Superfunds cleared to begin work under TPR interim regime

Superfunds, the broad term applied to vehicles that replace the reliance on the sponsoring employers with a capital buffer supplied by external investors, will have to pass a TPR assessment on financial sustainability and show that they are fit, proper, and have adequate systems and processes in place.

The regulator then expects individual transactions to be submitted for clearance, to avoid the use of its moral hazard powers. Superfunds will be subjected to one-on-one supervision by the watchdog.

The key question for schemes is how much investment risk do they want to take and how much they want to rely on capital from the sponsor if they experience poor investment returns. Answering these questions will identify the right option for trustees and sponsors

Colin Cartwright, Aon

With house names reportedly among the schemes lining up to transfer into a superfund, the interim guidance framework is the result of years of debate between government and regulators on how best to cater for DB schemes for which buyout with an insurer is not feasible.

The Department for Work and Pensions, which first signalled its support for commercial consolidation in a 2017 green paper, is still to set out a permanent and binding authorisation regime for the new sector.

Meanwhile, the regulator said it would publish specific guidance for ceding schemes in the coming weeks, and is expected to provide further requirements on enforceable member protections.

Regulator avoids prescription

The interim regime will revolve around the government’s expectation that members transferred into a superfund should have a 99 per cent chance of receiving their benefits in full.

Superfunds will have to demonstrate via modelling that in 99 per cent of cases, their capital buffer will be sufficient to maintain full funding five years after the transaction completes, with the buffer required increasing with the level of investment risk.

If the total level of assets and capital buffer dips to 100 per cent of the scheme’s liabilities, any remaining buffer will flow into the scheme and its strategy will come under full control of the trustees, with investors losing their money.

If the scheme’s funding level drops below 105 per cent of the liabilities covered by the Pension Protection Fund, trustees will have to wind up the scheme, thereby insulating the lifeboat from any claims.

The regulator has prescribed certain parameters, such as a discount rate of 0.5 per cent above gilts, and a longevity buffer that must cover a 2 per cent annual increase in longevity. 

But it has left other aspects up to superfunds and their modelling, such as the split between the scheme funding provided by the employer and the capital buffer provided by investors.

“To some degree we’re a little bit agnostic as to whether the scheme is fully funded on day one in terms of technical provisions,” said David Fairs, TPR’s executive director for regulatory policy, analysis and advice.

He cautioned that the regulator does expect the combination of scheme funding and capital buffer to ensure security for members. “The riskier the investment strategy that the superfund pursues, the higher that capital buffer will be,” he continued.

In practice, however, superfund operators told Pensions Expert that the regulator’s expectation is for consolidators to offer a stable journey for members. Industry practitioners agreed that investors in the ventures would look for stable, long-term returns, driven by improvements in actuarial experience, exposure to liability-beating real assets, and the gearing effect of reaping the returns from a larger pool of capital.

Mike Smedley, partner at consultancy Isio, said: “Most of the investors in these superfunds are looking at this as a relatively steady, safe return. Bear in mind that once they’ve put the money in this thing, it’s going to be pretty hard to get it out.”

Adolfo Aponte, managing director at Lincoln Pensions, told Pensions Expert that the regulator is “aware that new superfund models will emerge, so they probably don’t want to be overly prescriptive”. 

“Instead, what they’re proposing is a process by which the business model put forward by superfunds is first challenged by the regulator,” he said, suggesting that first transactions may be small in order to be proofs of concept.

Supers eye big prizes

Others, including the superfunds themselves, predict a heartier appetite when it comes to first deals.

Big name brands such as Debenhams and Thomas Cook have been reported by Sky News to be among a number of troubled schemes looking to make quick use of the range of options made available by the guidance.

Luke Webster, co-founder and chief executive of The Pension SuperFund, would not be drawn on specific deals TPSF has in the pipeline, but did suggest that making larger deals first would be preferable to building a base of small schemes.

“The reason consolidation is such a good idea is all to do with scale,” he said. “That plays through in various ways, and the most important one to my mind is governance.

“The larger the scheme is, the more reasonable a very highly qualified and resilient and robust governance structure and trustee board is as a cost.” 

Other benefits arising from larger pools include additional clout given to their investment managers, who have larger mandates to negotiate better fees, and greater ability to diversify, Mr Webster explained. 

Because scale is the ultimate target, he said: “I think it makes sense for consolidators to target larger transactions first, get that scale, and that will enable them to serve the market more broadly. There’s more uncertainty and risk in smaller schemes than in larger ones.”

Securing orderly exits

A key fear among policy experts in the lead-up to the new regime has been that of a partially formed market, where some schemes are transferred into a superfund that either sees its operating company collapse or never achieves scale.

Mr Fairs described the regulator’s policy for tackling these eventualities as two-pronged. First, its assessment of financial robustness will aim to check that new superfunds are able to sustain themselves, at a level of fees that the guidance states must be “appropriate, transparent and fair”.

Second, he said that the capital requirements and funding triggers put in place should ensure that any stranded scheme is still an attractive acquisition for operators remaining in the market. Failing that, trustees are still left with a well-funded, low-risk scheme to run off.

“We’re asking for a capital buffer that gives more than 99 per cent probability [of success], almost regardless of what happens to the entity that stands behind it,” Mr Fairs said.

“It could be that because of the capital that’s there, over time the scheme reaches a position where it’s possible to fully buy out its liabilities. We don’t envisage that we’ll end up with lots of zombie schemes.”

Trustees face key decisions

As it stands, industry experts said the regime looks to allow a sufficient discount to the cost of bulk annuity insurance to allow the market to develop.

While only two providers – TPSF and Clara Pensions – have formally entered the market, others including Christofferson, Robb & Company are said to be waiting in the wings.

Mr Fairs also warned that providers of so-called capital-backed journey plans, such as Aspinall Capital Partners and insurance giant Legal & General, could become superfunds if sponsoring employers become insolvent, and should plan for how they will meet requirements.

Mr Smedley said the sector is likely to prove attractive to both employers and investors.

“It looks like superfunds might be 10 per cent cheaper than insurance, certainly for younger members,” he said. “Superfunds and other potential players will look at this and say, ‘OK, we can put our capital to work’.”

The onus, then, will be on trustees to make good decisions and do careful due diligence, weighing sponsors’ offers of an immediate superfund transfer against the prospect of extracting more cash for buyout at a later date.

Colin Cartwright, partner at Aon, said: “Schemes now have in their toolkit the options of insurance, consolidators, contingent capital solutions and DIY. All of these are predicated on the assumption that given a certain level of assets and a solvent sponsor, then you can meet your long-term objectives with a low-risk investment strategy.

“So the key question for schemes is how much investment risk do they want to take, and how much they want to rely on capital from the sponsor if they experience poor investment returns. Answering these questions will identify the right option for trustees and sponsors.”