Trustees warned to be vigilant before approving superfund deals

Speaking to Pensions Expert, Nicola Parish stressed the importance of employer covenant to a defined benefit pension scheme, and cautioned trustees to be prudent in their assessment of a transfer.

Consolidation vehicles like the Pension SuperFund and Clara Pensions have attracted widespread attention in recent months, promising a more affordable way for cash-strapped DB employers to relinquish their liabilities.

“I think that trustees should first of all be considering very carefully the fact that losing the support of the sponsoring employer is very significant and what the mitigation for that will be,” said Parish.

In what circumstances have you got enough money to pay for a superfund but not enough money to get any closer?

Hugh Nolan, Spence & Partners

Any trustee board mulling a transfer-in should be asking "what’s the level of scheme funding, what’s the level of benefits that could be paid out through the superfund, and what’s the comfort that there can be around the financial sustainability of that superfund for the future?”, Parish said.

Of course, opting for a ‘buyout-lite’ solution from a superfund might generate cost savings for an employer. However this did not feature among Parish’s tests; she said any decision should be made “with a view to ensuring that member benefits are protected”.

Regulator will be a key force

If its involvement in recent merger and acquisition activity such as GKN and Melrose Industries is anything to go by, it is likely the regulator will be proactively outlining its expectations of any deals to trustees before they are made.

“We were very clear in that situation with the trustees, with GKN and with Melrose, about our expectations of how the pension scheme should be treated in the event of a takeover, and that’s an example of being clearer but also being quicker,” said Parish.

In all, Parish’s words may not make trustees any more cautious about superfunds than they already are.

Hugh Nolan, director of consultancy Spence & Partners, said he could only imagine trustees waving through a proposal for a superfund transaction without the kind of caution mentioned by Parish if they were being unfairly pressured by their employer.

“Once you start looking at professional trustees or people who are a bit more diligent they’ll be very wary of a new product like this,” he said. “What trustee would possibly do that without a huge amount of extra due diligence?”

Given that superfund propositions seen so far are by definition less secure than insurance deals, trustees may have to test claims of affordability carefully.

“In what circumstances have you got enough money to pay for a superfund but not enough money to get any closer?” asked Nolan.

Weighing up a transaction

That makes covenant, or the employer’s ability to pay contributions into the scheme, a question of central importance for trustees weighing up a superfund transaction.

“The assessment of whether or not the transaction is covenant-enhancing will be complex and will involve quantitative and qualitative considerations,” said Darren Redmayne, managing director at Lincoln Pensions.

He agreed with Nolan that it would be hard to sign off on a superfund transaction for either an employer with a strong covenant or with a very weak covenant, and said any demand would be filled by those with a “middling” ability to support their scheme.

“I expect that in the coming weeks and months we will see out of the Pensions Regulator additional guidance and thoughts about how trustees want to think about transacting with consolidation funds,” he added.

Covenant advice should be public

The expectations of regulators and trustees may be such that it modifies the nature of the advice provided by covenant advisers, according to Redmayne. Given the finality of a transaction, advice that was previously confidential might have to be public, more akin to a fairness opinion in corporate finance.

“Covenant advisers will likely have to raise their heads above the parapet and be prepared to be exposed to public scrutiny and challenge on the advice that they’re giving,” he said.

Redmayne said covenant advisers are busily trying to glean details from propositions that are currently active. But with differing business models already present, each one will have to be checked with care.

That may give sponsors pause for thought as well, according to Craig Brown, institutional distribution director at Mobius Life.

“Will sponsors moving assets to a superfund ever be truly free of the liabilities? If things change in the future is there a risk that the regulator will come knocking on the former sponsor’s door?” he asked.