First superfund transfers will put trustee decisions under spotlight

But this hasn’t stopped the noise from being turned up over the potential of untested superfunds, or commercial DB scheme consolidators.

Around £20bn of deals are in the pipeline this year for the two superfunds operating in the UK’s fledgling superfund market, according to recent estimates from Hymans Robertson, the consultants.

There are no details about the schemes involved, but superfunds are said to be cropping up as a solution in corporate transactions where a DB plan is a deal blocker.

There is a risk that employers and their advisers will paint an unduly negative view of the world to encourage trustees to come to the view that a superfund transfer will be better for members

Noise of this sort will no doubt inject some confidence into a market jittery about doing business with unproven superfund vehicles. The superfund market is currently developing under the existing occupational pension framework, but a new, tougher regulatory regime is planned.

The government is keen to encourage superfunds as a new option for employers wanting to make a clean break from legacy DB schemes at a cheaper price than a buyout with an insurer.

The Pensions Regulator believes superfunds could also be a force for good and drive up standards, and security, for some members.

But there are good reasons why most trustees should be wary about signing over a scheme to a superfund just now.

Regulatory environment remains unknown

The first and foremost consideration of any trustee is to ensure members’ interests are protected.

With a precise regulatory framework for superfunds yet to be finalised, trustees, and their advisors, cannot – in all but the most extreme cases – be absolutely certain that members’ security will be enhanced in a superfund.

Transfers to superfunds will usually involve a cash injection by the employer before the scheme is handed over.

But, significantly, the transfer involves breaking the employer covenant and replacing it with external capital provided by the superfund’s investors, who aim to profit from their investments.

Trustees must weigh up the merits of the move and evidence to the regulator, under its supervisory regime, that a transfer to a superfund will enhance member security.

There is a risk that employers and their advisers will paint an unduly negative view of the world to encourage trustees to come to the view that a superfund transfer will be better for members.

Trustees must be very comfortable that the financial covenant offered by the superfund is better than sticking with the employer, and will be so for the foreseeable future.  

The problem for trustees in getting comfortable is that there is no legal clarity as yet on areas critical to their decision making.

This includes the target funding level for these vehicles, fit and proper person tests, and whether there will be entry barriers for schemes in reach of buyout.

The Prudential Regulation Authority has made clear that it prefers an insurance regime for superfunds, which has tougher solvency standards. It also prefers profit extraction by superfund investors to be constrained until the scheme has been safely bought out with insurance contracts. If adopted, these recommendations could be a game-changer for the superfund market.

Buyout in five years or improved benefits?

A second challenge for trustees is choosing a superfund model, given the differences between the two vehicles currently operating in the market.

Clara Pensions is sectionalised and has a stated objective of passing assets and liabilities to the insurance market over time. The Pension SuperFund is not sectionalised and runs off liabilities in the scheme, rather than acting as a bridge to buyout. The Pension SuperFund, however, offers to share any upside with members through an increase to their benefits.

Oliver Morley, chief executive of the Pension Protection Fund, has said he regards superfunds that act as a bridge to buyout as “safer” for members than models that do not.

Interventions of this sort are not insignificant at a time when there is uncertainty over the final shape of the superfund regulatory regime.

Ahead of the rules being finalised, the regulator expects employers to apply for clearance for any proposed superfund transfers. The signs so far are that the regulator is being far from light touch.

Superfunds have the potential to improve member security, particularly for members of poorly governed schemes with rocky sponsors. But poorly funded schemes are not the sweet spot for superfunds.

Unions are rightly concerned that members risk being shunted from good company pension schemes, operated solely to pay their benefits, into vehicles with the primary aim of providing a return to investors. Much is riding on trustees, more than ever, to get decisions right for their members.

Josephine Cumbo is pensions correspondent for the Financial Times