Andrew Grime, Partner, Aon
The past year has seen a huge improvement in funding levels for the majority of UK pension schemes, with many now re-assessing their endgame. The best funded have the luxury of either targeting an insurance transaction, or alternatively looking to ‘run-on' to generate surplus to share with members and the sponsor.
But what about those schemes who, despite improvement to their funding levels, still need a helping hand to reach their endgame target?
This is where alternative risk transfer solutions - such as superfunds and capital backed funding arrangements - could help. Not only will some schemes now find themselves sufficiently funded to properly consider these solutions for the first time, but the past year has also seen notable developments in these alternatives to bulk annuities.
Superfunds
Essentially, superfunds are defined benefit (DB) pension schemes that accept bulk transfers of assets and liabilities from other DB schemes. Following a superfund transaction, the responsibility of the original company to support the pension scheme is removed, and support is instead provided through additional assets (the ‘capital buffer') that are provided by the superfund's investors.
Clara-Pensions is currently the only superfund within the UK (after a five year journey successfully negotiating regulatory and practical hurdles). It completed an approximately £600 million transaction with the Sears Retail Pension Scheme earlier this year. Clara has indicated its ambition is to build up to managing around £5 billion of pension scheme liabilities by 2025, with pricing for non-pensioner members expected to be broadly 15 percent cheaper than the traditional insurance market.
Is a superfund right for my scheme?
Typically, superfunds are likely to appeal to schemes which are relatively well funded (or could be with a one-off contribution), but where the sponsor covenant is weak and may not be able to support the scheme through to a traditional buy-in over a short-term period. Indeed, The Pensions Regulator has introduced gateway tests to ensure that schemes that wish to pursue a superfund meet these criteria.
Capital Backed Funding Arrangements
Capital Backed Funding Arrangements (CBFAs) are a solution by which a third party provides additional capital to protect a scheme against adverse experience. Unlike superfunds, the assets and members remain in the pension scheme, with the existing trustees retaining their responsibility. The added capital protection supports the scheme's journey to a pre-agreed funding target, over a pre-agreed timeframe and using a pre-agreed investment strategy.
If the CBFA goes to plan, the provider expects to have its capital buffer returned along with a share of the returns in excess of the funding target. If the funding target is not met, the capital buffer is used to top-up the scheme assets. The funding target is typically buyout, but some providers offer flexibility to target a specific investment return above liabilities.
The last 12 months saw Pension SuperFund ‘mothball' its superfund proposition until relevant legislation or regulator guidance is in place. However, its backers (PSF Capital), launched a CBFA known as CovenantPlus. This led to its first transaction for an undisclosed scheme, joining Aspinall as the only two providers known to have completed a CBFA. However, an increasing number of providers are entering the market and are keen to explore opportunities to deliver CBFAs for pension schemes.
Is a CBFA right for my scheme?
CBFAs can be designed flexibly to target schemes' specific circumstances. Ultimately, the additional capital provided can:
- Reduce downside risk from a higher return investment strategy - this might be appropriate for schemes which are willing to exchange some potential upside of a higher risk investment strategy to reach buyout sooner, or with more certainty over the time to reach buyout
- Provide additional security on the scheme's journey, reducing the chance of the scheme calling upon the sponsor for future contributions and increasing the chance of members being paid benefits in full. This might be appropriate for schemes seeking to reduce reliance on the sponsor.
In all cases, the downside protection is typically limited to the agreed amount of capital buffer (although the CBFA provider could choose to top this up). The sponsor remains responsible for tail-risks, with schemes needing to weigh up the benefit of additional capital against the risk of passing control of the investments and journey timescales to the CBFA provider.
Navigating the options
The increasing range of support is a welcome development for many schemes. The challenge for trustees and sponsors is understanding which of these options might be the most suitable for their specific circumstance and assessing the associated risks and rewards.
At Aon, we can help you understand these solutions, assess whether they could help deliver your objectives and where appropriate, support you through the process. For further information about alternative risk transfer options, please speak to your usual Aon contact or email [email protected]
