There are places where laypeople fear to tread

There are areas of pensions where laypeople fear to tread. Typically they are areas where there are guarantees secured by capital or debt.

LDI was such an area. Another area where consumer orientated commentators are unwelcome, is in discussions over the  quality of covenant offered to members of DB occupational schemes relative to an annuity or membership of a DB consolidator (aka a superfund). This is “professionals only!”

Recently , I argued that the Government cannot promote superfunds as having “potential to introduce significant pools of capital into the UK economy” while relegating them to”poor man’s buy-out“. Well funded pensions can get better funded with a pension super fund – better funding should be  good news for all.

I have been told that taking this line risks inciting the ABI to rise up in arms and to put the Pensions Regulator into a tailspin of fear for members and the PPF. In short – I’m getting clear signals to butt-out of an area which is best left to bankers, insurers and regulators.

Which of course a clear sign that I need to press on.

The door for superfunds is ajar, but should be open

The DWP’s paper on DB consolidation is hugely encouraging to Superfunds.

I understand the TPR are going through their internal governance processes to sign off their own review of the 2020 Guidance with a view to publication in the next two to three weeks. I’m meeting with TPR’s CEO next week, she’s asking for a new mindset, so am I!

The DWP’s consultation response includes this audacious statement;

The buyout market is .. not fundamentally interested in schemes that cannot afford their products and also has a natural ceiling to the value of schemes that can effect buy out in any calendar year.

Ouch! I suspect the ABI didn’t sign that comment off. A gateway test that excluded pension superfunds from competing for business that might be ready to buy-out suggests that schemes unwilling to pay the price of buy-out or stuck in the buy-out queue, would be denied access to a pension superfund by dint of being too well funded.

Barnett Waddingham estimated that approximately one-third of FTSE 350 DB schemes were now fully funded on a buyout basis – a substantial increase compared to the 11% recorded in May 2022.

Putting such a large part of the market out of scope of superfunds looks competitive to me. If their is to be a new mindset , then it should include fresh thinking on the options available to solvent DB pensions. They deserve the right to choose denied them by the gateway.

And it’s not just those who have funding to or beyond buy-out level, the DWP paper suggests that the gate would probably be shut on schemes close to a buyout level of funding and possibly the orange box too.

While the DWP still stands by its gateway, the DWP  consultation paper does suggest substantially lower minimum capital requirements that would make it commercially possible for superfunds to compete effectively against insurers , were they allowed to.

This is like dangling a carrot in front of a horse , never to let it eat it

People in the know tell me that  superfunds will be able to price 10% lower than insurance (although it’s not obvious whether they are second guessing future insurer pricing once the UK replacement for Solvency II is enacted).

The justification for this prediction is based on an analysis of the DWP’s proposals (read on). So why, when superfunds offer the capital that is needed to meet the Government’s productive finance targets, are they denied a crack at  the good stuff?!

Superfunds protecting the PPF?

The DWP’s analysis is right in saying that Superfunds can’t help very poorly funded schemes, especially where they have a weak covenant. Well not for while anyway

But in that meanwhile, those who have adopted a new mindset tell me that there are many schemes with weak employer covenants that can benefit from innovative approaches to funding such as Capital Backed Journey Plans with capital made available from the same sources as back pension superfunds.

The lower tier might not work for superfunds, but would work with CBJP’s targeting a superfund exit in due course   Indeed, the DWP response looks to widen the superfund/alternative covenant scheme definition to include materially altered, but not completely divorced sponsor covenant transactions. Goodbye regulatory apportionment agreements

The concept of CBJPs as feeders for superfunds , supports TPR’s aim of protecting the PPF while offering members an alternative to the PPF haircut. If only such solutions had been around in 2017 to support BSPS.

Superfunds can nurture PPF bound schemes and want to.

There are numerous tweaks put forward by the DWP  in its consultation response that suggest that Superfunds aren’t just backed, but this time they are back with a bang. Let’s start with three easements on capital employed to secure benefits.

The DWP is proposing a 1-year (currently 5 year) VaR test – the report seems to be suggesting this to be at the 99% level (compared with the  insurers’  99.5%) with intervention (and new business recapitalisation and profit extraction) triggers linked to this.  They actually note that TPR’s five-year 99% test was arguably more onerous that insurers one year 99.5%, which it was. It looks like someone has got the maths.

What’s more, the DWP are  proposing  moving to 98% rather than 99% chance of failure when setting capital, all else being equal , this  leads to smaller buffer funds needed for backing given liabilities and makes for a bigger gap between superfund and insurance pricing.

Finally… by allowing capital release/ profit extraction if funding is sufficient (rather than just on buyout) then given the point above the bar for sufficient is going to be lower.  Together with the point above, this makes superfunds such as PSF a much more investable proposition.

Further relaxations through TPR guidance

Allowing PPF+ superfund transfers to happen at less than 100% of full benefits puts them  on a level playing field with insurance.  This would definitely require legislative change to overturn Halcrow/s.67 but that is indeed a potential game changer. Interestingly though it will open up an argument for schemes/sponsors to be able to right size their liabilities to available assets as an alternative to an RAA.  I suspect these issues will be addressed in the forthcoming TPR review of its 2020 guidance

there look to be further relaxations over discount rates which look likely to settle at Gilts + 0.5% (as now) but plus up to a further 0.5% on a dynamic basis (i.e. could be the full 1% now given current market conditions for yields and available expected returns).

This has the effect of putting less in the scheme (perhaps 3-4%) . Preciously  more capital would have been needed in the buffer to maintain the overall probability of members receiving full benefits (albeit as that probability is reduced the overall total capital may be lower now, leading to a smaller buffer pro-rata).

It will be interesting to see whether there is any movement in Guidance on longevity growth reserves as even ignoring the Covid years, the proposed improvement rate was not justified by the last decade or so’s experience leading to overly prudent reserving at outset.