Defined Benefit Consolidation: The rise of the Pensions superfund?

The Pensions Regulator has published guidance for Trustees and Scheme Sponsors who are considering transferring a defined benefit pension scheme to a consolidator fund. The guidance sets out three gateway principles as well as more general guidance.

Over the past 18 months to 2 years, there has been increased discussion of defined benefit superfunds and their role within the pensions industry. There are a number of different models of consolidator but the Pensions Regulator’s guidance is aimed at those where a scheme employer is transferring its liabilities in respect of its Pension Scheme and severing that Employer’s liability to fund the Pension Scheme.

The Pensions Regulator describes a consolidator as one where the Employer’s liability to agree to a fund is severed in whole or in part and where one of the following conditions applies:

• the ceding scheme’s employer is replaced by a special purpose vehicle employer. This is essentially designed to preserve PPF eligibility;
• the employer’s liability to fund the scheme is replaced by an employer backed by capital injection to a capital buffer.

Clearance

The Pensions Regulator expects a transferring employer to speak to the Pensions Regulator at an early stage in the process. In particular, the guidance expects transferring employers to apply for clearance in respect of a transfer to a superfund. This is because the transfer will result in the removal of the transferring employer’s covenant meaning that in the first instance, the transfer would be detrimental to the Scheme. The Pensions Regulator recognises that the transfer to the consolidator together with any cash top up will provide mitigation meaning that overall, members do not suffer any detriment as a result of the transfer. 

As part of any clearance application, Trustees will need to demonstrate that they have considered any past corporate activity, such as mergers and acquisitions or re-financing as well as reviewing any recent significant value extractions from the Employer either by the wider employer group or shareholders.

Gateway principles

The Pensions Regulator’s guidance has identified the following three gateway principles which guide whether or not the transfer should go ahead. 

1. The transfer to the superfund should only be considered if the Scheme cannot afford to buy out benefits now.

The Pensions Regulator identifies that superfunds will not provide the same level of security as an insurer and therefore if a pension scheme can access buy out with an insurer then the Trustees should opt for buy-out rather than agreeing to transfer to a superfund.

2. The transfer to a superfund scheme should only be considered if the scheme has no realistic prospects of buy out in the foreseeable future given potential future Employer contributions and the insolvency risk of the Employer.

This follows from the first gateway principle; if a scheme is within reach of buy-out then it is unlikely that a superfund transfer would be beneficial to members. The Pensions Regulator expects that where Trustees conclude that the value the scheme would receive from future deficit repair contributions under the current Schedule of Contributions or from the Employer insolvency is sufficient to secure buy out in the foreseeable future then this principle will not be met. 

The Pensions Regulator regards “foreseeable future” as specific to the Employer’s circumstances but generally expects this to be a period of up to five years.

3. The third gateway principle is that the transfer to the chosen superfund improves the likelihood of Members receiving full benefits.

The Pensions Regulator recognises that in some cases the benefits to the Scheme from transferring into the superfund may be clear, particularly where there is a risk of the Employer entering insolvency and where the scheme funding is significantly below the estimated buy out funding level.

Transferring Trustee actions

The Pensions Regulator highlights that they expect independent and professional covenant advice to be obtained by the transferring trustees. This advice should cover the gateway principles as well as advice on the following:

• The Employers markets and strategic position affecting profitability;
• What constitutes “foreseeable future” in the specific circumstances for the Employer;
• The insolvency risk for the Employer within the foreseeable future;
• The estimated return to the Scheme on hypothetical insolvency of the Employer;
• The Employer’s ability to pay the contributions which is obliged to provide;
• The Employer’s capacity to pay additional contributions; and
• An assessment of the contributions that the Trustees could otherwise reasonably be expected to obtain.

The Pensions Regulator also makes it clear that the Trustees need to undertake their own due diligence before agreeing to transfer Members benefits to a superfund.  The process of transfer would currently be through bulk transfer legislation. There are certain steps which the Trustees need to take in accordance to the bulk transfer and additionally they would be satisfied that the transfer would be in Members' interests. 

In order to reach that conclusion, the Trustees would need to consider the Pensions Regulator’s Guidance and particularly the due diligence which the Pensions Regulator expects the Trustees to include. The due diligence should cover the following:

• The Trustees have considered all options available to them to improve the Scheme’s position. This might include considering whether support from the wider employer group is available;
• The Trustees understand the scope and the timing of the Pensions Regulator’s assessment;
• The destination superfund is right for Members;
• The superfund offering, including fees, funding and investment objectives, methods for implementing those objectives and risk to achieving those objectives;
• Where Member enhancements are being offered, Trustees should undertake appropriate due diligence of the proposals; 
• The Trustees review with their advisers the modelling outcomes that the superfund produces for their Scheme;
• The transfer is in line with the gateway principles and the Trustees understand the risks introduced by the transfer as well as how the transfer to the superfund results in improved Member position; and
• Consideration has been given to the risks attached to any residual liability left in the Scheme.

Member communications

There is a statutory obligation on Trustees to notify Members where a bulk transfer is taking place and the Pensions Regulator’s Guidance says that the Trustees communication to Members should be open and transparent and also be clear regarding the following;

That the Trustees have carried appropriate due diligence;

That in line with Gateway Principle 3, the transfer produces an increased likelihood of Members receiving full benefits; and

Where Members might be considering a transfer out of the DB Scheme, Trustees should be alerted to risks and support Members in making an informed decision in respect of the bulk transfer.

Conclusions and next steps

It is anticipated that a statutory framework will be put in place but the timetable for this is not yet known. In addition to the Pensions Regulator’s guidance for transferring schemes and employers, the Pensions Regulator has also published guidance for the superfunds themselves.

Circumstances where an employer transfers a scheme to a consolidator and severs all future liability to the scheme are not likely to be common. It may be that for some Schemes, a bulk transfer is preferable to the risks associated with an Employer continuing to limp along and for whom the prospects of achieving a full buy out or anything close to full buy out are limited.

For further information, please contact Suzanne Burrell or your usual Pensions Adviser.