on the vanguard are likely to have a red-hot burning platform, such as those with an insolvent sponsor. Unfortunately, there are quite a few of these schemes in the wake of the pandemic that will be considering superfunds as part of a range of options. As volumes grow and superfunds transactions become more common, the bar for trustees and sponsors may lower and the platform won’t have to be quite so scorching. Well-funded schemes with real question marks over their sponsor’s ability to survive and absorb unexpected deficits on the way to buy-out, may also become increasingly likely to consider if a superfund transfer is right for their members.”
Yiasoumi says: “Generally speaking, where you have got a weaker employer with a scheme that is underfunded going to an entity that is stronger, it will improve member outcomes. That can be quite binary because if an employer fails, some members can get cuts of up to 50 per cent of their benefits. The addressable market is big, measured in the several tens or perhaps hundreds of billions in size.”
“There is definitely awareness, but it is difficult for clients to commit a lot of bandwidth and resource until the two superfunds have a green light from TPR. Once that happens, when both have completed assessment, then you will see cases going through the advisory process. You will also see the early first movers who have already been in discussion with superfunds in some cases for two years, being able to make those applications hopefully for transactions in the first half of next year.”
“You wouldn’t want to see is the market growing too quickly and get growing pains. You want good steady growth. You are not going to see £100bn superfunds in two years’ time.”
Endgame focus
Eversheds Sutherland partner Jeremy Goodwin says: “There is huge growth in governance coming down the track towards pension trustees in the next 12 to 24 months.
“If we can get these DB schemes together into much bigger pots, it will really help with the economies of scale and getting better governance. Superfunds need to be funded to a particular degree to make sense. We have seen genuine increases in funding of DB schemes so the universe of schemes that are eligible to transfer into a superfund should be growing.
“Under the new funding regime, employers and trustees are encouraged to think about the endgame through the long-term objective. For the first time, employers are being encouraged to think about what the ultimate landing point for their scheme is. For many that will buyout for some self-sufficiency and for some it will be a consolidator, with superfunds as one of the real options.”
Sackers associate director Sonya Fraser says: “There is definitely interest in DB superfunds across the industry and a lot of focus on “end game planning” by trustees and employers. While superfund transactions gather initial momentum, the most likely candidates will probably be PPF+ schemes where the trustees may be able to secure a better outcome for their members than if they were to buy out benefits with an insurer. However, there’s likely to be a wider market for superfunds that will follow in due course with employer desires to sever ties with a legacy pension scheme or corporate transactions where there is a commercial driver for paying cash in return for a clean break from DB scheme liabilities.
“The other side of this is investor support, which is crucial for the commercial consolidator model. The regulatory regime is taking a long time to get off the ground and in the meantime the active consolidators are spending vast amounts of time and money investing in opportunities and moving interested schemes and trustees as far along the process as they’re able to, pending TPR’s assessment. The longer this assessment/regulatory process takes, the greater the risk that investors in the consolidator vehicles will step back and look for more reliable investment opportunities elsewhere.”
Cartwright scheme actuary and head of pensions strategy Jonathan Seed says: “Member security will be provided by the capital buffer, so the capital adequacy test will be critical with the key parts being the base liability assumptions and the rules for calculating the buffer.
The ‘Gateway Principles’ provide a good test but the outcome won’t always be clear. Reassuringly, regulatory guidance also includes a number of sensible tests relating to risk management, investments and running costs all of which feed into security for members.
The requirement for clearance helps to ensure that trustees have considered all of the key issues.”
Regulatory bar
There remains some debate over the regulatory burden. Pearce says: “The current framework consisting of TPR’s guidance for superfunds, trustees and sponsors sets a high bar. However, it falls short of the gold standard set by the insurance regime for buy-outs. This shouldn’t be a controversial statement. Superfunds are being created to provide an avenue to help members who are supported by shaky sponsors, and to relieve struggling sponsors of the shackles of their legacy DB schemes. For this to work, superfunds need to cost less than insurance, meaning they can’t be subject to the same standards.”
He says the current framework is a combination of existing legislation and TPR’s superfund-specific guidance. He predicts a formal regulatory regime will follow in an upcoming Pensions Act.
Goodwin says: “The draft regulations and the gateway principles in particular the principle of the transfer enhancing the security of benefits for the member means it limits the kinds of scheme that can transfer in. It feels as the regulatory framework is strong enough, but you might ask are the hurdles are too high. When, as an industry, you look across the pensions landscape it is those DB schemes which are relatively poorly funded, with a weaker employer covenant who might not meet the test but it is those kinds of schemes that could be consolidated, get governance into a better place, and give the members a greater chance of getting all of their benefits.”
DB transfers
Although it is early days, most experts felt there would be a limited impact on DB transfer activity. Seed says: “There will be an element of wait and see but we expect that individual transfers will continue to be an option so ‘business as usual’ levels of TV activity should continue post transfer to a superfund. We would not expect any one-off transfer exercises to be carried out within a superfund so this may lead to a reduction in overall TV activity.”
As for hybrid DC sections, Seed adds: “The main focus is on building DB assets and liabilities and then running these off with the aim of releasing capital and making a profit. Unless there is sufficient scale of DC funds, we would expect these to be transferred to a DC master trust or potentially separated out at the point of transfer to the superfund,” says Seed.
Fraser says: “For hybrid schemes that have both DB and DC sections, it’s likely that the trustees will need to consider alternative options for their DC members, one of which would be to transfer those members to a DC master trust if the scheme is winding up. However, there may be scope for the DB superfunds to take on some DC benefits, for example AVCs accrued during DB pensionable service. It’s likely that this will be considered on a case-by-case basis and will depend upon the particular superfund’s structure and offering.”
Making transfers happen
So who will pay to make transfers to superfunds happen? Pearce says: “We’ve already seen a big divergence in the structure of the two most well-developed superfunds out there – Clara Pensions, a sectionalised bridge to buy-out, and the Pension SuperFund, a pooled run-off vehicle.
“Schemes transferring to a superfund need to be funded to a certain level for the superfunds to take on the costs and risk of paying members’ benefits. Most schemes won’t be funded to that level, and so some sponsor contribution will be needed to facilitate the transfer in many cases.
“Trustees and sponsors are expected to spend a significant amount of time understanding how superfunds operate within the regulatory regime. As part of this review, some comfort can be taken from TPR’s own assessment of the superfunds, which will help to manage adviser costs.”
The three gateway principles for superfund transfers
TPR has issued guidance for trustees that makes clear employers have to apply for regulatory clearance and follow three principles:
1. A transfer to a superfund should only be considered if the scheme cannot afford to buy out now.
2. A transfer to a superfund should only be considered if a scheme has no realistic prospect of buy-out in the foreseeable future, given potential employer cash contributions and the insolvency risk of the employer.
3. A transfer to the chosen superfund must improve the likelihood of members receiving full benefits.
