Defined benefit superfund consolidators have been given the green light by the government, with The Pensions Regulator (TPR) outlining an interim regime based on stringent capital adequacy rules rather than an employer covenant.
Industry experts have generally welcomed the new regime, describing it as offering a genuine endgame opportunity for DB schemes, with LCP’s Steve Webb describing the development as a ‘landmark’ for DB pensions. It has also been described as a big boost for consolidators, Clara and The Pension SuperFund.
But Scottish Widows annuities director Emma Watkins sounded a note of caution, saying: “The framework does set out some parameters on triggers to protect members’ benefits, investment strategy restrictions, and limits on “value extraction”. However severing an employer’s liability to their defined benefit scheme should only be done in extreme circumstances. The gateway test should be instrumental in ensuring this regime isn’t abused, yet it gets only the briefest of mentions in the final guidance.
“In the absence of robust legislation and clear protections from a stringent gateway, trustees will need to approach consolidation into commercial vehicles cautiously to ensure that they are confident that the employer covenant is being replaced by an adequate capital buffer to best protect members’ benefits in the future.”
TPR will require superfunds to hold sufficient assets to meet the promises to savers with a high degree of certainty. This will include the requirement for the scheme’s liabilities (technical provisions, or TPs) to be calculated using specific assumptions set out in TPR’s guidance and for additional assets to be held in a capital buffer.
TPR says its modelling shows that savers can have a high degree of confidence they will receive the benefits promised from superfunds, if they adhere to its guidance.
TPR’s guidance is for those setting up and running a superfund ahead of the government’s proposed legislative authorisation and supervision framework.
TPR says trustees need to be certain that a transfer to a superfund is in their members’ interests. They should also only consider using a superfund or new business model once TPR has completed its assessment.
Minister for pensions Guy Opperman says: “The publication of today’s interim regime for DB superfunds is a big step towards a healthier and stronger pensions landscape.
“Well-run superfunds have the potential to deliver more secure retirement incomes for workers, while allowing employers to concentrate on what they do best – running their businesses.
“I look forward to learning from the experiences from the interim regime, which will provide valuable insights as we develop and finalise our plans for a longer term legislative solution.”
TPR chief executive Charles Counsell says: “Our priority is the protection of savers. In line with our clear, quick and tough approach, we are setting out now how our interim regime will assess and regulate superfunds, including new models, so there can be no doubt about the standards we expect before the Government’s permanent authorisation regime comes into force.
“We have set a high bar to ensure savers can have confidence in superfunds should their pension be transferred into one in the future.
“We have taken bold action now to ensure that the market develops in the best interests of savers, particularly as the impact of the Covid-19 crisis may prompt some sponsoring employers and pension trustees to consider what they can do to meet defined benefit pension promises in the future.”
PPF chief executive Oliver Morley says: “We welcome the Government’s plans to legislate to set up a permanent regime for superfunds. We fully support TPR acting to set out clear expectations in its interim regime to protect the PPF and our levy payers in advance of that legislation.”
ACA chair Patrick Bloomfield says: “TPR’s interim regime opens the door for a viable market in commercial consolidation for defined benefit pension schemes. This is an important and positive step forward. It has the potential to be good for scheme members and good for the businesses that support them.
“It is particularly welcome that TPR has chosen to issue this now, as businesses grapple with Covid-19. Recent unprecedented events have caused many previously sound businesses to face a worrying outlook. It is timely that TPR is making commercial consolidators a genuine option to consider, especially for businesses considering deals that could involve the Pension Protection Fund.
“TPR’s guidance is thorough and well thought through. It helps the industry make valuable progress, whilst we wait for the legislation needed for a full commercial consolidator accreditation regime. There are some aspects where TPR has erred on the cautious side. In particular, that consolidators won’t be allowed to extract profits in the first 3 years unless schemes are wound-up and with various controls around investment strategy. This will constrain the initial business models which consolidators are able to use.
