DB Pension Superfunds - Q&A

This questionnaire is intended to provide a clear explanation of what a DB pensions superfund is, why New Capital Consensus believes they are able to deliver the productive long-term investment that the UK needs whilst also protecting members, and what needs to be done to ensure they do not become a “niche” vehicle which has little effect.

A Superfund is a DB pension scheme with a difference. It takes in closed DB schemes from sponsoring employers, in exchange for an entry price, and consolidates these atomised funds into a larger and more efficient structure.

In a superfund, the inherently uncertain ongoing support of the sponsoring employer is replaced by a substantial capital sum, which is provided by investors. This “capital buffer” is legally ringfenced, so that it can only be used to protect members and cannot be withdrawn. If the superfund performs well, then the investors get a return on their capital. But if it does poorly and the level of capital falls below a pre-determined threshold, the investors lose their money, which is passed to the trustees to protect members' benefits.

No. The capital adequacy rules for superfunds ensure that they are very safe indeed, with a very high probability of paying members’ benefits in full when they fall due. In fact, a superfund will always be safer than the original scheme. The rules prevent a scheme from being moved into a superfund unless the trustees are satisfied that it provides a better prospect of paying members in full than the exporting scheme.

Insurance is a perfectly legitimate place for your DB savings in some circumstances, but Superfunds can offer a better alternative for many. A superfund has a lower entry price than insurance, which means some schemes unable to achieve buyout funding can get into a superfund, delivering an increase in security for members that would otherwise have been out of reach, and freeing up employers to focus on their core business. And because superfunds are not constrained by the rules of Solvency UK like the insurers, they can invest more productively in a wider range of assets, delivering tangible benefits not only for the members, but also for the wider UK economy.

Some superfunds do offer a “bridge to buyout”, but that’s not where the most exciting opportunities are to be found. Superfunds can also operate on a “run-on” model, where the fund continues to take in more schemes over time. As new members are brought in as new schemes are absorbed, there is no end point for the scheme where all the pensions need to be paid out, as there is with a traditional closed scheme. With no clear endpoint, such superfunds have very long time-horizons, and are therefore able to deploy truly patient capital, reaping rewards for members, for investors and for the wider UK economy.

No. Superfunds do not offer buyout on the cheap. They are a fundamental alternative, with contrasting characteristics, which trustees can choose where they think it is in the best interests of their members. There is complete transparency about design differences which distinguish superfund consolidators from insurance. Superfunds are very secure, but have a lower level of security, and a lower entry price compared to insurance. They also have greater freedom to invest in a wider range of patient and illiquid assets. These characteristics can be advantageous to sponsors and members alike. For example, Superfunds may be able to offer higher headline rates of benefit, alongside a lower entry price, while always delivering improved security compared to the exporting scheme.

Superfunds are able to deliver the investment capital that the UK economy so desperately needs. They can do this because their scale is much greater than individual schemes, so they can invest in more sophisticated ways. They are able to do this more effectively than insurers, because they are pension schemes, and not bound by the strict rules of Solvency UK. A ‘Goldilocks Effect’ whereby they are large enough to move the dial on growth, but small enough to invest in regional areas of the UK. And their significant capital buffers and unique incentive structures promote more productive investment. While a traditional DB scheme tends to invest defensively to help protect the sponsor from deficits which would appear on their balance sheet, superfund investors can only be rewarded for their investment if the fund grows through returns on productive investment. This helps align the incentives of investors, members, and the wider economy.

The DB landscape has changed, with most DB schemes being closed, so that no new members can join, and no new pension rights can be earned. As a result, large numbers of schemes have no new contributions coming in from active members and are only engaged in paying out pensions to retired members. Such legacy schemes are no longer a part of employers reward packages, but they are still responsible for funding the scheme. The number of employers seeking to cut their ties with such legacy schemes has increased from a trickle to a torrent as the closure of DB schemes has accelerated. With these rapidly increasing volumes there are significant risks from having a single default channel for securing benefits on the insurance market. The time is right for superfunds, as they offer a real alternative at the time when there is significant demand.

Superfunds can and do operate under existing law. They are developing now because the conditions are right for them, with large numbers of relatively well funded closed DB schemes reaching the point of their lifecycles where employers want to break their ties. But they can and will develop real scale and market share, if new regulations are framed effectively to protect members and embed effective incentive structures.

Superfunds will only thrive if they are controlled by a fair and effective regulatory framework that makes them viable in a mixed economy – where there is choice and competition between insurance, running on to drive surplus extraction, and superfunds. If the rules make superfunds so expensive that there is little price difference between them and the insurers, they will never reach the scale needed to make a real difference to the UK economy. Similarly, if trustees are not given the freedom to choose when a superfund is in the members best interests – for example if it offers a better headline rate of benefits, while remaining extremely safe, superfunds will not be able to reach their full potential. And finally, superfunds should not have the threshold at which they can take profit set materially higher than the point at which sponsors can extract a surplus. If these pitfalls are avoided, superfunds will be able to thrive.

The conditions are right for superfunds, and a number are in gestation. In the absence of hurdles put in their way, they will come to market and transform the DB and investment landscapes. It is therefore critical that the Government allows this to happen and does not embed insurance as the default destination for closed DB schemes by protectionist measures favouring insurance, under the mistaken belief that this is needed in the interests of member security.