Financial regulatory framework for superfunds: Report on superfund modelling as at 31 December 2022
Published 6 June 2025
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Executive summary
The Government Actuary’s Department (GAD) have completed stochastic modelling to investigate an approach to funding and regulating superfunds. The work was commissioned by the Department for Work and Pensions (DWP) to support its response to the 7 December 2018 consultation: “Consolidation of defined benefit pension schemes” (the 2018 Superfund Consultation) (Note 1).
The 2018 Superfund Consultation set out that the proposed authorisation regime will assess whether a superfund has a viable business model, is financially sustainable, is well governed, and has a high probability of being able to pay members’ benefits as they fall due. It listed a number of questions about specific aspects of the policy, and asked for comments on what suitable level of parameters to assess these criteria would be.
The main purpose of the GAD modelling was to assess possible regulatory parameters to determine whether a suitable authorisation regime might meet the superfund policy objectives. The GAD modelling involved analysing an example modelled superfund, designed to represent a typical superfund structure to ensure wide applicability. This model fund was tested against a range of Technical Provision (TP) discount rates and profit triggers and a selection of possible investment strategies to determine expected outcomes. The modelling was calibrated against market conditions and buyout prices as at 31 December 2022. We would be happy to discuss updating the modelling to current market conditions.
To model outcomes, we assumed that the long-term objective for the superfund scheme is to reach a buyout level of funding when most non-pensioners have retired and for the superfund scheme to buyout when this target is reached. We modelled particular assumed rates of return, but individual investors will have their own target returns which could impact on the commercial viability.
The modelling illustrates the trade-off between the superfund policy objectives for affordability, security, and commercial viability. For example, the lower the risk of failure of the superfund, the greater the cost and/or the lower the commercial viability, and vice versa.
The actual cost of entry to a superfund, or to complete a buyout, is subject to many factors including economic conditions and competitive pressures which will vary over time and between providers. Therefore, the modelling can only provide a broad indication of the cost of superfund entry relative to buyout. Furthermore, the consultation anticipates a range of regulatory intervention points that would trigger action if superfund finances deteriorated. The modelling does not allow for any actions that might occur from direct regulatory intervention, such as TPR demanding a failing superfund is wound up or transferred to another superfund.
Assessment of modelled outcomes
| Discount rate | Gilts plus 0.5% pa | Gilts plus 0.5% pa | Gilts plus 0.5% pa | Gilts plus 0.75% pa | Gilts plus 0.75% pa | Gilts plus 0.75% pa | Gilts plus 1.0% pa | Gilts plus 1.0% pa | Gilts plus 1.0% pa |
|---|---|---|---|---|---|---|---|---|---|
| Profit-taking requirement | 125% of ACR (Note 2) | 125% of ACR | 125% of ACR | 150% of ACR | 150% of ACR | 150% of ACR | 175% of ACR | 175% of ACR | 175% of ACR |
| Modelled investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| Security Modelled failure rate (Note 3) | 1.1% | 2.5% | 1.6% | 1.7% | 3.1% | 1.9% | 2.0% | 5.3% | 3.5% |
| Affordability Modelled price (% buyout) | 94% | 95% | 96% | 93% | 95% | 95% | 92% | 93% | 93% |
| Viability Modelled return-on-capital | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa |
Note 2: ACR is the Authorisation Capital Requirement
Note 3: Modelled failure rate is over the whole lifetime of the superfund
The modelling broadly supports the superfund policy objectives, albeit based on a particular investment strategy with specific risk and return characteristics. However, it is likely the regulatory requirements will need to be specifically configured to the approach taken for investments and the long-term objective to ensure sufficient member security for approaches with different asset allocations.
The modelling suggests a TP discount rate of around gilts plus 0.75% pa and a profit trigger of 150% of the Authorisation Capital Requirement may come closest to achieving the superfund policy objectives, balancing superfund viability and a reasonable cost of entry against a controlled risk to members’ benefits from superfund failure. The modelling indicates this approach has an assessed cost of around 93%-95% of buyout, with a risk of superfund failure of around 2% (depending on investment strategy), albeit there is a range of plausible outcomes.