“Whilst the ACA expects commercial consolidation to become a popular option in time, we don’t expect a rush of deals to be signed straight away. We support TPR’s intention to scrutinise each deal individually, checking that it is in the interests of pension scheme members.
“The ACA shares some concerns that have been voiced about commercial consolidation. It should not be allowed to undermine the security of members’ pensions, nor should it create a cheap option for schemes that can afford to reach full insurance. We are pleased to see TPR has put in safeguards against this.
“Finally, we applaud TPR for continuing to highlight the importance of climate risk in how commercial consolidators are run and help set the standard for climate risk policy in the pensions industry.” added Patrick Bloomfield.
The Pension SuperFund CEO Luke Webster says: “I am delighted that The Pension Regulator has now formally announced the details of the framework within which The Pension SuperFund can now accept the transfer of schemes.
“Rightly, TPR has taken a hard stance on security, resulting in a very high bar indeed. I give them great credit for producing a set of guidance which ensures that superfunds such as The Pension SuperFund will be providing a gold-plated solution to the market and that members will be extremely safe. This should be a huge reassurance to trustees.
“The framework which has been handed down today strikes a tough but sensible and sustainable balance which meets the needs of scheme members, the sponsoring employer, The SuperFund investors and the wider economy, including enabling us into invest in the UK’s long term infrastructure.
“Since we developed our proposals in 2017, at the government’s request, we’ve been passionate about the positive outcomes we can deliver for pension scheme members and businesses alike. I am delighted that we now have the chance to play our part in transformative and long overdue improvements in the way defined benefit pensions are organised, capturing the strengths of the existing system while attracting fresh capital to secure member benefits and allowing businesses to focus on generating the growth our economy needs more than ever.”
Scottish Widows annuities director Emma Watkins says: “In the current environment, the publication of this interim framework will inevitably result in the first pension scheme transfers to a superfund. While consolidation might offer a better outcome, the key to protecting members’ benefits is robust legislation and this still seems some way off.
“The framework does set out some parameters on triggers to protect members’ benefits, investment strategy restrictions, and limits on “value extraction”. However severing an employer’s liability to their defined benefit scheme should only be done in extreme circumstances. The gateway test should be instrumental in ensuring this regime isn’t abused, yet it gets only the briefest of mentions in the final guidance.
“In the absence of robust legislation and clear protections from a stringent gateway, trustees will need to approach consolidation into commercial vehicles cautiously to ensure that they are confident that the employer covenant is being replaced by an adequate capital buffer to best protect members’ benefits in the future.”
XPS Pensions head of risk transfer Harry Harper says: “The Regulator’s expected announcement is absolutely great news for the consolidators, Clara and The Pension SuperFund and also for the whole pensions market. This brings to an end two years of waiting.
“More broadly superfunds increase options for schemes with stressed employers and on corporate transactions where locking down pensions costs can support activity. Schemes with more deferred pensioners will benefit most from pricing differences with insurers.
“We hope it will drive even further innovation allowing more end game options for schemes. We expect the financial security the Regulator will require will not be as high as that for insurers, but nevertheless can offer a reasonable level of comfort to scheme members.“
“The framework from the Regulator is expected to see them take on responsibility for assessing the financial strength of superfunds as well as regulating, at a broad level, the contract terms and governance of the consolidators, recognising that pension schemes do not usually have the right skills or resources to do this thoroughly themselves.
“The Regulator’s approach should make the cost of transacting more reasonable. While Trustees are not absolved from their own due diligence duties, they now know that the Regulator has been there first and can take a degree of comfort from this. It will be interesting to see what action the insurers now take as we go forward. This marks a sea change in the risk transfer market and enables providers to offer both insurance and non-insurance solutions (or even a combination of the two) and there will doubtlessly be further innovation.”
