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Superfunds – Solving the DB funding crisis

Chris Baker

Market Evangelist

discusses superfunds

8 November 2017

The last year has seen an increased focus on Defined Benefits (DB), with a plethora of reports and recommendations seeking ways to solve the funding crisis in this sector. The fundamental DB issue is the mismatch of total investments against future liabilities. Schemes are, in general, underfunded. The Pensions and Lifetime Savings Association (PLSA) task force highlights that millions of savers have only a 50/50 chance of having their pensions paid in full. Something needs to be done.

'Superfunds' is the current hot idea from the PLSA, and is receiving support from other industry luminaries.

But are superfunds the answer to the DB funding crisis? Not completely.

Would they be a positive addition to the DB landscape? Quite probably.

Taking a common-sense and simple view of DB schemes, there is, in reality, only a small number of actions that a sponsoring employer and trustees can take to address a funding shortfall. Short of mass poisoning of the members, the following options exist:

  1. Pay in more money until the funding position improves.
  2. Improve investment returns by achieving higher growth and/or reducing running costs.
  3. Reduce the benefits payable to scheme members.
  4. Pay money to a life company or re-insurer to de-risk some or all of the future liabilities.

In addition, the Pension Protection Fund (PPF) exists as the safety net for those employers that fail financially and cannot successfully implement any of the above actions. The PPF already supports a quarter of million members, but does not pay out the full level of benefits initially 'promised' by the employer.

The PLSA's idea of a superfund contains elements of options 1, 2 and 3. One objective is very straightforward: by merging many small schemes into a single entity, significant economies of scale are achievable, with lower fund fees, more efficient administration, (which requires more automated and scalable administration technology), and simplified benefit structures and governance. More complex is the proposal that a superfund would be allowed to 'water down' pension benefits, with an objective to pay full benefits only 90% of the time. Employers would still have to pay to pass their liabilities into a superfund, much as they do with current de-risking, only at a lower premium because of the allowable reduction in benefits, while the superfund itself would be a full commercial entity, with capital at risk much like a life insurer. Superfunds would also have a social element, being able to invest in major infrastructure projects benefitting the wider economy.

We can already see a version of superfunds working in practice within the Local Government Pension Scheme (LGPS), a multi-employer, multi-fund scheme with assets of over £200 billion. Eight pooled funds are now in place across the 89 English and Welsh LGPS Administering Authorities, with most initially focused solely on achieving investment economies of scale. The closest to the PLSA vision is undoubtedly the Local Pensions Partnership (LPP), which is actively managing its pension schemes across the board, delivering scale efficiencies in administration, stronger management of its employers' funding positions and improved investment returns, with very positive results already in improving funding positions. It is not, of course, allowed to de-risk, nor to change scheme benefits, but in all other aspects is an excellent example.

One option is for new entities, similar to LGPS Pooling, to set up as new superfunds in the private sector. It might be good to engender competition in that way but, equally, we already have entities doing very similar things. Superfunds sit on the spectrum between the PPF and full de-risking providers. A scheme moving into the superfund is effectively taking a 'gold star' version of the standard PPF proposition or a 'de-risking lite' solution in comparison to a buy-in or buy-out option. Logically therefore, the industry solution could see life companies widening their de-risking propositions, with cheaper products that reflect the relaxing of the benefit guarantee, or the PPF being enabled to take on board a second tier of schemes with a 'better than current PPF standard' promise to pay future benefits.

In reality, were superfunds to come into being, we might well see all existing types of business compete in this middle ground – new specifically-created commercial superfunds, de-risking providers and even LGPS 'pools' such as LPP or the PPF stretching more into the commercial sector. In principle, all of these entities do much of what is required for the proposed superfund model:

  • Scale efficiency to reduce costs
  • Strong financial management of the investments to improve returns
  • Good and efficient governance
  • Financial strength to meet the future pension commitments
  • Socially responsible supporting investments in UK infrastructure

With an estimated £2 trillion of assets in DB schemes and only £150 Billion already de-risked, there is a huge market demand and opportunity, one which should be very attractive to existing players and which may further encourage new entrants into the DB/de-risking sector.

Chris Baker is Market Evangelist at Aquila Heywood, the largest supplier of life and pensions administration software solutions in the UK.

Further Reading