Summary
The Department for Work and Pensions (DWP) has been consulting on a legislative framework for the consolidation of defined benefit pension schemes into superfunds, in order to provide adequate protection for members being transferred into such schemes.
Many of the proposals in the consultation will require primary legislation. Until this can be passed, DWP expects:
- any superfund considering entering the market to engage with the Pensions Regulator (TPR) and the Pension Protection Fund (PPF) and
- employers considering a transfer of their DB scheme into a superfund to seek voluntary clearance from TPR before any transfer takes place.
DWP will ask TPR to provide guidance for superfunds for the period before the authorisation régime is in force, preferably through a “Superfund Code” with appropriate penalties for non-compliance.
Regulating superfunds
DWP proposes to define a superfund as having the following main characteristics:
- a superfund is, or contains, an occupational pension scheme set up for the purposes of consolidating of DB pension schemes’ liabilities,
- a transferring scheme’s link to a its sponsoring employer is severed on transfer to the superfund,
- the new “employer covenant” is a capital buffer, provided through external investment, that sits within the superfund structure and
- there is a mechanism to enable returns to be paid to people other than members and service providers.
Regulation of these funds will comprise an authorisation régime and ongoing monitoring.
Superfunds will not be required to provide the same level of confidence as an insurer that benefits will be paid in full. However, the regulatory framework for superfunds should avoid incentives for insurance companies to establish such a vehicle outside the current regulatory structures, which might reduce the level of protection available for members of DB schemes.
As superfunds will be DB occupational pension schemes, members will be eligible for PPF protection rather than the higher level of compensation available under the Financial Services Compensation Scheme.
Authorisation
Superfunds will be required to seek authorisation from TPR in order to operate. TPR will have to be satisfied that the superfund:
- is run by fit and proper persons,
- has effective administration, governance and investment arrangements,
- is financially sustainable and
- has contingency plans in place to protect members.
The corporate entity of a superfund will have to be established as a comapny in the UK.
DWP proposes that all trustees should be independent of the corporate entity and of any third-party service providers. However, it believes that a requirement to appoint member-nominated trustees is inappropriate for superfunds.
Financial sustainability
Financial sustainability will be assessed at commencement and on an ongoing basis.
DWP has set out four options for defining the financial adequacy required. These include a stochastic modelling requirement which might require superfunds to demonstrate at least a 99% probability of paying all members’ benefits in full, at authorisation and then annually with the annual valuation. Other options involve setting long-term objectives, to be achieved within a defined timescale, or requiring the superfund to demonstrate solvency on an annual basis.
DWP suggests that schemes in a superfund should be required to secure benefits with an insurance company at the earliest possible opportunity when funding levels allow.
The legislation will set minimum standards in relation to the capital buffer to ensure that it can be relied upon to be available to the scheme when needed, including rules for how it can be invested.
Ongoing supervision
Superfunds will have to submit annual funding valuations to TPR and produce quarterly updates on the funding position. In addition there will be a series of trigger points that will require certain action if funding levels fall below certain prescribed limits. These actions vary from restrictions on when profit can be extracted to forcing the superfund to wind up.
There will be additional reporting requirements on the superfund’s corporate entity, including a requirement to report certain “significant events” to TPR. These might include, for example, an investigation by another regulator, a change to the business plan or a fall in the funding level.
DWP proposes that superfunds be subject to a bespoke levy to cover ongoing supervision, which would be ring-fenced for the sole purpose of regulating superfunds.
Superfunds will be a statutory employer for the purposes of an employer debt under section 75.
Transfers of existing schemes into superfunds
Trustees must act in the best interest of beneficiaries; they will need to be convinced that members’ benefits will be more secure in a superfund than remaining with the sponsoring employer and the current funding arrangements. DWP’s aim is that superfund consolidation should offer a viable option for a segment of pension schemes to improve security for members while ensuring that consolidation cannot be used as an alternative to buy-out.
Therefore DWP intends to introduce a “regulatory gateway” based on the following principles:
- excluding schemes that the trustees believe should be able to buy out benefits in full at the point of transfer or in the next 5 years and
- requiring that transferring schemes meet a minimum funding level, to avoid weakening the funding position of the superfund scheme.
DWP proposes to introduce a new notifiable event arising in advance of any transfer, requiring trustees to:
- notify TPR at the earliest available opportunity of their intention to transfer to a superfund,
- make a declaration to TPR outlining the trustees’ rationale and evidence that the scheme’s transfer to a superfund enhances member security and
- if professional covenant advice has not been taken, explain to TPR why it is not appropriate in their particular circumstances.