The importance of the Department for Work and Pensions (DWP) December 2018 Consultation on defined benefit (DB) pension scheme consolidation does not need to be stated. However, were there any doubt, the breadth and depth of the responses to the consultation, following its close at the beginning of February, underscore how critical the legal and regulatory framework for “superfunds” will be.

This blog explores some of the key proposals in what we consider to be the most critical areas covered by the DWP’s consultation, together with the feedback and proposals that the DWP has received in the respective responses of The Pensions Regulator (TPR), the Pension Protection Fund (PPF) and the Prudential Regulation Authority (PRA).

Superfunds as vehicles for DB pension scheme consolidation

Superfunds are consolidation vehicles – one of a number of options that may be available to companies and trustees looking to de-risk a DB scheme.1 Superfund consolidation is similar to an insurance buy-out in several important respects; principally, the liabilities are transferred away from the scheme and sponsoring employer, replacing the employer’s covenant with the superfund’s capital buffer. In most circumstances this breaks the link with the original employer, creating an important policy question of how best to protect the long-term interests of the members of the scheme.

Consolidation (in this and other forms) is likely to be of benefit to the employer, as well as having the potential to improve the availability and deployment of long-term capital in the economy as a whole. Consolidation also has the potential to benefit many current DB scheme members. Smaller DB schemes may struggle, for example, to operate efficiently, or may be practically unable to access more complex investment opportunities (including direct investments in real assets such as housing and infrastructure) that can otherwise be well-suited to a DB scheme’s investment horizon and liability profile. The employer covenant also carries risk, vis-à-vis the ongoing operation and solvency of the employer. This is eliminated, in theory, through the substitution of an appropriately-governed pool of buffer capital, although whether this, in fact, presents a net reduction in risk for the scheme members will depend on the pool’s permanence and strength of capitalisation as compared with the covenant of the predecessor employer.

An important “gap in the market”

These benefits are, of course, already available in varying degrees to those schemes that can access insurance buy-out or buy-in. Insurance provides a “gold standard” of security to members, backing pension obligations with capital set by the Solvency II insurance framework, and providing access to the Financial Services Compensation Scheme (FSCS) in extremis.

However, insurance is a more expensive proposition than many DB schemes can afford to fund, and it is, therefore, for less well-funded schemes that superfunds may offer the most benefit. The potential for the consolidation of such schemes to be in the best interests of the sponsoring employer, the scheme members, the superfund provider and its investors, as well as the economy at large, is spurring the current efforts to develop an appropriate legal and regulatory framework; facilitating the superfund market could prove to be “win-win” for all concerned.

However, the various consultation responses point to some substantially different ways of achieving these outcomes, illustrating the challenges that DWP is likely to face as it determines a policy approach.

Regulating superfunds

The DWP’s consultation covers, inter alia, the regulatory perimeter, minimum standards for authorisation and operation of a superfund (including governance and accountability, and financial sustainability), supervisory processes, and superfund transactions, of which the most important component is the “gateway” for the transfer of a DB scheme to a superfund.

Each of these topics is assessed in relation to alternative benchmark approaches of regulating superfunds as:

  • DB schemes, on the basis that they are, essentially, DB schemes with a capital buffer rather than an employer covenant; or as
  • insurance companies, recognising that the risks they acquire are fundamentally the same as those taken on by an insurance company.

In practice, the DWP’s preferred regulatory approach appears to be based on the DB pensions framework but with certain adaptations modelled on the Solvency II approach.2 Ultimately, these different approaches attract quite different, opposing views from the regulators responding to the consultation, with the PRA proposing a regime that is markedly closest to Solvency II.

Critical components of the future superfunds framework

We see the following issues as most critical to the future regulatory framework:

Financial security and sustainability, including internal models

The DWP describes the target funding level for superfunds as “arguably the most critical and difficult area”, and highlights a difficult balance to be drawn between “improved protection to members”, “reasonable affordability for employers” and “sufficient potential profitability to attract investment capital”. The PPF highlights that the cost of a superfund transaction (which is most directly driven by the strength of member protection) may mean that “it is unlikely that many of the schemes government is most concerned about, ie those with weak funding and sponsors, can get access [to superfund consolidation].” The PPF states clearly, however, that “the answer should not be to reduce the security of superfunds.”

The DWP will also need to consider how to measure against the objective it sets. This is likely to require modelling by either TPR or individual schemes, requiring TPR to develop a “standard” model for the sector, and/or evaluate bespoke models developed by individual superfunds.3 The experience of Solvency II demonstrates clearly the complexity of designing and operating such a regime, including implementing regulatory expectations for model risk management.

Distress triggers and the ladder of supervisory intervention

DWP proposes a ladder of triggers for intensifying supervisory action as follows:

  1. profit-extraction restricted;
  2. superfund closed to new schemes;
  3. fund business transferred to another superfund or wound up above PPF levels;
  4. finally, the scheme is wound up.

