On 18 June, The Pensions Regulator (TPR) issued guidance on a regime that now allows defined benefit schemes to proceed to consider and ultimately transact with a commercial consolidator or “superfund”.
This is welcome news and was needed, not least because a different capital-backed solution led by Aspinall Capital Partners transacted in the market recently.
Although the new regime is interim, there are some concerning features that mean, for now, superfunds can’t offer as much value to scheme members as they might.
Firstly, profit extraction. TPR has said a superfund can only release profits to its shareholders when it has bought out a scheme with an insurer. They have also said that they will not review this within the first three years of this interim regime. For now, this is probably fine, as I can’t imagine the business plan of any superfund has any profits being released in the first three years. However, it is a potentially worrying sign of TPR’s thought process because:
(1) It makes the superfunds’ existence dependent on insurers. It’s clear from recent press coverage that neither the insurers or the Bank Of England, which regulates the insurers, are keen on this new market, therefore why would insurers offer attractive pricing for a superfund to insure some or all its liabilities?
(2) It creates an implicit link between superfunds and insurers, which ultimately means their pricing will be closely aligned. This could stifle innovation and lead to superfund pricing that isn’t materially different to that of insurers. If that is the case, what is the point?
(3) There are numerous aspects of the insurers’ own regulatory environment that produce “odd outcomes”. For example, the part of insurer capital called the “risk-margin” is, by the Prudential Regulation Authority’s own admission, too prudent and leads to insurers transferring most of their longevity risk to offshore reinsurance companies, which the PRA also notes has the potential to be a regulatory concern. In addition, certain features of scheme benefits, such as underpins or guarantees, can be eye-wateringly expensive to insure because of how they are treated from a capital perspective. Schemes with such benefits may be able to get a much better solution from the consolidator market, but not if consolidators are being forced to ultimately plan to insure.
Secondly, I also question why as an industry we are trying to create a second option for schemes that is effectively bulletproof. Insurer capital is set at 99.5%, i.e. to withstand a 1-in-200 failure to pay benefits, and superfunds at 99%, i.e. a 1 in 100 chance of failure. Compare this to the protection most scheme members have today; scheme funding alongside the scheme employer’s ability to stay in business and fund those benefits. Not only does this differ scheme to scheme but it also differs between members of the same scheme.
As an example, 90-year-old pensioners’ benefits only need the employer to stay in business for a relatively short period of time. If it doesn’t, then in the worst case, the member transfers to the PPF and may get lower pension increases going forward. In contrast, a 40-year-old deferred member, in an underfunded scheme, potentially needs the employer to survive for 40 or more years to get their full benefits. I fall into the latter camp and would prefer a better funded scheme, rather than one that relies of my previous employer remaining in business for half a century.
There are clearly a variety of ways funding can be improved but superfunds offer employers an incentive, i.e. the ability to walk away, if they contribute to their scheme and improve funding.
For younger deferred members, especially considering the current difficult economic times, what chance do they have of receiving their benefits in full? For many, I suspect this is significantly lower than the security offered by superfunds. So why are we not allowing there to be a more attainable targets for many of these schemes, i.e. one that still improves member security but isn’t necessarily bullet proof. As it stands buyout is out of reach for most schemes and consolidators will only be an option for a modest number of additional schemes.
There are many aspects of the interim regime I welcome. Clearly, we don’t want superfunds to effectively take large gambles, safe in the knowledge that if it goes wrong, the PPF will pick up the pieces. We must protect the PPF from this risk and I believe the two-tier funding triggers set by TPR is appropriate to do this. I am also very supportive of consolidators having strong governance, systems, and controls. This is an absolute must for all entities who have responsibility for many people’s financial wellbeing and to ensure such entities provide the level of service that members deserve.
Overall, it’s pleasing that we at least now have something that enables a market to start to develop, but I worry that we still have a long way to go to create the market some schemes so desperately need.
Adam Davis, Managing Director, at K3