By Tom Hargreaves FIA Associate at Barnett Waddingham
This is merely the end of the beginning for the DB superfund market; in the coming months we will see the existing vehicles being granted authorisation, deals starting to be cleared and new entrants emerge. We will also see further input from TPR as the interim regime develops.
Whilst we now have a much better idea of how DB superfunds will be operating, this is only one side of the equation. Where is the demand for the superfund market going to come from, and what impact is the Covid-19 pandemic likely to have had on this?
The funding sweet spot
One scenario where superfunds should be attractive is where schemes are in a funding ‘sweet spot’; where buyout is not affordable, but a superfund transaction is. However, schemes that were previously in that sweet spot may no longer be there because:
the funding level fell following the market turmoil during March; and/or
the sponsor is no longer able to spare the cash to make the transaction feasible.
On the other hand, schemes that were previously considering buyout, but cannot now go ahead in the short- to medium-term for the same reasons, may see superfunds as a good alternative where sponsors are keen to settle benefits sooner rather than later. The pandemic has “helped” illustrate how volatile pension scheme funding can be, particularly for schemes with low levels of liability hedging. Despite potential difficulties in the short-term, particularly in terms of spare cashflow, this could prompt sponsors to try and bring forward their endgame plans and settle their pension risk once and for all.
Availability of capital
Superfunds might also be popular where external capital is available (e.g. from a purchaser or overseas parent) to settle scheme benefits.
This capital may now be harder to come by, but there are causes for optimism:
opportunistic investors will be on the look-out for cases where businesses look undervalued and hope to profit from their resurgence; and the disruption could prompt more corporate restructuring exercises, with pensions risk being dealt with as part of the process, particularly in light of Brexit concerns.
PPF cases
A further source of business for superfunds may well be distressed schemes, potentially as part of a ‘pre-pack’ administration process but also for schemes coming out of PPF Assessment and looking to secure benefits (at “PPF+” levels) in the insurance market.
We may well start to see an increase in claims on the PPF resulting from the pandemic as Government support begins to fall away, albeit it will take time for schemes falling into PPF Assessment now to be ready for a PPF+ transaction if that is their outcome.
In theory, superfunds should be able to secure a higher level of benefits for a given level of assets than can be secured in the insurance market, though this difference will be more significant for some schemes than others. There are a number of reasons for this, but fundamentally it comes down to the level of risk; based on the interim regime superfunds are subject to lower capital requirements than insurance companies, and are able to price more attractively as a result.
It may therefore be possible for a scheme to secure full benefits with a superfund despite this not being possible in the insurance market. Trustees will have different views on whether the difference in benefits is appropriate given the additional risk being taken, but it is certainly something worth considering.
However, the number of schemes that could secure full benefits through a superfund in this scenario could be small, as securing 100% of original scheme benefits with a superfund is still likely to require a scheme to show a considerable surplus against PPF benefits. At present, the legal difficulties associated with targeting less than the full scheme benefits would make a transaction very complex. This is not directly addressed by TPR’s guidance and is something that could feasibly change as the market develops and transactions begin to take place.
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