U.K. superfund consolidators still see roadblocks

U.K. superfund consolidators could still face obstacles when helping plan sponsors with outsourcing pension fund assets and liabilities despite trustees receiving a long-awaited green light from the financial regulator.

The superfund idea, in which consolidating vehicles bring defined benefit assets as well as liabilities of many smaller plans together, has been teased by the U.K. Department for Work and Pensions since 2018. Consolidators were seen as a good idea because they could ready smaller plans for an insurance buyout that they were unlikely to achieve on their own.

But even though some consolidators such as Clara-Pensions Ltd. and The Pension SuperFund had appeared in the market, it wasn't until Oct. 21 that the U.K. Pensions Regulator moved closer to clarifying how such consolidators could practically operate in the market.

The regulator has now permitted plan sponsors to move corporate plans to consolidators — which will be regulated as pension funds — as long as trustees can justify that a buyout won't be possible in the next five years without a consolidator's help.

Consultants estimate that about 10% of U.K. plans might ultimately find a suitable home for their assets and liabilities at a consolidator. The market could reach £170 billion ($220.1 billion) in the next 10 years, according to an estimate by PricewaterhouseCoopers LLP on Oct. 16. Consultant Barnett Waddingham LLP calculated that on the basis of current contributions, 46% of FTSE 350 plans might be able to transfer to a superfund in the next five years compared with 24% that independently might be in a position to conduct a buyout with an insurance company in the same period.

But sources said some questions and hurdles remain as consolidators are at the mercy of the regulator before they can first win business.

'No superfund has so far made it to the regulator's approval list. The two known consolidators also differ from one another. Clara Pensions intends to ring fence every plan's assets that it will acquire and target a separate buyout for each of them. Its only known competitor, The Pension SuperFund, is set to pool assets and liabilities into a single fund but will not target a buyout.

Also, the cost of moving assets to a consolidator for a plan sponsor will depend on the superfund and the transferring plan, according to the regulator. As consolidators effectively replace plan sponsors and The Pensions Regulator will scrutinize every individual transfer, superfunds will have to show they have secured access to a capital buffer from external providers and if needed one-off contributions from plan sponsors, sources said. Because the plan's employer covenant is removed when a plan transfers to a consolidator, the regulator expects a 99% probability that the benefits will be paid in full.

Huw Evans, director at independent trustee services firm BESTrustees Ltd. in London, is less optimistic about consolidators looking to buyout. He thinks consolidators could be constrained commercially by players they have to work with such as insurance companies. "The pricing (in the insurance market) has already moved to squeeze consolidators out of the market," he said. "When consolidators started talking to schemes, they were talking about saving of about 10%. They don't tend to do that anymore," he said.

Mr. Evans also sees obstacles with regards to the group of plans in the Pension Protection Fund assessment that could be looking to secure more than the PPF benefit limits with a consolidator but less than 100% of the benefits promised.

"As the law stands, this could only be achieved by getting members to agree to transfer to a scheme with lower benefit promises. The tragedy of this scenario is that it's the most vulnerable who don't reply to correspondence and so end up with an insurance company annuity for the lower amount," he said.

Insurers also criticized the model, stating that consolidators are for-profit institutions but will not be regulated as financial institutions. "We think consolidators are frankly not a good idea," said Jay Shah, chief origination officer at Pension Insurance Corp. in London.

"They are targeting a product that is often the same as a buyout but proposing to do it cheaper by offering lower security, adopting a more aggressive investment strategy and operating in a less regulated environment," he said.

The regulator's guidance on Oct. 21 is also requiring consolidators to wait at least three years before they can profit and require that buyouts are conducted before they profit to offer extra security to participants' benefits. The regulator said in the next three years it will revisit the interim regulatory framework and finalize a law for consolidators.

Consultants say that there are a few types of plans that could be interested, including U.K. corporate plans of sponsoring employers with overseas parent companies or well-funded plans that have entered the Pension Protection Fund's assessment due to their sponsors' insolvency.

Alistair Russell-Smith, head of corporate DB at consultant Hymans Robertson LLP in London, said overseas groups selling a U.K. business could give sale proceeds to pension funds to go to a consolidator. An overseas parent company might see value in separating the pension fund from the U.K. subsidiary, potentially at lower costs than via an insurance buyout, he said.

John Baines, partner and head of bulk annuities at Aon PLC in London, agreed that consolidators can help plans that can afford to secure benefits with a consolidator but wouldn't be able to afford a full buyout with an insurance company. That's because consolidators are offering to hold liabilities until all plan participants have retired.

Retired participants' liabilities are cheaper to insure than those of participants that are yet to retire because there is less uncertainty about longevity influencing the amount to be paid. In addition, insurers need less risk capital, which is reflected in the price, sources said.

Mr. Baines added that consolidators can remove risks differently to other vehicles that consolidate assets such as multiemployer plans, known in the U.K. as master trusts or fiduciary managers. Superfunds are letting plan sponsors sever links with the plan. Master trusts or fiduciary managers can help to improve governance or provide access to higher-risk investments at scale but they leave the link with the employer intact, requiring sponsors to keep plans on their balance sheets.

Mr. Baines thinks the first plans that are likely to choose a consolidator are those in the PPF assessment but are unlikely to be transferred to the lifeboat fund for insolvent employers. "There are a few cases in the market that are actively looking at a consolidator," Mr. Baines said.

Plan sponsors could see their pension assets and liabilities sectioned off from other plans if they choose to go with the model offered by Clara. Adam Saron, London-based CEO and founder of Clara, said Clara is backed by private capital provided by global investment firm Sixth Street Partners LLC and reinsurance company Wilton Re Overseas that replaces the sponsor covenant, and will manage assets using a fiduciary manager for between five to 10 years.

Clara will charge a management fee of 15 basis points paid from plan's assets, much like an adviser to cover administration and actuarial costs but will not take profit or return profit to its shareholders until individual buyouts are completed.

In order for a frozen plan to mov to a consolidator, Mr. Saron said the TPR will assess the capital needed for the transaction to the consolidator, the plan's own funding position and will ask the sponsoring employer to fund any gap. "The regulator has made it clear that all consolidators need to be fully funded on a technical provisions basis," he said. If incoming schemes' assets are insufficient, the plan sponsor has to make up the difference, he added.

"There is no payment of profit along the way. Neither the capital that we provide or any return on the capital goes back to investors until every member's benefits in a section are insured. Only after the buyout can we get our capital back and profit if there is any," he said.

Clara's competitor, The Pension SuperFund, has a different model as it aims to consolidate assets and liabilities into a single fund, and it is not a bridge to buyout.

Peter Cazalet, managing director, deal origination at the fund, which is also backed by equity investors such as other pension funds, sovereign wealth funds, insurance companies and banks, said that one of the big expenses of going to buyout for a pension fund is that it has to move its portfolio into an insurance-friendly format. For example, private assets could be very expensive for an insurer to hold under Solvency II, he added. "The cost of transition can be quite high," he said.

Instead, the superfund expects to create surplus capital by a combination of good performance, economies of scale, improved governance and reduction in liabilities. The Pension SuperFund's buffer fund reimburses the manager on a cost recovery basis, Mr. Cazalet said.