Clara-Pensions cleared as first U.K. superfund

The concept of superfunds that consolidate defined benefit funds is now a reality in the U.K., following regulatory approval for one model. After years on the drawing board, plan sponsors have a significant new option for derisking, experts say.

Interest in derisking options has been growing, and the dramatic improvement in plans' funding levels this past year will foster more activity, pension consultants predict. According to the London-based Pension Protection Fund for insolvent companies' plans, U.K. defined benefit plan aggregate funding levels topped 100% for the first time since 2010. Funding levels reached 105.9% as of Oct. 31, according to PPF data.

The change for superfunds came Nov. 30 when The Pensions Regulator approved the process submitted by defined benefit plan consolidator Clara-Pensions, London. Approval allows it to accept pension funds seeking to consolidate, and the first transactions are expected in mid-2022.

The timing is right, according to an analysis by London pension consultant Lane Clark & Peacock LLP. It found that fewer than 30% of pension funds with more than £1 billion ($1.3 billion) in assets and even fewer smaller ones have taken their first steps in transferring pension risk in the form of a buy-in, buyout or longevity swap.

Over the next decade, such risk transfer activity in the U.K. could reach more than £650 billion, LCP estimates.

With superfunds now a viable option, "it seems reasonable that the superfund market could see £5 to £10 billion of deals a year in two or three years' time," said Gordon Watchorn, LCP partner and head of corporate consulting in London. "This approval certainly gave credibility to the markets."

Based on the level of interest already shown, Clara-Pensions expects to assume as much as £5 billion in pension liabilities over the next five years, founder and CEO Adam Saron said.

The superfunds proposed in the U.K. so far use different models.

Clara-Pensions is what LCP calls the "bridge to buyout" model. It consolidates pension funds to provide a more cost-effective buyout outcome than the individual funds could manage themselves. Buyouts happen when interest rates, plan demographics and other factors make the timing right to purchase annuities.

Members and assets of each transferred pension fund form a section within Clara-Pensions that it will ultimately buy out. Clara-Pensions can also buy-in or buy out tranches of one or more sections, if it chooses.

A second "ongoing" model proposed by The Pension SuperFund in London and awaiting regulatory approval, calls for it to pay pension benefits on an ongoing basis, rather than completing a buyout. Pension funds would transfer all assets and liabilities to it.

Both models have investors providing a capital buffer to ensure their own financial health, and The Pensions Regulator sets minimum capital requirements. Clara-Pensions is backed by private capital from global investment firm Sixth Street Partners and reinsurance company Wilton Re Overseas. Details on the Pension SuperFund model, such as how it will operate financially, were not disclosed.

"Clara makes a return from being patient," Mr. Saron said in an email. "Over time we expect the price we would pay for securing members with an insurer to fall — we can wait out that time in a way that the current sponsor and trustee cannot. Alongside some outperformance of our assets against our liabilities, this means when we secure our members, there will be a return on the capital that provides our funded buffer."

In June, Clara-Pensions hired Kempen Capital Management as fiduciary manager to handle manager hiring and ongoing investments.

Mark Austin, head of U.K. for the institutional investor group at Northern Trust Corp.'s asset servicing arm in London with $15.8 trillion under custody and administration, does not see consolidators approaching their investment decisions much differently than a large pension scheme aiming for an eventual buyout. "They are both trying to achieve a target level of funding by taking an appropriate level of risk. The difference comes with the chosen end game. The approach will also be influenced by other factors such as sponsor covenant, scheme maturity and current funding level," he said.

"The bigger the (consolidator's) pool, the more sophisticated they can be. The received view is that a larger pool of assets can start to allocate to a broader range of assets and often to those assets directly, and the larger pool can support more sophisticated in-house investment analysis," Mr. Austin said.

Neither model will be right for all pension funds, consultants caution. The target candidate for a superfund is a well-funded pension fund that could not afford an insurance buyout in the near term, either because of the upfront cost of funding up the plan to make the transfer, the demographics of plan participants, liquidity or other factors.

Plan sponsors will still need permission from The Pensions Regulator to make the transfer, and pension funds likely to reach buyout on their own within five years would not generally be permitted to do so.

Superfunds would compete with insurers by making it less expensive for a pension sponsor to transfer the entire pension fund to them. The cost of going to a consolidator could be 5% to 15% lower, pension analysts say. The sponsor may have to make additional contributions to make the transfer, but the volatility and uncertainty over future contributions and other decisions would be over.

Each pension fund transferred would have to be fully funded according to Clara-Pensions requirements, and sponsors may have to fund some of the capital buffer, but it is still less expensive than a traditional buyout under insurance regulations.

Another selling point for sponsors is that the superfunds can potentially offer a better outcome for participants, whose benefits might otherwise be at risk of reductions if the pension fund was assumed by the PPF.

Pension fund trustees nervous about the corporate sponsor's willingness or ability to continue supporting the plan could also find consolidators an attractive option.

"Ultimately, this is about members" of a pension fund, said Andrew Ward, head of U.K. DB risk for Mercer Ltd., London. Their benefits would be protected by a well-capitalized consolidator being closely watched by a regulator, he said.

While companies at risk of insolvency are obvious candidates, "the interest is much broader than I think even we'd originally considered," said Mr. Saron of Clara-Pensions. "We are also seeing corporates and their owners, where there might not be a risk of insolvency but who want to resolve (in the right way) their historic pension responsibilities" to focus on growing the business or facilitate a sale or restructuring, he said.

For Mr. Ward, the regulatory green light for Clara-Pensions "helps trigger a broader conversation around strategies for pension schemes. We should not assume that all pension schemes have to go to a superfund or a buyout."

The range of options includes having a single professional trustee, outsourcing investment decisions to a fiduciary manager, master trusts, superfunds, partial buy-ins and full buyouts, he said.

"As sponsors figure out where they want to be, and how to get there, consolidation with a superfund is on the spectrum of options," Mr. Ward said. "However, it is very scheme-specific. Each scheme is on its own journey and it will be a longer path for some than others."

LCP experts agree that Clara-Pensions' approval could pave the way for other models for plan sponsors to consider. With an estimated £2 trillion in unsecured pension liabilities in the U.K., "there is a lot of capital to be injected. There are new solutions that might be better outcomes for everyone," said Mr. Watchorn of LCP.