Defined Benefit Superfunds – A guide for Trustees and Employers

The Pensions Regulator (the “Regulator”) has published guidance for trustees and sponsoring employers of Defined Benefit (“DB”) pension schemes considering a transfer to a DB superfund or similar consolidator model.

What are DB superfunds?

DB superfunds are a relatively new, but rapidly evolving, model which allows a sponsoring employer to pass its DB pension liabilities to another entity for less than the cost on buying-out those liabilities with an insurance company.

The sponsoring employer’s liability is generally replaced by an employer backed by a capital buffer, which is held outside the pension scheme itself.

Generally, the capital buffer will comprise investor capital and contributions from employers and a transfer to a superfund will involve the exiting employer injecting a cash sum into the capital buffer as the “cost” of transferring its pension liabilities to the superfund.

The guidance emphasises the obligation on trustees to be satisfied that a transfer to a consolidator would be in their members’ best interests, and sets out three gateway principles that the Regulator expects trustees to consider as part of their due diligence before deciding whether to transfer to a DB superfund.

While there is a role for sponsoring employers to play in this process, ultimately the decision as to whether to transact with a superfund lies with the trustees.

Trustee Due Diligence

The Regulator is in the process of assessing the superfunds that are currently on the market.

None will be authorised until superfund legislation is enacted, and in the meantime the Regulator will supervise superfunds under an interim assessment and supervision regime.

A list of superfunds assessed under this interim regime is due to be published and will provide some comfort to trustees, but they must still carry out their own due diligence and show that thorough consideration has been given to their decision.

The level of due diligence will depend on the size of the scheme, its funding position and the requirements for the transfer.

The Regulator expects trustees to consider (amongst other things):

• all options available to them to improve the scheme’s position (and to provide the rationale for concluding that transfer to a superfund is the most appropriate);
• any material changes to the superfund since it was assessed by the Regulator;
• whether transfer to the superfund is right for members (which will include open and transparent open communications with the members throughout); and
• whether the transfer is in line with the gateway principles.

Trustees will need professional advice in relation to a proposed transfer and the Regulator expects employers to pay for such advice, which should include reports evaluating the employer’s market position.

In addition, sponsoring employers will be expected to make available to the trustees all necessary resources, time and information to consider a transfer properly.

Gateway Principles for Superfunds

As part of their due diligence process before transfer to a superfund, the Regulator expects trustees to consider how the transaction meets the following ‘gateway principles’.

1. A transfer to a superfund should only be considered if the scheme cannot afford to buy out (based on the scheme actuary’s estimated buy-out funding level). The Regulator expects that if a DB scheme can afford to buy-out its members’ benefits with an insurer, it should do so rather than transferring to a superfund. Trustees will need to provide evidence from their advisers of the funding position of the scheme and estimated buy-out liability/costs no more than a month prior to the date of the clearance application.
2. A transfer to a superfund should only be considered if the scheme has no realistic prospect of buy-out in the foreseeable future, taking into account potential employer cash contributions, the insolvency risk of the employer and projected scheme asset returns. ‘Foreseeable future’ is expected to be a period up to five years. Trustees are also expected to have undertaken an independent covenant assessment as part of their consideration on whether to agree to a transfer. Where trustees choose not to take covenant advice, they will have to explain the reasons for this.
3. A transfer to a superfund must improve the likelihood of members receiving their full benefits. The trustees (and their advisers) must undertake an appropriate and proportionate quantitative analysis to assess the likelihood of members receiving their full benefits if the scheme remains with the employer as compared to after transfer to a superfund. When considering this the trustees will need to review the employer’s short- to medium-term covenant, any potential recourse to the employer’s wider group (if the scheme remains with the employer), and the employer’s current market(s) and other external risks.

Superfund Clearance

The Regulator considers that transfer to a superfund will be a new category of Type A event, and (with the exception of some schemes in a PPF assessment period) the Regulator expects employers to apply for clearance prior to the transaction.

The Regulator will need to be satisfied that the removal of the employer’s covenant is adequately mitigated. The trustees will be expected to confirm that the gateway principles have been met and provide an explanation for this conclusion.

Although the decision whether to transfer to a superfund rests with the trustees, the employer will be the applicant for clearance and the Regulator expects employers and trustees to work together and collaborate to achieve the best outcome for members.

The Regulator expects that a decision on clearance will be reached within three months but it will be significantly longer if the superfund is yet to be assessed by the Regulator. Where a transaction proceeds it is expected to take place within three months of the issuance of a clearance statement.

To transfer or not?

Whether a superfund is appropriate for a scheme or not will depend entirely on the individual scheme and sponsoring employer’s circumstances.

The Regulator intends to provide further guidance as the market evolves and will publish the list of superfunds it has assessed “shortly”.

If your scheme is considering transfer to a superfund, or an alternative consolidator such as a DB master trust, please get in touch with someone in the team who would be happy to assist.