On 7 December 2018 the Government published its consultation on ‘superfund’ consolidation vehicles.
A superfund allows companies to cede their defined benefit schemes to it, replacing the employer covenant of the ceding employer with a capital buffer (assets held to improve funding and meet contingencies). The structure comprises a statutory employer, an occupational defined benefit scheme (including a trustee board) and an amount of additional capital provided by investors and/or the ceding sponsor. They could also additional have in-house administration, actuarial and investment expertise.
There are some similarities with insurance in that a transfer to a superfund is designed to break the link with the ceding sponsor and the employer covenant is replaced by the superfund’s capital in helping to ensure members’ benefits are paid in full. Unlike insurers which are regulated by the FCA and PRA and the Solvency II regime, it is proposed that superfunds would be regulated by TPR as occupational schemes.
Superfunds would allow employers to cede their schemes for a lower premium than required by an insurer accepting that there will not be the same level of confidence that benefits will be paid in full as an insured buyout. The justification? In some scenarios where there is a weak employer covenant with limited prospect of reaching buyout, superfunds could provide a better outcome for members, potentially achieving buyout at some point in the future. There are also likely to be economies of scale in terms of expenses and access to investment opportunities.
Key aspects proposed:
- TPR will authorise superfunds and regulate them as occupational schemes
- Authorisation will require demonstration of fit and proper persons (similar to FCA approach), good governance and financial sustainability
- There should be at least a 99% probability of members benefits being paid or secured over the lifetime of the fund (based on stochastic modelling)
- Additional powers would be required for TPR to ensure it can regulate effectively
- New notifiable event of intention to join a superfund would be introduced
The consultation is seeking views on a number of aspects:
- Financial stability and adequacy – this is likely to be one of the more contentious areas and broadly asks whether funding adequacy should be on a prudent pensions funding approach or an insurance based Solvency II approach
- Should they have a long term objective eg fully fund on a buyout basis?
- Should they be required to buy out benefits at the earliest possible opportunity?
The consultation makes clear that Government is keen not to allow arbitrage against the more heavily regulated insurance industry. Without an effective regulatory ‘gateway’ superfunds would have a considerable competitive advantage over insurers given lower capital requirements. The regulatory regime therefore should prevent schemes that could otherwise buy out, or have a realistic prospect of sponsor support in achieving buyout in the future, from entering a superfund. Overall, the decision to enter a superfund must enhance the likelihood of members receiving full benefits.
TPR will expect the trustees of a scheme contemplating entering a superfund to take independent employer covenant advice of the ability of an employer to provide future support. External covenant advice should be the norm on a comply or explain basis.
The full consultation can be found here.
Argyll comment: As the consultation itself acknowledges, superfunds can already legitimately be set up under the existing regulatory regime. It also acknowledges that superfunds present a different risk profile given the reliance on a capital buffer. The Government is keen to ensure the regulatory regime can be adapted to effectively regulate these arrangements.
From our perspective superfunds represent an interesting development and with proportionate regulation should be able to improve member outcomes in some (but not all) circumstances. The key factor for trustees will be to ensure they understand the potential for their sponsor to provide support currently and therefore what they will be giving up if they transfer their scheme to a superfund.
