Global menu

Our global pages

Close

DB superfunds – we have lift off!

  • United Kingdom
  • Pensions

19-06-2020

The Pensions Regulator yesterday published its interim guidance on defined benefit (DB) superfunds. With a number of schemes already reportedly “waiting in the wings”, this guidance should enable superfunds to begin moving forward with transactions.

What are superfunds?

Superfunds, also known as DB consolidators, are DB pension schemes set up on a commercial basis to accept bulk transfers from other DB schemes. The original scheme employer’s liability to fund the transferring benefits stops and is instead taken on by an employer in the provider’s group, which is backed by a capital buffer. The buffer is separate from the superfund but is available if certain trigger events occur.

Currently, the two main providers are Clara Pensions and the Pensions SuperFund, which have different business models. Other providers, with different structures, are also beginning to emerge.

Why has the Regulator issued guidance?

The Regulator considers that the consolidation of some DB schemes in a superfund could provide a better outcome for both their members and the Pension Protection Fund (PPF) and improve the funding of DB pensions. While superfund type models have long been available in other countries, they are relatively new to the UK. As the Regulator says in its guidance: “They bring their own benefits. They also bring challenges”.

Given the absence of an ongoing employer covenant under this model, the Regulator is keen that superfund members’ benefits should be protected “to a high degree of certainty”. It has been considering superfunds for some time and the DWP published its consultation on this topic in 2018.

Superfund models could in theory complete transfers within the current legal framework. However, the Regulator stated that its clearance must be sought and the parameters for granting clearance had not previously been clear.

What does the guidance cover?

This interim guidance sets out the standards which the Regulator expects superfunds to meet until a formal legal authorisation framework is put in place. Superfunds must demonstrate to the Regulator that they meet these standards before transacting. The guidance is not exhaustive, and is likely to evolve as the market develops.

What does the guidance say?

Minimum funding level - Where a superfund wishes to accept the transfer of a new scheme, it must be funded to at least a set level calculated using a specific “technical provisions” (TPs) basis (plus a minimum amount in the capital buffer – see below). The guidance sets out how the superfund’s TPs should be set, including discount rate, approach to inflation and mortality.

Capital buffer - The superfund’s capital buffer is regarded as a proxy for the employer covenant. It is fundamental to the security of members’ benefits. The capital buffer must be risk-based and tailored to the scheme’s circumstances – the higher risk the investment strategy, the larger the capital buffer required. It must be set at a level that should (when added to scheme assets) achieve a 99% probability of being funded at or above the minimum TPs in five years. A longevity reserve of around 3% will also need to be factored in.

Eight principles are set out in relation to the investment of capital buffers. These include maximum allocations to single securities and limits on illiquid assets.

Funding trigger - If the assets and capital buffer combined fall below 100% of the minimum TPs, legally enforceable triggers must (assuming there is no other capital injection) lead to funds in the capital buffer flowing into the scheme.

Wind-up trigger - A superfund must begin winding up if funding falls below 105% on the s179 funding basis, unless otherwise agreed with the Regulator. This gives protection against a claim being made on the PPF.

Financial stability - As with the authorisation of DC master trusts, the financial stability of the superfund is crucial. It will need to show that it is adequately funded. There should be a robust business plan in place and a costed strategy for dealing with wind-up. The corporate entity’s financial reserves are expected to be ring-fenced with a proportion in cash (or cash-like) assets.

Value extraction - Superfunds are commercial enterprises and so they have certain risks that are not common in a traditional DB scheme - key among those is value extraction. The Regulator has decided that superfunds should not be allowed to extract funds from the scheme or the capital buffer until members’ benefits are bought out in full. This position will, however, be reviewed within three years.

In addition, surplus funding in the scheme or capital buffer may not be used to support new transfers into the superfund. All transfers in should be able to meet the capital adequacy test on a “standalone” basis.

Also, fees or charges levied by the superfund will need to be “appropriate, transparent and fair”, broadly no higher than market rate. This is designed to prevent value extraction “by the back door”.

Schemes that should not consider this option - The Regulator does not expect superfunds to accept a transfer from a scheme that is on course to buy out within the “foreseeable future” – the example given is in the next five years. This broadly echoes previous proposals from the DWP.

Clearance - As previously trailed, employers will be expected to apply to the Regulator for clearance in relation to a transfer of their scheme to a superfund – it considers this to be a new “Type A” event.

Governance - Superfunds must demonstrate that their corporate and trustee boards are robustly governed, with appropriate checks and balances in place and having a breadth of knowledge and experience. Potential conflicts of interest will need to be identified and managed. As with other DB schemes, there should be an integrated risk management framework in place, with regular monitoring against the framework. There must be a member complaints procedure and also clear processes for assessing and controlling investment risk.

Information requirements - Superfunds will need to provide a lot of information to the Regulator as part of their initial assessment – this includes details of individuals carrying out key roles, such as the founder, trustees, risk officer and those who can amend the fund’s rules or appoint/remove trustees. Evidence will need to be given that the people running the fund are “fit and proper”. Many of the requirements will seem familiar to those who have been involved with the authorisation of DC master trusts.

Administration - The Regulator will look closely at administration/IT systems and processes, including how sensitive member data and cyber risks will be managed, the processes for acquiring further schemes and the approach to member communications and feedback.

Comment

This Regulator guidance sets a high bar for superfunds but has opened up another potential option to DB schemes and their sponsors, and finally paves the way for transactions to begin. We understand a number of schemes have been “waiting in the wings” for some time.

The Regulator is mindful that different superfund models are likely to emerge. It will be keeping a close eye on how the market develops and will adapt its approach accordingly. We can expect further details soon on issues including capital buffers, enforceability provisions, administration, transfers out, reporting requirements and data security issues. And of course this is only interim guidance – the superfund legislation is yet to come (timescales for that are not currently clear).

For more information contact

< Go back

Print Friendly and PDF
Subscribe to e-briefings