Articles - Superfund market opportunity for DB pension scheme sponsors

By Lewys Curteis, Partner and Senior Consultant - Corporate Actuary, Barnett Waddingham

In this article, we explore some of the key features of the superfund market, the potential benefits for DB scheme sponsors and some of the key issues that should be considered when approaching this market.

"All signs are pointing towards the superfund market becoming an established risk transfer option for UK defined benefit (DB) pension schemes."

"Corporates should be aware that a scheme that is approaching full funding in its corporate accounts could have sufficient assets to support a superfund transaction without a material additional contribution being needed to facilitate this."

While a technical description of a superfund’s capital requirements is beyond the scope of this article, very broadly these requirements are likely to result in pricing that is a small margin above a typical prudent funding basis. Based on current market conditions, this pricing may be broadly comparable to the DB scheme liabilities calculated on a corporate accounting basis.

Noting that pricing will vary depending on scheme specifics, corporates should be aware that a scheme that is approaching full funding in its corporate accounts could have sufficient assets to support a superfund transaction without a material additional contribution being needed to facilitate this.

The regulatory framework has been deliberately designed to ensure that a superfund transaction can only proceed where it demonstrably enhances benefit security and improves the chances of members receiving their benefits in full, compared to other available options.

The position of the scheme before and after a superfund transaction will need to be considered to assess the potential impact on member outcomes, and while the threshold will be easier to meet where the employer covenant supporting the scheme is relatively weak, this does not mean that the superfund market is reserved only for distressed employers looking for a quick exit.

"The regulatory framework has been deliberately designed to ensure that a superfund transaction can only proceed where it demonstrably enhances benefit security and improves the chances of members receiving their benefits in full, compared to other available options."

For schemes where the employer covenant is not at the weaker end of the spectrum, the immediate improvement in funding position resulting from the capital injected as part of the transaction might be sufficient to justify the superfund transfer. There is also the option of retaining some form of recourse to the employer to facilitate the transaction, where breaking this link would otherwise weaken the scheme’s position (see the 'connected covenant' innovation below as an example).

The trade-off for these future savings is that implementing a superfund transaction involves a substantial upfront cost. The data and benefit work required will be similar to the work required for an insurance buyout, with similar costs incurred. The route to market is not quite as well-trodden as an insurance buyout, but future superfund transactions can now benefit from the experience of earlier deals – at BW, for example, we have template project plans and documentation available to streamline the transaction process.

One of these innovations is the recent BW-advised connected covenant transaction, where the ceding employer agreed to a post-transaction guarantee to provide an additional layer of security to the scheme members. In simple terms, this reduces the employer’s exposure to pension-related risk from 100% to just 1-2%, with Clara’s capital buffer calibrated (in line with regulatory guidance) to withstand 98-99% of potential financial and demographic scenarios. From the trustees’ perspective, the scheme members continue to benefit from a backstop position similar to the existing employer covenant, but with the additional protection of a significant capital buffer to mitigate against future risks.

This connected covenant structure makes a superfund transaction possible for schemes with stronger employer covenants, where previously the improvement in benefit security following a transaction would have been difficult to demonstrate if the link to the employer was broken.

We are also aware that Clara is working to streamline its transaction processes, potentially involving a dedicated 'small schemes' proposition which could reduce the minimum transaction size below £50m. This further widens the range of schemes that may be able to consider a transaction.

The final point to note is the impact that new entrants may have on the superfund market. TPT has formally announced its intention to enter the market, with other providers expected to follow soon. These new entrants are likely to have different propositions, and potentially different pricing dynamics, broadening the options available for schemes and introducing some competitive tension into the superfund market.

Another key area of focus for corporate decision-makers is the impact that a superfund transaction might have on the accounts. A typical transaction will involve the bulk transfer of assets and liabilities to a superfund and, as a result, the link to the employer will be broken. We would generally expect the impact of this transfer to be recognised as a settlement through the company’s profit and loss account, with the exact amount disclosed depending on the funding position of the scheme at the point of transfer. However, as for bulk annuity insurance transactions, there may be opportunities to explore alternative accounting treatments through early engagement with auditors.

"For companies with DB schemes that remain underfunded on a buyout basis, now is the time to assess the feasibility of a superfund transaction."

The viability of a superfund transaction will depend on the specifics of both the DB scheme and its sponsoring employer. Having been involved in half of all superfund transactions undertaken to date, we have a deep understanding of this market and the characteristics required to support a transaction.