The Department for Work and Pensions has had a busy pandemic. Since the start of the first lockdown, along with HM Treasury, DWP has been the pivotal department in maintaining jobs and responding to one of the greatest economic shocks since the Great Depression. That being said, the Coronavirus response is not what Guy Opperman, the Pensions Minister, said was his proudest achievement during lockdown when speaking at a conference last year. No, that would be pensions – and more specifically the greenlighting of superfunds.
Superfunds are a new model for running pension schemes, that are being established to pool defined benefit schemes together from different sponsors, subsequently to be run as a sum-of-all-parts pension fund. These new pension vehicles have great admirers within government but, as with all untested and new financial models, they are not without their sceptics, particularly among regulators. The Bank of England, for instance, has expressed concern about the impact that they may have on financial stability and the threat of systemic risk (in the event a large superfund sector was to emerge).
This concern has led to legislation being delayed and not being included in the recently passed Pension Schemes Act, despite it being originally expected. It was announced in March’s Tax Day that ministers and officials are reviewing the current interim regulatory regime that was introduced by The Pensions Regulator back in 2018, and since reviewed in 2020. Industry insiders expect that this interim framework is likely to form the permanent governance of the industry, bar any high-profile issues in the coming months and years.
Superfunds have the benefits of economies of scale. They would be more valuable, safer for pensioners, cheaper to run, more efficient, and have greater voting weight and resultant investment options or negotiation options. Of course, consolidators are profit-making, so a proportion of the return will be retained by the fund operator. This does also mean that the fund would be profit-seeking and therefore more commercially run. As with all things with profit potential, superfunds have been of interest to capitalists and some PE firms are already signing up consolidators and demonstrating interest in the market, just as it begins to take off.
These new funds offer a solution for companies and schemes to deal with long-term DB pension liabilities. Their view is that the traditional model of uncapped corporate liability is over, with pensions historically being a concern weighing heavy on the shoulders of directors, investors, and boards.
A scheme transferring to a pension superfund would shift the liabilities off the balance sheets of listed companies. When coupled with the consideration of data breaches, sponsor issues, insurer options, deferred pensioners, demographic changes, regulation, reputations, it is no surprise that superfunds are of interest to company directors and pension scheme trustees. New legislation may add further motive, as negligent directors can face prison terms for the mismanagement of pension schemes in the most extreme cases.
Perhaps more importantly, the transfer of schemes to a superfund would allow directors to focus on their business risks rather than their pensions liabilities. In the eyes of the consolidators, the risk is sitting in the wrong place – this is the superfunds’ societal purpose. The risk under such schemes would now be shared between the members and investors, not one or the other. This past year of Covid, and the coming recovery years, must be the greatest advert for pension superfunds. One might imagine superfunds are increasingly attractive to those in the hospitality, retail, and those sectors vulnerable to be impacted in future crises. With pensions no longer a concern for companies signed up to superfunds, investors will eye companies with less uncertainty, and this could likely facilitate more M&A activity. This would have benefits to members too, as often in deals, restructurings, and insolvency proceedings, the pensioners are the last ones considered.
Some trustees will go down the more established insurer buyout model. Superfunds have several benefits compared to insurer buyout, no less than the fact the scheme sponsor company has to pay an expensive premium to the insurer to take on the risk. This upfront cost can be a major hindrance for schemes that may benefit most from an insurer buyout, and often DB schemes will not have the backing required to adequately afford the premium demanded by insurers to take on the risk. With superfunds, instead of a corporate sponsor having to pump in money to schemes, investors are sought to provide a capital buffer.
The obvious winners from a superfund structure appear to be the “old school” big pension schemes with lots of members and deferrers (not yet claiming their pension); the ones with the greatest liability to their sponsors. Other examples can include “PPF-plus” cases, where the sponsor is near failure, and therefore the scheme has access to a finite amount of money and with no opportunity for the pot to expand.
The PPF was, in essence, the first pension superfund – consolidating the pensions of failing or failed companies into a larger, single fund. The only real difference between the PPF and pension superfunds is that the sponsor has already failed in a PPF scenario. In contrast, joining a superfund is a choice for companies. And this is a choice that we may see more and more taking over the coming months, years, and decades.