The Pensions Regulator opens the door for DB superfunds

The Pensions Regulator has issued new guidance for those setting up and running defined benefit (DB) superfunds. It has also published a detailed response to the consultation it ran on certain aspects of DB superfunds during September 2019.

The new guidance establishes an interim regulatory regime – which will allow the DB superfund market to progress – pending the introduction of a formal legislative authorisation and supervision framework by the Department for Work and Pensions (DWP). Until now, progress had stalled since the DWP's consultation on DB pension scheme consolidation closed in February 2019.

DB superfunds

DB superfunds are trust-based pension schemes set up on a commercial basis to accept bulk transfers from other DB pension schemes. There are different models, but the basic idea is that, when the transfer is made, the employer covenant is replaced by a capital buffer (established using investor capital and a lump sum contribution from the employer). The capital buffer is then invested and, if it generates more money than is needed to fund the relevant benefits, any excess can be returned to the investors and (depending on the model) shared with members.

Focus of the new guidance

With the Pensions Regulator's aim being to ensure that members’ benefits are protected, the new guidance focusses on an initial assessment and ongoing monitoring of three main areas for DB superfunds:

• DB superfunds must be run by fit and proper persons and have effective governance arrangements in place.
• DB superfunds must have suitable administrative systems and processes in place to guarantee that they will be run effectively.
• DB superfunds must be financially sustainable and have appropriate contingency plans in place to manage funding level triggers and an orderly exit from the market if needed.

The new guidance says that it will be added to over the next few months and beyond, as the DB superfund market continues to evolve. This will include updates to the Pensions Regulator's existing guidance notes aimed at trustees and employers considering a transfer to a DB superfund.

Key points

The new guidance contains some key points about the capital adequacy requirements for DB superfunds:

• The Pensions Regulator's overarching objective in respect of the capital adequacy requirements is for there to be a very high probability of member benefits being paid in full (99% is the target given, taken from the DWP consultation).
• The new guidance sets out certain minimum expectations and assumptions for how DB superfunds must decide their technical provisions (which have been set prudently) and, connected with this, the amount of capital buffer they must hold. It also sets out a number of investment principles, which must be followed in the investment of both the scheme assets and the capital buffer.
• DB superfunds must operate with two "intervention triggers", which must be legally enforceable and lead to certain action being taken at key points relative to funding levels:
  • if total assets fall below 100% of the DB superfund's technical provisions, assessed in accordance with the Pensions Regulator's minimum expectations and assumptions, control of the entire capital buffer must be transferred to the DB superfund trustees (unless the capital buffer is increased); and
  • if the DB superfund's funding level falls below 105% assessed on a section 179 Pensions Act 2004 basis (that is, the funding level that would be required to secure Pension Protection Fund compensation with an insurance company), it must wind-up, unless agreed otherwise by the Pensions Regulator in exceptional circumstances.
• Pending the introduction of a legislative authorisation and supervision framework, no profits should be extracted from DB superfunds unless members' benefits have been secured in full with an insurance company. It is worth noting here that Clara-Pensions is specifically aimed to act as a "bridge to buy-out" but the Pension SuperFund is primarily designed as a run-off vehicle. The Pensions Regulator has committed to reviewing this point within the next three years.

Next steps

The Pensions Regulator will now be able to carry out "initial assessments" of DB superfunds against the expectations set out in the new guidance. Following this, where appropriate, the Pensions Regulator will grant an "initial approval".

DB superfunds that have received this initial approval from the Pensions Regulator will be subject to an ongoing supervision regime, with various annual, quarterly and monthly reporting requirements.

We understand that the initial approvals for the Pension SuperFund and Clara-Pensions are likely to be granted by the Pensions Regulator in the next few weeks. This will allow transactions with them to be progressed, with the main next step being for the Pensions Regulator to review and respond to the clearance applications required from the relevant transferring employers.

In this respect, the Pensions Regulator has confirmed that it expects all transferring employers to apply for clearance in relation to a DB superfund transfer. It has also confirmed that DB superfunds should not accept transfers from schemes that have the ability to buy-out or could do so within the foreseeable future (i.e. the next five years). This aligns with the "gateway proposals" contained in the DWP consultation.

As mentioned above, the Pensions Regulator will be updating its DB superfund guidance notes aimed specifically at trustees and employers in due course. In the meantime, it is worth remembering that trustees will still only be able to agree to transfer scheme benefits to a DB superfund if they have the power to do so and it is in the best financial interests of members.

Other entrants to this market, besides Clara-Pensions and the Pension SuperFund, may still be a little further off. However, the new guidance applies to both DB superfunds and other new and innovative solutions where external capital is used to either fully or partially sever an employer from its liability to contribute towards its DB pension scheme.

Osborne Clarke comments

This is a positive development for the pensions industry, as it adds to the number of de-risking options that are available to the employers and trustees of DB pension schemes. This is likely to be particularly helpful in the wake of the Covid-19 pandemic.

Transfer to a DB superfund will not be appropriate in every case and, given the new and untested nature of this option, employers and trustees might still be inclined to tread carefully. However, DB superfunds should be an attractive option in certain circumstances where buy-out is not affordable but another way of de-risking and increasing the security of members' benefits is sought.

If you are considering de-risking, whether by transfer to a DB superfund or otherwise, please feel free to contact one of our experts.