Superfunds – Feature
Being responsible for funding peoples’ retirement is rarely easy, but it must have been less stressful when 10-year gilts returned around 8% and most members paid into their pension pot each month. Trustees of defined benefit (DB) funds today face a differ- ent reality. Of the almost 5,500 schemes in the Pension Pro- tection Fund’s (PPF) universe, only 11% accept new mem- bers, while 44% do not and the same percentage are closed to further accrual. Rising deficits resulting from low gilt yields are also increasing the pressure on sponsors. At the start of the year, deficit reduction contributions accounted for 60% of all employer payments into DB schemes, the Office for National Statistics (ONS) says. Add to that the economic impact of the Covid crisis, which is still unfolding, and it becomes clear why more and more trustees and sponsors want to pass the responsibility of paying their members’ pensions to someone else. So far, buyouts have been the preferred option for those looking to de-risk. The size of this market has the potential to grow significantly. Indeed, in the next 10 years, 72% of final salary schemes will have enough capital to secure a full buyout, up from 6% today, the Pensions Policy Insti- tute predicts. For schemes that cannot currently afford an outright buy- out, a new option is approaching on the horizon. Consoli- dation through a trust-based, commercial pension provider which manages the assets of several defined benefit schemes.
The potential market for these trusts, known as super- funds, could be significant. Despite defined contribution (DC) scheme members outnumbering those saving into a DB scheme, the latter owns most of the assets. Indeed, by the end of 2019, £1.8trn of the £2.2trn of UK pension assets were managed by final salary schemes, according to ONS. The managing director of one of these consolidators pre- dicts that funds such as his could radically alter the pen- sions landscape. “If the UK follows the experience of the Dutch and the Australian market, the 5,500 schemes we have today could fall to 1,500 by the end of the decade,” says Antony Barker of The Pension Superfund. “A percentage of those, maybe as of today, will go into insurance buyouts and 50 to a 100 schemes, maybe 1% or 2%, will unfortunately end up in PPF assessment due to the failure of the sponsor, and that no doubt may accelerate over the next couple of months. But if you do the maths, that leaves potentially 2,000 or more schemes that could end up with a superfund. That’s probably £800bn or more at today’s valuations.” It’s no wonder then, that competition for the biggest chunk
of the consolidation cake is growing. And this is also where the debate on the merits of DB consolidation becomes not only contested, but fiercely political. At the heart of it is that the financial burden or retirement provision is increasingly born by individuals, rather than their employer. As scheme sponsors are offloading such commitments to corporate entities such as insurers or con- solidators, the question remains as to how much income risk will member be exposed to. Then there are the issues of how should consolidated investment risks be managed and who polices these funds.
Because superfunds target schemes in the PPF universe, if they default schemes would fall back into the protection of the pension lifeboat, for which members would potentially pay the price through lower retirement benefit. The lack of regulation for superfunds has attracted fierce criticism from insurers. Hetty Hughes, senior policy adviser for long-term savings at the Association of British Insurers (ABI), warns: “By underwriting superfunds with the PPF, you are potentially privatising the gains and socialising the losses.”
A two-tier system Superfunds are being created to fill a gap in the DB de-risk- ing market. Despite most final salary schemes no longer admitting new members; an outright buyout, which would require high levels of funding, is only available to a fraction of schemes as in most cases it would be too expensive. As covenants come further under pressure from the Covid crisis, many employers are looking for alternatives to offload their pension liabilities. A recent survey of trustees and their investment directors showed that one in five schemes have discussed superfunds as a potential exit route, according to Willis Towers Watson. The government has also made clear in its March 2018 Whitepaper that it welcomes consolidation through super- funds. Emboldened by political support, two main providers – The Pension Superfund and Clara – attracted significant start-up capital while there are reported to be other players looking to enter the market.
The two main providers aim to tackle different parts of the market. Clara, which is on track to receive up to £500m in seed capital from TPG Sixth Street Partners, describes its services as a “bridge to buyout”, rather than a permanent transfer. By extension, the transferred assets will be man- aged on a segregated basis. In contrast, The Pension Superfund, which is backed by an initial £500m from private equity firm Disruptive Capital, offers a permanent run-off model for DB schemes and the assets, as well as liabilities, will be pooled.
Issue 95 | August 2020 | portfolio institutional | 43
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