PPF chief hints at closing superfunds’ regulatory advantage

Grilled by the Work and Pensions Committee on Wednesday about the protections needed to avoid new superfunds exploiting the occupational pensions framework, Oliver Morley said his main priority was to ensure that commercial ventures pay an appropriate levy for the risk they pose to the system.

The UK’s defined benefit sector is highly fragmented compared to other countries – some 5,588 schemes managed £1.58bn at the end of March, according to the PPF’s 7800 Index.

But while many in the pensions industry agree on the need for consolidation, superfunds offering a cheaper alternative to insurance via bulk annuities have sparked concern.

Typically they won’t be as well funded as insurers and will be more risky than insurers

Jon Hatchett, Hymans Robertson

“We’re concerned that the right protections are in place for that funding covenant,” said Morley. “It’s very important to us that this is not an opportunity simply for schemes to transfer risk onto members… we want to make sure that risk is shared in the right way.”

The PPF is limited in its powers to influence pension scheme strategy, relying on the Pensions Regulator as its guardian. But it can set levies for schemes that reflect the risk it is exposed to, and Morley and his team seem determined to do so for consolidators.

“We would obviously want to make sure that the levy that was applied reflected the level of risk and collect accordingly,” Morley told MPs.

The lifeboat fund may also lean on the regulator and Department for Work and Pensions to impose extra restrictions, he hinted.

“We would hope and expect that the regulator was really focused on ensuring there is a really strong funding covenant… which had to a certain degree some of the protections that you might, for example, have in an insurance buyout,” he said.

PPF protection may be inevitable

Steve McCabe, MP for Selly Oak and a member of the select committee, questioned whether profit-seeking bodies were even appropriate for inclusion within occupational regulations.

“Why should a scheme like The Pension SuperFund be eligible for PPF protection, and why should the PPF and people paying the levy be effectively underwriting what is a commercial, profit-making venture?” he asked.

Unless the laws surrounding pensions are modified, Morley explained that regulators may have no choice but to afford superfunds PPF protection.

The “way a superfund would be designed could effectively mean that it is automatically legally compliant with the legislation and therefore would be eligible for PPF funding”, he said.

Insurers point to member risk

Morley’s comments will only go so far to placating an insurance industry that is crying regulatory arbitrage, and has argued that any reduction in the cost of employers removing their DB liabilities simply means an increase in the risk to members.

“Certainly some of those measures would mitigate the extent to which there was an opportunity just simply to arbitrage between two different regulatory regimes,” said David Collinson, head of strategic development at the Pension Insurance Corporation.

However, he pointed out that alongside the prudence built into pricing, member security in the insurance world is protected by intense regulatory oversight, involving teams dedicated to surveying individual companies, which may also have to be replicated by the Pensions Regulator.

Yvonne Braun, director of policy on long-term savings and protections at the Association of British Insurers agreed that a hefty levy alone “does not cut the mustard.”

“The PRA [Prudential Regulation Authority] is the only regulator with the expertise to robustly regulate profit-making ‘Superfunds’ and protect scheme members’ benefits,” she added.

Collinson maintained that a superfund would have to take more risk than an insurer to offer a better price, especially given the difference in scale between the fledgling propositions and the insurance giants.

“In principle we should be charging less than a superfund,” he said. “So where’s the difference, how could a superfund offer an employer a cheaper way out?”

However, some commentators feel that a riskier option than buyout may be needed for poorly funded schemes, for whom buyout is so far into the future that they are painfully exposed to their employer’s shaky covenant.

Jon Hatchett, a partner at consultancy Hymans Robertson, called the increased risk “part of the quid pro quo” for schemes to consider.

“Typically they won’t be as well funded as insurers and will be more risky than insurers,” he added, estimating that superfunds looking for business were quoting between 80 to 90 per cent of the cost of a buyout on average.

Superfunds are not for every scheme

The question is then for which schemes a superfund solution is appropriate. Hatchett maintained that it should not be a consideration for schemes nearing buyout anyway, and could not be for those poorly funded schemes for who either option would require a significant increase in funding.

“There’s a layer underneath them where actually buyout feels quite distant but a superfund feels quite close,” he said, adding that covenant advice will be instrumental in weighing the employer’s strength against the security offered by the superfund and an increased funding level.

Hatchett also questioned the PPF’s focus on using the levy as a deterrent, and encouraged the regulator and DWP to focus instead on governance.

“I’d expect most schemes transferring to a superfund to have a healthy PPF surplus,” he said. A robust regulatory regime would ensure that companies wind up before their funding levels pose a threat to either members or the PPF.