In the Government’s tax policy paper yesterday, the tax treatment of superfunds is an area that was mentioned in relation to defined benefit (DB) pension schemes.
Below, Simon Taylor, Partner at Barnett Waddingham, shares deeper analysis into ‘the superfund tightrope’ that the Government is walking in reviewing the tax treatment of superfunds. Simon also shares more detail on superfunds and how they work.
Written by Simon Taylor, Partner at Barnett Waddingham.
The Government is walking an extremely fine line as it begins the process of reviewing the tax treatment of superfunds. Any significant adjustment to the tax regime which reduces the returns that investors can make will either increase the price for transferring schemes, such that there’s no longer a clear incentive for schemes to move to superfunds rather than the insurance market, or discourage capital investors from entering the superfund market altogether.
The Government will also need to consider how it ensures consistent treatment for schemes which transfer now, before a permanent regime for the superfunds is in place – moving the goalposts would be perilous, unfair, and unwise. We estimate that two thirds of DB schemes would be able to afford a superfund transaction for their scheme in the next 10 years, but this could fall if drastic tax changes are made. The real question is whether the fiscal revenue will be worth the risk. Undermining the superfunds while their foundations are still being built would reduce the consolidation options available to schemes, which could do real damage when having a route to endgame is more important than ever.
What are superfunds?
DB superfunds aim to provide a way for employers to settle pension scheme benefits where buyout is unaffordable. Two DB superfunds are awaiting assessment by TPR:
- The Pension SuperFund – a run-off vehicle (i.e. where pensions are paid by the superfund until the last member dies)
- Clara-Pensions – a bridge to buyout (i.e. where a buyout transaction is targeted a certain period after the transfer)
How do they work?
The link to the employer is severed and the ‘covenant’ is provided by a capital buffer provided in part by the employer as part of the transfer, and in part by external capital backers. The superfund aims to make profit through economies of scale, member experience and investment returns, through which it can pay returns to its capital backers (with potentially some profit being paid to members in some models).
What clearance is needed?
Superfunds are subject to an interim regulatory regime. Clearance from TPR will need to be sought before a transaction can take place. TPR will consider the following “gateway principles”:
- Buyout now – transfer to a superfund should only be considered if the scheme can’t afford to buyout now.
- Buyout in future – transfer to a superfund should only be considered if a scheme has no realistic prospect of buyout in the foreseeable future, given potential employer cash contributions and the insolvency risk of the employer.
- Member security – transfer to the chosen superfund must improve the likelihood of members receiving full benefits.
Where might transactions come from
- ‘Funding sweet spot’ – a scheme must be well funded enough for the transaction to be affordable, but not so well funded that buyout is affordable within 3-5 years.
- External capital – third parties (e.g. private equity firms or overseas parents) could put up the cash needed for a transaction as part of M&A or restructuring activity
- PPF+ cases – schemes who are unable to secure full benefits with an insurer may be able to do so with a superfund