The UK government has signalled the importance of introducing a permanent superfund regulatory regime.

After the excitement around Clara-Pensions’ approval as a “superfund”, or pension consolidator, in late 2021, the market generally expected that other pension superfund structures would soon follow suit. Last year’s mini-budget and the ensuing liability-driven investment (LDI) crisis, which triggered intervention by the Bank of England, no doubt weighed negatively on the development of the pension consolidation market, along with an increased focus on investment strategies for pension schemes generally. The expected pipeline of further approvals failed to deliver new participants in a market which was to provide much-needed de-risking capacity alongside the burgeoning and highly successful insurance bulk annuity transfer market.

Hopes were revived by the Chancellor’s Mansion House speech on 10 July 2023, which commented on the fragmentation of the defined benefit (DB) pension scheme landscape in the UK and the importance of introducing a permanent superfund regulatory regime, presenting a key policy direction by the government.

On 10 August 2022, the Pensions Regulator (TPR) announced revised guidelines for pension superfunds. The original guidance, issued in 2020, established an interim regime for superfunds and set out tests for when a pension scheme would be appropriate to transition to a superfund.

This blog post examines the updated pension superfund guidance and provides a high level overview of the key changes.

Guidance for Trustees — “Gateway Principles”

The guidance directed at employers and trustees of pension schemes considering a transfer to a superfund includes revisions to the so-called “gateway principles”. These three principles require that a transfer should only be considered if (1) the scheme is unable to enter into a buyout transaction, (2) there is no realistic prospect of a buyout transaction in the foreseeable future, and (3) the transfer improves the likelihood of members receiving full benefits. TPR approval of a transfer through the clearance process is a precursor to any transfer, and the gateway principles are a core feature of such clearance application.

The gateway principles have been a subject of debate since the guidance was originally issued, in particular how “the foreseeable future” and the comparison of likelihood of benefits should be assessed. The updated guidance seeks to provide additional detail on these three principles, including in relation to affordability of a buyout and what time period should apply. Specific elements for the assessment of a scheme against the gateway principles have been identified, such as how the buyout funding level may progress in future by reference to asset returns, future employer contributions, broader employer support, potential development of buyout pricing over the relevant periods, and data quality issues.

Trustees should also base their assessment of whether a buyout is feasible on a response by an appropriate insurer, such that if the trustees receive a refusal to insure or are told that a buyout cannot be completed within a reasonable period due to scheme-related factors, it would be reasonable to conclude that the scheme could not access a buyout. Given the stretch for insurers in meeting current demands for pricing, it is unclear how practical it will be for some schemes to get an appropriate response, as insurers may be unwilling to apply their resources in assessing schemes which, at first blush, are doubtful of reaching an executable deal.

The guidance notes that testing a buyout within the foreseeable future will be specific to the circumstances of the sponsoring employer, with TPR reiterating a period of up to five years as relevant for the assessment. However, TPR acknowledges that there is likely to be greater certainty over the employer covenant during the first three years and that longer periods are unlikely to provide requisite clarity, which suggests a softening towards the three-year period.

A key consideration of the gateway principles is the assessment of what the scheme expects to receive in the future and the level of confidence regarding such amounts. TPR expects trustees to take professional covenant advice.

The assessment of securing future benefits will require trustees to compare the likelihood of members receiving full benefits with a superfund against the likelihood of their receiving full benefits should the scheme remain with the employer. TPR expects the assessment will require professional advice which takes into account the employer’s short- to medium-term covenant, sector of operation, and market trends, as well as other external risks. Modelling is likely to be appropriate. In addition, TPR mentions broader factors, such as the prior behaviour of the employer with respect to scheme support; the improvements that a consolidation may bring, including economies of scale within a superfund; the availability of other superfunds; and other options for consolidation, such as DB master trusts. TPR will expect an in-depth and fully reasoned assessment, albeit one that includes the potential upside that a superfund might provide.

Guidance for Superfunds — Profit Extraction

The guidance for those operating superfunds has been amended in a number of areas, but of particular import is the position on profit extraction. The guidance remains scant, given that TPR still needs to undertake further analysis to develop the profit-trigger mechanism, on which it has announced plans to engage further with relevant stakeholders. However, TPR no longer states that during the initial period there should be no extraction of funds from the scheme or the capital buffer unless members’ benefits have been bought out in full. TPR has also dropped its previous language referring to the deliberate circumventing or gaming of the profit-extraction principle. These changes point to a softening approach from TPR on profit extraction, which is a key feature of the regime for investors and funders of future pension superfunds.

In the meantime, the government’s response to its consultation on the consolidation of DB schemes, issued on 17 July 2023, reiterated the government’s support for the development of the superfund market and a permanent regulatory regime to encourage investment in the sector. Despite improved funding levels, the DB pension sector is still seen as exposed to risks, including from world events such as the impacts of COVID-19. The government also acknowledged that the insurance sector is not an option for all schemes, not least given the expected overwhelming demand for bulk annuity insurance over the coming period.

On the important question of profit extraction, the consultation feedback indicates that the profit trigger will be implemented to allow extraction only when assets are at a suitable prudent level above technical provisions. For segregated models, the ability to distribute profits from a section would only apply once either (1) that section’s assets exceed its technical provisions plus a percentage over the authorisation capital requirement, or (2) a transfer of that scheme to an insurer occurs. The feedback also expressly recognises that allowing superfunds to extract profit above certain levels of capitalisation is necessary for the commercial viability of these funds.

The rhetoric in the marketplace around profit extraction has changed. In the past, profits were expected to be locked in. Now, reasonable and prudent profit extraction is acknowledged as a commercial reality, providing important comfort for investors and placing superfunds firmly back on the de-risking menu.