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LCP Reaction -
DWP Defined benefit pension scheme consolidation

7 December 2018

Today the DWP released it’s much awaited consultation regarding the regulation of defined benefit (DB) pension scheme consolidation vehicles, known as “superfunds”. As expected, the consultation suggests a new style of regulation for occupational DB schemes, which is more akin to firms authorised by the Prudential Regulation Authority (PRA) than a simple extension of the regime that applies to occupational pension schemes.

Subject to the outcome of the consultation, it appears that the new superfund authorisation regime is essentially “Insurance Company Light” regulations, rather than a mere strengthening of the current DB regime enforced by The Pensions Regulator (TPR). This follows the approach adopted for DC Master Trusts, which again was a very different style of regulation to that seen in the past from TPR.

A huge difference, however, between regulating Master Trusts, which are Defined Contribution (DC) in nature and superfunds, which are DB in nature, is that detailed actuarial projections are required to monitor DB arrangements. This is because future projections on asset returns and benefit payments will be required and there is significant judgement required in deciding what assumptions are appropriate. This will no doubt be a key area to be discussed in the consultation responses.

One area that is essentially absent from the consultation is the ability for pension schemes, including superfunds, to simplify pension scheme benefits. It appears that the DWP have missed a trick in not providing for rules that would provide much needed simplification to the DB pension landscape. This might also have made the DWP’s stated aim of seeing the many smaller DB pension schemes in the UK market transfer to a consolidator more achievable.

We expect the existing consolidation vehicles to welcome many aspects of the new consultation – having a clearer regulatory regime will give Trustees and Companies the confidence that they need to make transfers into these arrangements. Indeed, TPR has issued clear guidance on its website about what it expects from both trustees and companies before entering into a transaction with a consolidator and that will be welcome for all parties involved in future transactions. Historically, the pensions industry has been slow to adopt new ideas, and clarity on what is required under the new regime will be helpful in preventing inertia.

One point made in the consultation is that Companies and Trustees will want to consider whether a suitable long-term objective would be to specify a date by which a scheme may be able to transfer into a superfund. This thinking is not new, as it mirrors the thinking that was set out in the DWP Green paper in March 2018 although it was not picked up by many commentators at the time.

There is a proposal to have a new “Gateway” through which a scheme needs to pass in order to be eligible to transfer to a consolidator. This Gateway approach will prevent those pension schemes that could transact a buy-out with an insurer in the foreseeable future from transacting with a consolidator. The consultation envisages that the foreseeable future is around 5 years, although we would expect that element to be queried in the consultation process. In particular, we will be looking for clarity over what is required to be considered in each case – ideally including some flexibility in the rules to consider the unique circumstances of each scheme and their sponsor, rather than just prescriptive rules.

Alex Waite, partner at LCP, said: “There is a fine balancing act for the regulators to achieve here: the level of confidence provided by the financial covenant of a superfund needs to exceed that provided by the current employer; however, the consultation explicitly states that superfunds will not be required to provide the same level of confidence as an insurer. Whilst the consultation talks of a ‘99% confidence level’ there is much work to do to work through the practicalities of how such a calculation would be performed. If the balance is not struck correctly, then the consolidation market will not be able to provide a much needed alternative vehicle for DB pension schemes.

Looking to the future, the superfund regime could form a basis for all DB occupational pension schemes at some future date other than where buyout is a realistic short term target. This means that the consultation could ultimately become relevant to all trustees and companies that sponsor DB pension schemes.

LCP will be responding to the consultation by the deadline of 1 February 2019 and we would encourage all trustees, and sponsors of DB occupational pensions schemes to consider doing the same.