Soaring high over the City, a new breed of corporate consolidators are preparing to swoop on our pensions.
Last month, UK regulators gave the green light for the creation of “pension superfunds” — commercially run entities capable of pooling final salary schemes from different employers and running them as one large fund.
With the first deals expected to be struck later this year, experts believe the path to consolidation could be hastened by the pandemic.
From an individual investor’s point of view, a final salary or defined benefit pension promises a secure and comfortable retirement. However, the generous lifetime benefits provided by legacy pension schemes are a significant liability for many UK companies and many are under pressure to pump in extra funding.
Offloading pension liabilities to a third-party may seem like an attractive long-term solution — but it also an expensive and tightly regulated market.
Before superfunds arrived on the scene, increasing numbers of companies were going down the buyout route, paying hefty sums to insurance companies to take over the running of their pension schemes.
Although the superfunds market is in its infancy, looser regulatory requirements means it could provide a much cheaper way of doing this. Pooling several schemes together should, in theory, make them cheaper and more efficient to run — but in return, operators expect to make a profit, which has attracted controversy.
While company pension trustees may be aware of what’s waiting in the wings, the latest developments may have escaped the notice of the average final salary pension member.
Here, FT Money sets out what would happen if your pension was snapped up by a super fund, how this could affect your future benefits and what the interim guidance means in practice for consumers.
How would superfunds work?
More than 5,000 companies in the UK still sponsor traditional “defined benefit” (DB) schemes which provide a secure retirement income based on salary and length of service for over 10m members in the private sector.
So-called pension superfunds would consolidate two or more existing company DB plans into a single scheme, taking over the assets and liabilities of pension plans and pooling them with others. In return for the consolidator taking over these responsibilities, the employer will typically make a lump-sum payment, and outside investors will also put money in.
The superfund will then run the schemes either for decades until all the pensions have been paid, or until the scheme is financially strong enough to be passed on to an insurance company.
The full legal framework is not yet in place, but interim regulatory guidance was issued last month to get the market moving. Consolidators won’t have to wait for the final rules before striking deals.
Superfunds will be run like existing pension schemes, with their own trustee boards, and be supervised by The Pensions Regulator.
Unlike traditional workplace pension schemes, these new DB consolidators do not have a significant employer that is responsible for ensuring pension promises are funded. The employer is replaced by a capital buffer, which can be drawn on to support the scheme. This cash pile is ringfenced and typically provided by institutional investors.
The other major difference is that superfunds can be run for profit, with private equity investors backing some consolidators who are vying to break into the UK market.
What sort of pension schemes might appeal to superfunds?
Consolidators are only interested in the pension funds of companies that are solvent, as they expect a significant lump sum to be paid at the point when a deal is struck.
Typically, schemes will be closed to future accrual and relatively immature with over 40 per cent of members yet to start drawing pension benefits. For more mature schemes, an insurer-led buyout is likely to be more appropriate, says Gordon Watchorn, partner at Lane, Clarke & Peacock, the actuarial consultants.
The superfund route may well appeal to companies in industries under pressure from the pandemic, such as retail, hospitality and travel. Wayne Segers, partner at the XPS Pensions Group consultancy, says that schemes will need to be well-funded for consolidation to be a realistic option.
“It may be that only a few schemes are funded well enough to meet the superfunds’ price, and The Pension Regulator’s minimum requirements,” he says.
Would my pension be more secure with a superfund?
Members of traditional final salary schemes know that their pension promises are only good while their employers remain a going concern.
If a company goes bust, its pension scheme will enter the Pension Protection Fund — known as the “pensions lifeboat” — but only 90 per cent of benefits are guaranteed for members who have yet to retire.
The theory is that as superfunds grow in size, the cheaper they will be to run, with improved funding, economies of scale and better governance underpinned by a substantial capital buffer.
“What moving to a superfund should offer members is greater long-term financial stability for the scheme so that over time it can become fully funded with a reduced risk of failure,” said Jane Kola, partner with Arc Pensions Law.
Claire van Rees, partner with Sackers, the legal firm, adds that a lot of
of the industry and regulatory support for superfunds is based on the idea that the consolidation will strengthen the position of smaller schemes.
Together, they can pack a bigger punch with better investment options, stronger negotiating powers for superfund trustees, and better governance for members, she says. However, the business model is untested in the UK.
“They are a less secure option for members than a buyout with an insurer, although they may still provide more security than the original employer-sponsored scheme as a result of the injection of funding required for the transfer to go ahead,” she adds.
How is this different to an insurance buyout?
In recent years, companies including Rolls-Royce, the General Electric Company and Telent have struck deals with large insurance companies to take over their defined benefit schemes through a buyout.
So far, this has affected more than 2m members of final salary schemes. The insurance companies who take over the pension schemes are subject to stringent regulation under the EU’s Solvency II rules.
These regulations detail how much capital the insurers have to put in to back the pensions they are promising to pay, and what assets they can invest in. Insurers say they offer pension scheme members a “gold standard” of financial protection.
In the unlikely event of an insurance company going bust, members would be fully covered by the UK’s Financial Services Compensation Scheme.
Superfunds, on the other hand, will be governed by a different set of rules laid down by The Pensions Regulator. It currently expects superfunds to provide 99 per cent certainty that benefits will be paid in full.
