As the consultation on defined benefit (DB) consolidation closes this week, PIC's Jay Shah sets out his concerns about the superfund model
I do not believe so. Superfunds are targeting larger, relatively well-funded pension schemes.
We have entered another phase in the project originally kicked off by the PLSA's taskforce. Its aim was to enable some level of consolidation of sub-scale schemes to bring asset management and operational synergies, possibly combined with benefit simplification. This was expected to improve the funding of smaller less efficient schemes and increase the likelihood that members receive their full benefits.
But the superfund model is quite different. Superfunds want to take on large, well-funded schemes; exactly the sort of schemes that will benefit least from the operational synergies of consolidation. The employer will be able to sever its financial commitment to the scheme for a one-off contribution without securing the pensions on a guaranteed basis. The superfund will be able to offer a financial product that promises a pension but without guaranteeing it.
What are superfunds and how should they be regulated?
Superfunds are expected to be multi-billion pound, for-profit financial institutions backed by financial investors seeking an appropriate return from pension provision. They should be regulated in the same way as other for-profit financial institutions like banks and insurers.
The original thrust of the PLSA taskforce doesn't appear to be commercially viable. It has instead evolved into the superfund model - a form of 'insurance lite' buyout: 'lite' in the sense that the benefits are identical but not guaranteed and therefore cheaper to transfer and 'lite' in the sense that the governance and capital adequacy framework falls short of insurance or banking; this despite superfunds being commercial for-profit financial institutions.
In my view, superfunds should be seen as for-profit financial institutions backed by private equity offering a financial product. They should also be regulated as such. The starting point should be the regulatory framework for insurers, which has been tried and tested over many decades. One idea is that superfunds should be regulated by the same regulator as insurers. There have to be very good reasons for diverging from this when it comes to protecting pensioners' income.
Which schemes should be eligible to transfer to a superfund?
The consultation envisages that only pension schemes that cannot expect to get to buyout within the foreseeable future should be allowed to transfer to a superfund. Given that scheme liabilities sit ahead of the sponsor's equity, the eligibility test should allow for the full value of the sponsor. It is difficult to justify, for example, that a sponsor that is paying dividends should be able sever its commitment to its pension scheme without fully securing pensions.
An insurance buyout is seen as the gold standard of security. The pension benefits are guaranteed by a financial institution regulated ultimately by the Bank of England. The consultation recognises that an insurance buyout is the ideal outcome. A key proposal in the consultation, therefore, is that only pension schemes that will not be able to afford an insurance buyout in the foreseeable future, even after taking into account the sponsor's ability to support the schemes, should be eligible for a superfund. This raises two questions:
First, what is the "foreseeable" future? The consultation asks whether five years are enough. But sponsors and trustees - with support from The Pensions Regulator (TPR) - have often agreed deficit contribution schedules that stretch out over 10 to 20 years. These sponsors and trustees, as supported by TPR, have regarded 10-20 years as foreseeable in the context of pension schemes. The period for the "foreseeable future" test for transfer to a superfund should be consistent with this precedent.
Second, what should be included in the assessment of the sponsor support of a pension scheme? Pension liabilities rank above shareholders in priority. So, it would be rational for the assessment to take into account the full equity value of the sponsor, including any support that the sponsor might reasonably expect from a parent company. It would not be rational, for example, for a pension scheme to be transferred to a superfund if the sponsor was (or could now or in the future be) paying dividends. This would put shareholders' interests above pension liabilities. The assessment should be based on the pension scheme's assets, plus the equity value of its sponsor, plus the value ascribed to parent group support. Only if the cost of an insurance buyout exceeds this should a transfer to a superfund be allowed.
Even if eligible, the decision to transfer a scheme needs to be made by the trustees. There would need to be protections to ensure that trustees are not put under pressure from a sponsor who might see superfunds as a means of a cheap buyout. Trustees would need to make objective and well-advised decisions on the level of security offered by a superfund, how this compares to an insurance buyout, the true value of the sponsor and the covenant, the quality of the governance and regulation of a superfund, the relative level of regulatory oversight by the superfund regulator versus an insurer's regulator, and the relative level of underpin provided by the relevant safety net (PPF vs Financial Services Compensation Scheme).
Jay Shah is chief origination officer at Pension Insurance Corporation
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