As an interim regime for consolidators is launched, Emma Watkins looks at how to enhance protection of members’ benefits.
The Pensions Regulator (TPR) is responsible for protecting people's pensions, reducing the risk of schemes falling into the Pension Protection Fund (PPF), and helping employers balance the needs of their defined benefit (DB) pension scheme vs their business.
In most situations those responsibilities are completely aligned, but in the middle of a pandemic where there is a real risk of businesses failing and the aggregate deficit, as measured by the PPF, of DB schemes rose by 37% in the last month alone, it creates a real tension.
So perhaps we shouldn't be surprised that TPR has decided now is the time to publish the guidance for supervising the commercial consolidation of DB pension schemes into "superfunds", almost 18 months after the Department for Work and Pensions (DWP) first published its consultation in December 2018.
Given the current environment, the publication of this interim framework will inevitably result in the first pension scheme transfers to a superfund. While superfunds will not offer the high level of policyholder protection that is available from insurers operating under the Solvency II regime, they could offer underfunded schemes with stressed employers a potentially better outcome than inevitable entry into the PPF.
However, the inconsistencies of a two-tiered regulatory system will provide tempting loopholes for employers, and future third-party withdrawals of profit from commercial consolidators may be viewed as "asset stripping". So while consolidation might offer a better outcome, the key to protecting members' benefits is robust legislation. And this still seems some way off.
That said, the guidance does set out some parameters that are focused on protection:
- Triggers - these include the need for the scheme assets plus capital buffer to be at least the level of the scheme liabilities calculated on a prescribed technical provisions basis plus a minimum amount of additional risk-based capital. Whilst this is helpful, trustees will need to take advice on whether this is sufficient to replace their ongoing employer covenant, and it should be noted that this is considerably less than that which is required to be held by an insurer.
- Investment strategy restrictions - to avoid a superfund investing too much or too quickly before achieving scale, the guidance requires that the superfund's investments comply with eight principles; including maximum allocations to the total issuance of a security and to single securities and issuers. There are also limits on the levels of illiquid assets held. While assets transferring across are required to have a transition plan in place, a period of 12 months to achieve this (particularly in the early days of these superfunds) in hindsight could prove to be overly generous.
- Limits on "value extraction" - the key limitation during this initial period is that superfunds should not extract funds from the scheme or the capital buffer unless members' benefits are bought out in full. To guard against value extraction in other ways, TPR has also included a requirement for any fees and charges to be transparent and fair. Trustees should make sure that they are comfortable that these costs are justifiable.
Regardless of how helpful these parameters might be, severing an employer's liability to their DB scheme should only be done in extreme circumstances. The concept of the gateway test, which was first introduced in the DWP consultation, is instrumental in ensuring this regime isn't abused. Yet it gets only the briefest of mentions in the guidance and is focused on the short-term (for example, in the next five years). This mechanism needs to be strengthened to give due consideration to the full strength of the sponsor and should be based on professional advice.
I'm not "anti-consolidation" - given that it's the very principle underpinning insurance. However, we shouldn't forget that these pension schemes hold millions of members' lifelong savings (deferred salary if you will), many of which they will have contributed to personally. And so I do think it's important to highlight that while superfunds might promote better member outcomes, it is not a given. As TPR says, "they bring their own benefits. They also bring their own challenges."
In the absence of robust legislation and clear protections from a stringent gateway, trustees will need to approach consolidation into commercial vehicles cautiously. This will help them ensure that they are confident about the employer covenant being replaced by an adequate capital buffer to best protect their members' benefits in the future.
Emma Watkins is director of annuities at Scottish Widows
Aviva Life & Pensions has concluded an £875m buy-in with its own staff pension scheme, following on from a similar transaction last year.
Just Group has completed a £74m pensioner buy-in with the UK pension scheme of a US-listed engineering business.
The Smiths Industries Pension Scheme has secured a £146m buy-in with Canada Life in its fourth bulk annuity and its sponsor’s tenth overall.
The Prudential Staff Pension Scheme has entered into a £3.7bn longevity swap with Pacific Life Re, insuring the longevity risk of over 20,000 pensioners.
The Baker Hughes (UK) Pension Plan has secured approximately £100m of liabilities through a buy-in with Just Group.