Are superfunds the answer?
The PLSA is thinking big when it comes to tackling DB risks
Just a fortnight after the government kicked the issue of a DB overhaul into the long grass, the pensions industry has picked it up and dropped it right back at their feet.
The Department for Work and Pensions’ green paper on the subject concluded there was no crisis in DB funding. It made some positive noises about the benefits of consolidation, but came up with little of substance on how this might be achieved.
The Pensions and Lifetime Savings Association (PLSA) has taken a very different tack. In the final report of its DB taskforce, the trade body warned that members of weak schemes had just a 50/50 chance of getting their benefits in full. The taskforce’s proposed solution is radical: ‘superfunds’ that will absorb single-trust schemes, leaving their former sponsors free of liabilities.
The idea is bold, but fraught with difficulties. The taskforce’s chair Ashok Gupta (pictured) is clear on the potential benefits, however. “We believe superfunds have the potential to offer great benefits to members, employers, the regulator, the industry and the economy,” he says. “Members get a better chance of more pension benefits being paid. Employers get a lower cost alternative to a buy-out. The regulator gets a sector with better managed risks. The economy benefits from improved investment by superfunds and employers are freed from onerous DB burdens.”
But there will need to be some major changes of mind set and regulation to get from today’s fragmented landscape of 6,000 schemes to a handful of behemoths. The report’s authors outline the main changes that will be required:
- A new requirement on trustees to ‘consolidate, improve or justify’ with an annual report explaining either how they plan to consolidate or else justifying how existing arrangements produce better value for money
- A review and overhaul of the regulations and guidance setting out the process for re-shaping scheme benefits to simplified structures of actuarially equivalent value (either within a scheme or upon transfer to a new scheme) – consolidation depends on clear standards that schemes and their advisers can implement with certainty
- A regulatory framework for the creation, authorisation and supervision of superfunds, which will permit employers to discharge their obligations in respect of transferring benefits
The taskforce believes these measures will tackle the three main problems identified in its interim report – the fragmented nature if the current system, inefficient risk management, and the rigidity of benefit structures.
Risk v reward
Providers have responded warily to the idea. Many have expressed broad support, but throwing their full weight behind the concept would be a case of turkeys voting for Christmas. For providers consolidation on such a large scale would provide a handful of winners, and many losers.
Hymans Robertson head of trustee consulting Calum Cooper says: “There are good reasons to question whether consolidating DB schemes to improve efficiency and investment returns represents the most effective means of addressing the issues. There’s an elegance to the theory but it feels vulnerable to be being hijacked by reality.”
Cooper warns that the significant upfront costs of setting up superfunds and transferring members into them would have to be balanced against the undoubted benefits.
The Association of Consulting Actuaries (ACA) focuses on who should bear the risk that will remain in the consolidated funds when sponsors have been let off the hook.
“Insurance companies have to hold regulatory capital and are subject to strict financial supervision; ordinary pension schemes have an employer to fund them,” says ACA chairman Bob Scott. “Superfunds would have less capital than insurance companies and no sponsoring employers and so, if the available capital is not adequate they will fall back on the Pension Protection Fun (PPF).”
Scott welcomes the fact that the PLSA is not talking about compulsory consolidation for well run small schemes, however.
Transferring members en masse will throw up serious legal considerations. Arc Pensions Law senior partner Anna Rogers says: “The taskforce is looking at the macro level but the law protects the rights of individuals. Current law offers mechanisms based on informed consent or overall equivalence, both on a member by member basis.”
Rogers says the equivalence test is not too tricky when comparing benefits packages, but factoring in the value of employer covenant and PPF compensation is no easy task.
“The government can only sign off on legislation that meets the human rights test, and we saw in the Brewster case that pensions can be protected by human rights law,” Rogers adds. “Consolidation would bring a tidal wave of work for advisers, so this isn’t vested interests speaking.”
The difficulties the sector would face consolidating schemes into superfunds cannot be glossed over. Nor can the fact that, with so few private sector schemes remaining open, this whole debate is coming at least a decade too late. But it’s good to see the PLSA is bringing some big ideas to the table.