Calibrating these triggers turns on one of the most important policy questions facing the DWP, namely, what level of financial security a superfund should offer. This is closely connected to the level of risk that a superfund may pose to the PPF, recognising, of course, that a transferring DB scheme already presents a risk to the PPF, albeit one that is likely to be backed by an employer covenant.

The PPF proposes that the risk posed to it should drive the calibration of the triggers, requiring “a superfund to cease operating as soon as the risk of a claim on the PPF becomes too high”. TPR supports the DWP’s proposed tiers of intervention, but also draws attention to commercial considerations, noting, for example, that a profit extraction trigger “will need to balance protecting the capital buffer with the need for the superfund to attract investment capital in the first place”.

The challenge facing the DWP is to legislate in a way that provides adequate security for members. It is likely to be challenging for the DWP, as a matter of public policy, to determine and justify trigger points that target a lower level of financial certainty than already provided for insurance policyholders for substantially similar risks under the Solvency II framework.

The transaction gateway

The “superfund gateway” determines the conditions in which a DB scheme may transfer to a superfund,4 and therefore the factors that a scheme’s trustees should take into account when considering such a transfer. The DWP recommends that the gateway should be “principles-based”, and specifically that the transfer must “be based on evidence it enhances the likelihood of members receiving full benefits”. Further, DWP suggests that a superfund transfer should not be available to schemes that could afford insurance buy-out within the next five years.

Again, the gateway attracts a range of views. Most strikingly, the PRA recommends that the gateway should determine not just access at the point of transfer, but that consolidation should be considered only “as bridge to buy-out with an insurance company”.5 Consistent with this, the PRA recommends that profit extraction should be “constrained until the scheme has been safely bought out with insurance contracts.”

The PPF does not go as far as the PRA, but nonetheless recommends that “it would only be appropriate for a transfer to take place if there is a significant increase in security, so that the advantage offered by the consolidator is clear cut”, and further that “[t]here should be a presumption in favour of the status quo.”

As these various responses illustrate, superfund consolidation is very closely connected with insurance, and the two regulatory frameworks will need to interact with and support one another. The DWP is likely to need to work closely with the PRA on these interactions, in particular to minimise risks of regulatory arbitrage (to which the PRA draws attention in its response).

Senior management skills and accountability

The DWP proposes that a fit and proper persons requirement should apply to certain members of the senior management of superfunds, in common with other authorisation regimes. On this point, there is, unsurprisingly, relative agreement in the consultation responses.6 The PRA goes furthest, recommending that “the DWP mirrors more closely the full PRA and Financial Conduct Authority (FCA) requirements under the Senior Managers and Certification Regime”.

Scheme reporting and disclosure

The DWP devoted relatively little of its consultation to reporting for superfunds, although it did invite comment on whether superfunds should be required to produce regular public disclosure. TPR suggests that “consideration will need to be given to appropriate reporting requirements”, and proposes further work with DWP in the future. This may result in a significant variation between the reporting and, particularly, public disclosure, required of superfunds compared to the extensive reporting and disclosure requirements that Solvency II applies to insurers.

Role and powers of The Pensions Regulator

The DWP recognises that TPR must have “the right tools and powers to intervene when necessary”. Those powers will need to be determined as the regulatory framework develops. However, it is notable that a number of the policy approaches discussed in the consultation could require substantial new powers for TPR (for example, to evaluate scheme modelling of financial sustainability), which may require associated increases in regulatory resources and expertise.


The consultation illustrates the sensitive balance the DWP has to strike between, on the one hand, enabling the benefits superfunds can offer and, on the other, ensuring adequate member security and avoiding regulatory arbitrage with the insurance prudential regime. The DWP’s final policy determination, and the balance it strikes, will be critical to the development of the superfund sector, and hence of great interest to DB schemes, superfunds and other consolidators, and insurers operating in the DB industry.


1.Other options available to de-risk a scheme’s liabilities include insurance buy-out or buy-in. A scheme may also benefit from other consolidation options that retain the link to the sponsoring employer, for example a transfer to a DB master trust arrangement. These options (including superfund consolidation) may also be cumulative, for example a scheme may pursue an insurance buy-in or consolidation as a stepping stone to a later buy-out.

2. For example, the DWP discusses scheme-specific modelling of the funding strength of the scheme, based on a calibrated target level of confidence. The DWP and all respondents are agreed that the level of certainty provided to members by a superfund is lower than that provided by an insurance company, but whether the suggested 99% target is too high is a question on which there are differing views in the various consultation responses.

3. The PRA notes in its response, for example, that “[w]e have found that it is very important to have a robust approval regime in place to thoroughly review proposed models…We consider that such a robust approval regime should be put in place.”

4. The gateway is, therefore, closely connected to the triggers for supervisory intervention.

5. The PRA comments that “[a] prudentially sound framework would effectively prohibit transfer to a DB pension scheme consolidator where buy-out is feasible and where buy-out is required once the consolidation vehicle reaches buy-out level.”

6. TPR, for example, suggests that “[t]hose involved in running the superfund should be fit and proper persons.”