The Pensions Regulator has issued guidance on the interim regime for regulating defined benefit (DB) superfunds, which is effective immediately.
Superfund consolidation allows for the severance of an employer’s liability of a DB scheme by transferring their schemes’ assets and liabilities into a consolidated superfund pension scheme that is separate from the ceding sponsoring employer whilst the original scheme winds up.
The ceding sponsoring employer may need to make a cash payment to the superfund to provide enough funding to transfer the scheme and to ensure that there is a sufficient capital buffer in place to provide security for members. The capital buffer will come from a combination of capital raised by the superfund, assets transferred by the ceding scheme and payments made by the ceding sponsoring employer.
Superfunds will need the Regulator’s authorisation to operate and must prove they can meet the interim regime before taking on legacy DB schemes. The DWP is developing a legislative authorisation framework which will soon be in place to safeguard the benefits of members moving into superfunds.
Regulatory approach
Superfunds will have to explain how they will meet the expectations outlined in the guidance before accepting any legacy DB schemes.The focus of regulatory scrutiny will be on:
Ceding scheme entry requirements
Prior to a scheme transferring across to a superfund the following requirements will have to be adhered to:
Running a superfund
The superfund will need to have its processes clearly documented. This will include the management of conflicts, triggers of intervention or wind-up and key powers. The corporate entity running the superfund will need to ring-fence financial reserves with the Regulator expecting a proportion of these to be held in cash or near cash, to address any short-term liquidity issues in the event of failure.
Capital Buffer
The level and quality of assets in the capital buffer are fundamental to the success of a superfund. The key aim is to ensure a high degree of certainty that members’ benefits will be paid. To achieve this the superfunds must comply with the following:
The superfund will need to document rules around extraction of profit; fees and expenses; investment arrangements and risk management. All of which will come under frequent regulatory scrutiny.
The Regulator has included many provisions relating to the expectation that not all superfunds will survive (e.g. they will fail to reach sufficient scale or funding may deteriorate) so there needs to be sufficient funds and liquidity in order to transfer to new arrangements.
Superfunds cannot accept new business if they are not funded to the minimum regulatory level.
Regulatory Intervention Triggers
There are two legally enforceable intervention triggers that will result in the Regulator taking action at key points in a superfund’s funding level. They are described below:
Surplus Funds
During the initial period (which is expected to be a duration of 3 years) there should be no surplus extracted from the capital buffer or pension scheme unless scheme benefits are bought out in full with an insurer.
Any surplus value should not be used as capital to support new transfers into a superfund. All transfers into a superfund should be able to meet the capital adequacy test on a standalone basis.
Investment Principles
The Regulator has set rules on the investment of funds (including the capital buffer); limits on the concentration of assets; portability in the event of the superfund winding up; liquidity; and restrictions on investments provided by the ceding employer. The Regulator appears to be concerned that not all superfunds will survive so highly complicated and idiosyncratic approaches are discouraged in the early years as they may prevent the efficient transfer of funds to new arrangements.
As expected, the Regulator wants the investments held to be appropriate (and realisable or transferable for full value) to enable 100% of members’ benefits to be protected to a high degree of certainty.
Our comment
The interim regime for superfunds is stronger and more rigorous than the funding requirements for occupational DB schemes generally. However, as expected, it provides lower security to members and policyholders than the Solvency II regime followed by insurers.
Ultimately, trustees will need to decide whether it is better to take cash from their sponsoring employer and transfer to a superfund or rely on their sponsor’s covenant to support them on the longer journey to buy-out with an insurer.
Given increased uncertainty over sponsor covenants currently, we expect some schemes will start exploring the superfund option now. Significant questions remain including whether, within this new regulatory regime, superfunds can deliver their product at a price that is significantly lower than the price of a bulk purchase annuity which, to many, is the preferable destination.
Initial thoughts, a transfer to a superfund may be up to 25% cheaper than a buy-out with an insurer; the saving versus the buy-out premium reduces significantly as a scheme matures.
With appropriate advice on the prospects for the financial strength of the sponsoring employer and the financial strength of the superfunds, we expect that some trustees and employers will transfer their schemes to superfunds, with the first schemes being imperative to wind-up, schemes with 75% to 95% funding on a buy-out basis but will not reach 100% within the next 5 years or schemes with a simple benefit structure.