70: Superfunds: DB scheme consolidation

On 30 November 2021 the Pensions Regulator (TPR) announced that it has approved the first authorised defined benefit (DB) Superfund, Clara-Pensions. Authorisation comes after TPR completed a rigorous assessment process against a number of key expectations: people, governance, systems and processes and financial stability. A further assessment process will be triggered when TPR is notified of an intended transfer into Clara. More Superfunds, including the Pension SuperFund, are likely to gain TPR approval during the course of 2022.

What is a Superfund?

A Superfund is a consolidating scheme that allows a scheme sponsor to sever funding liability for the scheme by making a bulk transfer of scheme assets and liabilities. The sponsor’s funding liability is replaced by a capital buffer constituted of DB Superfund investor capital (for Clara this is provided by Sixth Street Growth and Wilton Re) and, in most cases, an initial contribution from the scheme sponsor. Once the transfer is complete, there is no ongoing link to the transferring scheme and the sponsoring employer is free from further liability to the scheme.

Superfund models

The buyout model – Clara

Assets and liabilities transferred from a scheme to Clara become a new section of the Clara Pension Trust. The capital buffer stands behind each section and is funded by a mix of Clara capital and a one-off payment from the outgoing sponsor. Clara then targets buyout of the section in around seven to ten years. Once member benefits have been fully secured then any excess assets in the section and buffer provide a return of and return on capital to Clara and its investors.

The ongoing model – (eg the Pension Superfund)

Assets and liabilities transferred from a scheme to the Superfund are pooled together to create one, large occupational pension scheme. The Superfund then assumes responsibility for member benefits going forwards. The intention is to capitalise on advantages of scale to achieve higher returns with lower costs, greater stability and less risk. Again, a capital buffer sits behind the scheme funded by a combination of institutional investor funds and sponsor contributions. There will be mechanisms for return of capital that are not entirely clear at present.

Which schemes may be considering a transfer to a Superfund?

Many schemes will have targeted a buy-out of scheme liabilities with an insurance company as a long term funding objective but that remains an unrealistic short or medium term de-risking option, despite the buoyant insurance buy-out market.

Clara may offer an alternative DB de-risking option for such schemes provided that they meet certain ‘gateway principles’ which means that they:

• cannot afford to buy out now;
• have no realistic prospect of buy-out in the foreseeable future, given potential employer cash contributions and the insolvency risk of the employer; and in respect of which
• a transfer to the chosen Superfund will improve the likelihood of members receiving full benefits.

How will a transfer to a Superfund be achieved?

TPR issued guidance for ceding trustees and sponsors in October 2020. Scheme sponsors must apply for clearance from TPR for any transfers to a Superfund as it will constitute a new Type A event. During clearance TPR will assess whether the removal of the sponsors covenant is adequately mitigated by the transfer of the scheme and any top up contribution by the sponsor.

Trustees must notify TPR at least three months’ prior to any transfer to a Superfund and will need to have carried out due diligence, demonstrate thorough consideration has been given to their decision and justify why their decision is in the best interests of scheme members. Due diligence is expected to include:

• consideration of other options available to improve the scheme’s position. This could include whether the wider employer group is able and willing to contribute more;
• understanding the scope and timing of TPR’s assessment of the Superfund and whether any material changes have taken place since that assessment;
• the Superfund is right for the members, given the members’ experience and the scheme’s circumstances;
• consideration of what the Superfund is offering, associated fees, funding and investment objectives and methods for achieving those as well as the attaching risks;
• professional advice on any offered member enhancements;
• reviewing any post transfer modelling outcomes;
• whether the transfer is in line with the gateway principles and the trustees understand the risks introduced by the transfer; and
• consideration has been given to the risks attached to any residual liabilities left in the scheme.

Trustees must also take appropriate professional advice, including legal advice on issues that may include:

• power to transfer under scheme rules and the statutory conditions for transfer without member consent;
• managing conflicts of interest including advisor conflicts;
• the requirement for and scope of covenant, actuarial and investment advice;
• the level of benefits that the trustees are obliged to provide (a benefit specification exercise);
• any necessary steps to resolve benefit issues – this is likely to include GMP equalisation for example;
• balance of powers pre and post transfer; and
• discharge of liability, indemnities and insurance for residual risk.

Comment

The authorisation of Superfunds offers a further opportunity for scheme sponsors to remove DB pension liabilities and for trustees to ensure the best outcomes for scheme members. However, the process of transferring to a Superfund is likely to be onerous and time-consuming for trustees and sponsors, involving a significant amount of preparation and due diligence. Early planning and consultation with advisers will be important. If this is something that your scheme is considering, our pensions team has a wealth of experience in DB de-risking and will be delighted to assist.