If a superfund were to fail, the scheme would become part of the Pension Protection Fund, meaning some members could see a cut in benefits — a worse position than if an insurance buyout failed.
Yet, adds Ms van Reeves, the big advantage for employers is that a superfund “should be a cheaper way to end their responsibility to the scheme than transferring the liabilities for benefits to an insurer”.
How would my pension be protected in a superfund?
Legislation to set out a formal regulatory framework for superfunds has been delayed, but The Pensions Regulator has set out a “tough” interim regime outlining the minimum standards it expects superfunds to meet before they start doing business.
It says its guidance has set “a high bar” for how superfunds must show they are “well-governed, run by fit and proper people and are backed by adequate capital”.
The regulator is also insisting that consolidators don’t extract profits unless members’ benefits are secured in full through an insurance buyout.
Employers are also expected to apply to The Pensions Regulator for clearance before a transfer can proceed.
“This should help provide comfort that transfers will only go ahead where appropriate in the circumstances of the scheme, and where the transfer is expected to provide more security for members’ benefits than remaining in the employer’s pension scheme,” says Ms van Rees.
However, concerns have been raised about the risks these new supersized pension arrangements could pose for the financial system, under their present regulatory framework.
In June, the head of the Bank of England, Andrew Bailey, reportedly wrote to Thérèse Coffey, secretary of state for Work and Pensions, to raise concerns about superfunds being allowed to operate with less stringent rules than insurers.
Last year, the Prudential Regulation Authority, part of the BoE, recommended for superfunds to be subjected to the same tough capital standards as insurer buyouts.
Ms Coffey has said the government was still finalising its rules for the superfund market and consolidators “should not assume” that the interim regulatory regime will become permanent.
The Trades Union Congress, the umbrella body for trade unions with more than 5m members, says it is not in the interests of workers to hand their pension funds over to profit-seeking private equity vehicles.
“The best way to make sure that pensions are paid in full is to keep the backing of a sponsoring employer,” said the TUC.
“The government must focus on supporting employers in the hardest hit sectors to help them stay in business so their pension funds don’t fall into the Pension Protection Fund or a superfund.”
Superfunds will also have trustee boards looking after the interests of members, who will be subject to the regulator’s rules.
Clara and The Pension SuperFund, the two most established players in the UK market, both say their trustee boards will be independent, even though they have been appointed by the superfunds, and initially paid by them.
Neither firm plans to allow pension scheme members to sit on the trustee board, citing the challenges of members from multiple workplace schemes choosing a single member to represent them.
Could my pension benefits change?
Usually when groups of members transfer from one scheme to another they are offered benefits in the new scheme on a “like for like basis” so the benefits don’t change. But that does not mean they cannot be changed, says Ms Kola of Arc Pension Law.
“The law permits changes in benefits as a part of the move as long as the transferring scheme actuary signs them off as broadly no less favourable than the original benefits,” says Ms Kola. “For example, this might mean a later retirement date in return for more years and months of service or different pension increases.”
She says she expects that the first transfers into superfunds will be on a like-for-like basis as this will be easier to explain to members.
“As superfunds grow I expect a trend to develop of changing member benefits as a part of the transfer so that all members get the same type of benefits as such schemes are much easier and cheaper to run,” she adds.
Can I stop my pension from being moved to a superfund?
In a word — no. Members are only entitled to be told about such transfers one month before they happen and there is no obligation to consult or get member agreement. However, company scheme trustees are required to act in the best interests of members and to take professional advice before making these sorts of decisions, and they will also need the approval of The Pensions Regulator before the deal takes place.
According to the regulatory guidance, it will still be possible for members who have yet to take their pension benefits to “transfer out” of a superfund — trading the promise of a regular retirement income for a cash lump sum.
Additional reporting by Oliver Ralph
Superfunds circling the UK market
“Clara is a bridge to an insurance buyout — members will ultimately have their pension paid by an insurer,” says Wayne Segers of XPS Pensions Group, noting that Clara only takes a profit when members benefits are secured with an insurer.
“Clara is a commercial consolidator and we do aim to make a profit for our investors, but members always come first,” says Adam Saron, founder and chief executive of Clara.
The superfund says it hopes to “welcome its first members” later this year. Once members’ full benefits are secured, any assets not required will be returned to Clara’s investors, which include the private equity group TPG.
Clara says its investment approach will be low risk, seeking to match the assets of the pension schemes that enter Clara with their liabilities to ensure a smooth journey to buyout.
In contrast, the Pension SuperFund will pay the member their pension benefit over their lifetime. “It is a ‘run- off’ fund and they will take profits whenever there are surplus assets in the superfund,” adds Mr Segers.
It says it intends to hold the vast majority of its portfolio in cash flow matching assets, common to many large, closed pension funds. The remainder of the fund will be invested in high-quality, cash-generative assets, including infrastructure and debt.
Richard Wohanka, chair of the trustee board, says the superfund will make money through “modest and consistent” outperformance of assets against liabilities.
“Any increase above the initial surplus position of scheme plus buffer will be released over time and shared between members and investors, as and when deemed appropriate by the regulator,” he says.
The interim rules from The Pensions Regulator offer a lot more flexibility over what assets consolidators can use to back the pension payments, meaning that the superfunds will be able to invest in assets that are higher risk, but offer the chance for higher returns.
Experts predict more consolidators, with potentially different business models, will enter the market later this year.