Superfunds: a new alternative to buy-outs?
Estimated reading time: 4 minutes
Superfunds are the new kid on the defined benefit (DB) consolidation block. Unlike ‘traditional’ master trusts, their USP is that they offer non-insured risk transfer. It is a new concept that is being held up as an alternative to scheme buy-out.
Everybody wants a buy-out
Now, most schemes will see buy-out as the natural end to a scheme. If it wasn’t so expensive, most schemes would do it in a heartbeat.
Much has been said about the new superfund presenting an alternative to buy-out for the scheme that cannot quite afford it. This notional discount on buy-out comes, in part, because of how deferred liabilities are priced in the insurance market, but also because part of the cost is met by the superfund’s capital provider. But superfunds are also able to offer lower ‘premiums’ as they are not subject to the same capital requirements as insurers.
Two key tests
Trustees have two key questions to answer when considering superfunds for a potential de-risking exercise.
The first is whether members will be better off as a result of the transaction than they are at present (i.e. are they more likely to receive their full benefits after the transaction?). That will all depend on the current funding level and the relative strength of the sponsor covenant, compared to the capital provided as part of the transaction.
The second is whether the scheme can afford to execute a buy-out. The consultation on DB consolidators has shown that the Government expects schemes that can afford to buy-out (either now or in the short-term) to go down this route, but the detail is yet to be confirmed.
"The more you know about the condition of your scheme, the better placed you will be to make a decision"
Doing the hard yards
If your scheme cannot afford to buy-out now, might it be able to within the next five years? Determining how close you are to that is very difficult until you have actually gone to market.
The Regulator certainly believes there is plenty of productive work that trustees and employers can be doing while they assess that possibility. This includes member tracing, data cleansing and spring cleaning all the scheme’s legal documents.
After all, the more you know about the condition of your scheme, the better placed you will be to make a decision in the medium to long term.
Long-term benefits
Some employers may consider the superfund option as a cut-price route to liability settlement. But trustees will require robust advice to ensure they meet the requirements to justify a superfund transaction and that this is in the members’ best interests.
They must be confident their position is defensible should someone – the Regulator, Ombudsman or a member, perhaps – come back to them in future to ask them why they thought it was a good idea.
A niche market?
Though we expect a superfund transaction to be similar to a bulk annuity transaction in terms of practicalities, superfunds could be much more of a niche market. They do, however, require critical mass to drive sufficient returns in order to help meet the margins their capital providers demand.
Where it does offer value, both the members and employer potentially win. Members may have secured better chances of receiving their full benefits than if a weak employer failed and sent them into the Pension Protection Fund (PPF), whilst the employer’s liability to a costly DB scheme is removed.
However, the authorisation and supervisory frameworks have not yet been finalised. The proposals in the recent consultation document could be interpreted as being too close to an insurance-style regime, and careful thought will be required to make sure a superfund market is able to thrive whilst providing suitable protection for members.