LCP head of corporate consulting Gordon Watchorn says: “This new guidance is a major step towards opening up the superfund market after years of stalemate. Although it is described as an interim framework, this approach will apply until Parliament has set out its own rules and any such legislation is likely to be several years away. A variety of consolidator models is springing up and it is welcome that the regulator is looking to have a single, consistent framework for regulating them all. With the significant challenges facing many sponsors in light of Covid-19, superfunds may now offer a real option for some schemes that are unable to reach buyout in the near term.
“Whilst the consolidator approach will not be the right answer for all, many sponsors and trustees will wish to give careful consideration to the range of capital-backed solutions, both the existing superfunds and others that are likely to emerge. Insurance buy-out will continue to be the major part of the market as sponsors and trustees will want to go down that route where affordable but the announcement today paves the way forward for the first superfund transactions. The Regulator had to strike a tricky balance between ensuring adequate member security and facilitating a viable market for superfunds. The new frameworks sets a high bar but overall the publication of this new framework is an extremely welcome step and will lead to considerable creativity in tackling the long-term funding challenges of Britain’s DB pension schemes”.
Hymans Robertson head of corporate DB Alistair Russell-Smith says: “Today’s interim guidance for superfunds from TPR is welcome and should help kickstart the market ahead of a longer term authorisation regime. The main block to commercial consolidators taking off to date has been the delay to the authorisation regime. Whilst there has been a theoretical interim regime in place for 18 months now, transactions have not happened. In part this has been due to nervousness around consistency between the interim regime and where the final regime might land. Furthermore the viability of consolidators is undermined when there is no visibility on the long term authorisation regime.
“The fact that TPR has now issued updated guidance which appears to align with a longer term legislation and authorisation regime suggests TPR and DWP are joined up on the direction of travel. This gives the market far more confidence on the long term viability of consolidators and will provide the impetus that leads to the initial transactions into consolidators.
“This guidance is particularly helpful given that Covid-19 will lead to more corporate insolvencies. Some of the schemes in this situation may now be able to secure a higher level of member benefits than before. PPF+ cases, where a scheme is fully funded on PPF so does not fall into the PPF, but is insufficiently funded to buy-out full benefits, stand to benefit. If they can secure 95p in the £ with a consolidator, or 90p in the £ with an insurer, then trustees need to weigh up the higher benefit level with the lower level of security in a consolidator. This benefit coverage vs security point means there does need to be clear water between consolidator pricing and insurer pricing for consolidators to provide a genuine alternative to insurance. The proposed capital requirements have been set at a level where this looks like this should be achievable, particularly for more immature schemes.
“We welcome the gilts + 0.5 per cent discount rate and intervention trigger being kept under review by TPR. Having a fixed margin above gilts yields is simplistic and could lead to unintended consequences, such as triggering the intervention threshold (which tips all the capital into the scheme) when credit spreads widen for what might be a temporary period. It is also good to see a shift in the long term objective for superfunds from potentially having to target buy-out (one of the options in the DWP consultation) to instead targeting run-off. This will allow a range of superfund models, driving innovation and choice for the market.
“Despite the progress, there appears to be a block on investors extracting value until benefits have been bought out, at least for the first 3 years. If this were to stick longer term, it would seem inconsistent with the capital adequacy proposals, and likely to be problematic for some models. Interestingly the guidance also covers capital backed solutions that do not initially sever the link to the employer covenant at the point that covenant is severed. This may well impact on the structure of new capital backed solutions coming to market.”
Barnett Waddingham policy and strategy lead Amanda Latham says: “We believe that superfund consolidation vehicles offer a genuine endgame option for schemes where buyout is perhaps out of reach, so we are pleased to see that TPR’s interim regime has been published during the Covid-19 pandemic.
“The guidance will give employers and trustees, who may be facing uncertain outcomes, confidence in the viability of another choice for securing members’ benefits. Trustees considering transferring to a superfund can be confident knowing TPR will be supervising these new arrangements.
“There are a number of areas where TPR will issue further guidance in the coming months and we look forward to seeing how this market develops, both in terms of transactions starting to take place and seeing more new entrants emerge.”