On 21 October 2020, The Pensions Regulator (TPR) published updated guidance for trustees and employers considering a transaction involving a pension superfund. This guidance builds on that issued in June 2020; for more information, please see our previous blog post available here and longer briefing here.
As previously explained, superfunds (also known as ‘DB consolidators’) are a form of pension fund that replace the employer covenant with the security of third-party capital. The guidance published by TPR in June 2020 set out the interim regulatory regime applicable to superfunds (and superfund transactions) until the Government’s permanent authorisation regime is in force.
The new guidance issued last week covers the following areas of particular interest:
The three ‘gateway principles’
A transfer to a superfund should only be considered in the following circumstances:
- The scheme cannot currently afford an insurance buy-out
- The scheme has no realistic prospect of buy-out in the foreseeable future
- The transfer improves the likelihood of members receiving full benefits
TPR has explained that, although they see superfunds as providing a high probability of members receiving full benefits, they do not consider the solution as providing equal security to that of an insurance buy-out. Where a scheme can secure benefits with an insurer, it should do so rather than transfer to a superfund.
The employer’s position will be particularly relevant when considering these three principles, particularly in assessing the future prospects of a buy-out and the likely capacity of the employer to pay deficit repair contributions. Where the employer covenant is currently weak or trending to weak, the justification for the transfer may be relatively straightforward; however, where the covenant is strong or trending to strong and the employer is able to pay deficit repair contributions this may be more difficult.
Gateway principle 2 – that the scheme has no realistic prospect of a buy-out in the foreseeable future – will be particularly relevant for superfund providers, such as Clara, who offer a “bridge to buy-out” rather than a permanent solution. Echoing its comments on the employer covenant in the recent DB funding code consultation, TPR says that the “foreseeable future” will generally be up to five years, with greater employer covenant certainty in the first three years.
In addition to the gateway principles, the new guidance makes it clear that trustees should be open and transparent with members about the planned transfer to a superfund, and be clear in their communications. Members may consider transferring their pension separately, or retiring from the scheme when they would not otherwise have done so, and trustees must be mindful of these options and their role in supporting members in light of the irreversible impact the member’s choice will have on their retirement benefits.
Transfers to a superfund are considered by TPR to be a new ‘Type A’ clearance event, meaning that the ceding employer must apply for clearance prior to the transfer. The process and rationale behind the decision to transfer will form part of TPR’s assessment during the clearance application, as well as any mitigation of potential detriment from the removal of the employer covenant. Correspondingly, the superfund will be expected to demonstrate that it continues to meet TPR’s expectations as to capital adequacy.
Whilst the ceding employer will be the applicant for clearance, the new guidance envisages a significantly greater role for trustees than they would play in a clearance application about transactional activity. Trustees are expected to conduct the assessment under the gateway principles described above, and demonstrate that thorough consideration has been given to their decision. This would take into account the impact of members, other options, residual risks, and other matters.
TPR has also confirmed that the trustees will need to demonstrate they have considered past significant corporate activity for any material detriment, such as mergers, acquisitions and refinancing. Trustees should also undertake a review of recent “value extraction”, such as dividends paid by the employer. Trustees should then assess whether the superfund transaction mitigates any material detriment, or whether alternative steps could be appropriate. Though not stated in the new guidance, there is risk that TPR will look-back at the ceding employer’s conduct in the past six years for the purposes of its moral hazard powers. Ceding employers should therefore consider whether they could provide evidence that the interests of the scheme were properly considered when significant transactional activity was undertaken during the six-year lookback period.
Trustees and employers must engage with TPR as early as possible in their consideration of the transfer, and should allow at least three months for a clearance decision to be made. In parallel, TPR will engage with the relevant superfund to ensure that it meets their expectations.
Interaction with PPF Assessment
A new area covered by the most recent guidance is specific advice for schemes who are considering a transfer to a superfund as part of an exit from an assessment period by the Pension Protection Fund (PPF). The advice covers the factors that trustees must consider, primarily the difference of the level of benefits offered by a superfund compared to a buy-out at a lower level of benefits, as well as more practical questions such as when scheme assets can be used to pay for the costs associated with the transfer.
The key take-away from the guidance in respect of the PPF is that the PPF expects all schemes to complete the assessment period in the usual way prior to the transfer unless there is a scheme rescue. Some parts of the assessment period may even assist in preparation for the transfer, for instance the data cleanse required will ensure the correct asset and liability position is known.