DWP will need to take a view on suitable levels of risk and affordability levels it is prepared to support in the authorisation framework, and should consider appropriate levels of controls within this framework to ensure it can operate effectively. For example, the consultation suggested that a 99% probability of superfunds paying full benefits might be achievable – our modelling suggests that a level closer to 98% is more realistic.
The assumptions and methodology set out in this report are appropriate as at the date of calculation, 31 December 2022. The outcomes should be considered within the context of the economic position as at that date. Any changes or movements in economic conditions since this date have not been factored into the modelling or analysis. One key driver of the affordability of the modelled superfund (relative to buyout) is the additional yield on credit investments above gilts. If this additional yield is lower than at the modelling date (as has been the case in the recent past) it is likely to make the modelled superfund price closer to buyout, for the same amount of risk.
When establishing a suitable regulatory framework, the framework should be designed to be robust to such changes in market conditions over time. We would be happy to advise DWP on the impact of varying the different elements of the regulatory framework at the same time as updating the modelling to current market conditions. Please note however that market conditions are currently particularly volatile and the future outlook remains uncertain.
Introduction
The Government Actuary’s Department (GAD) completed stochastic modelling to investigate an approach to funding and regulating a superfund. The work was commissioned by the Department for Work and Pensions (DWP) to support its response to the 7 December 2018 consultation “Consolidation of defined benefit pension schemes” (the 2018 Superfund Consultation) and its subsequent response. (Note 1)
The GAD modelling involved analysing an example modelled superfund, designed to represent a typical superfund structure to ensure wide applicability. This model fund was tested against a range of Technical Provisions (TP) discount rates and profit triggers and a selection of possible investment strategies to determine expected outcomes. The modelling was calibrated against market conditions and buyout prices as at 31 December 2022.
Common expressions used in pensions are in bold the first time they appear in the body of this report, and are defined in a glossary of terms at the end of the report.
We make no recommendations or actuarial judgement regarding the regulatory requirements or long-term objective for superfunds. These were matters set out by DWP in the 2018 Superfund Consultation and its response.
This introduction sets out relevant background to the report. It includes basic information on the approach as well as drawing attention to some important points to make about the modelling. The rest of the report is set out as follows:
- Results of the modelling: sets out the results of the modelling as well as sensitivity analysis to explore some of the risks facing the example modelled superfund and the potential impact of varying some of the assumptions on the outcome of the modelling.
- Compliance statement and limitations: an important section as it sets out in more detail the modelling limitations.
Further detailed information is included in the Appendices.
Key elements of the 2018 Superfund Consultation
The modelling and this report are intended to support DWP’s response to the 2018 Superfund Consultation. Key assumptions that are reflected in the modelling approach are:
- Superfunds will have the flexibility to set their own long-term objective and therefore the way in which benefits are provided and profits distributed; however, they will need to state clearly their long-term objective so that Trustees of schemes transferring to a superfund will have clarity on the “end-game” and what this might mean for the security of members’ benefits. We set out below the specific long-term objective assumed for this modelling (see “The example modelled superfund” section below).
- There will be a common test applied to all superfunds for authorisation, profit-taking, and if necessary for regulatory intervention. The test will set the Technical Provisions and capital requirements for a superfund so that it can expect to remain solvent in nearly all scenarios. For this purpose, a superfund would need to have sufficient assets to allow it to continue as a scheme without a significant sponsor. The TPs are based on a best estimate of the liability cash flow with an allowance for expenses and a longevity risk margin. The impact of 3 different discount rates (gilts + 0.5%, +0.75%, +1.0% pa) is modelled. The capital requirement for authorisation will be based on a 1-in-100 one-year event. A stricter test is proposed for the profit trigger based on a multiple of the authorisation capital requirement (ACR). The likelihood of superfund failure resulting from different profit triggers (expressed as multipliers to the authorisation capital requirement) forms part of this review.
DWP also set out two triggers that will determine when regulatory action may be required for a failing superfund:
- “Level 1” trigger: the level of funding at which “any remaining funds in the capital buffer are tipped into the scheme assets, under full control of the superfund Trustees, and the section or superfund would be allowed to then run on without a substantive sponsor or to transfer liabilities to another superfund, if such a transfer is available.
- The winding-up trigger: determined using a PPF valuation of pension liabilities. The trigger will be set above the PPF level of funding to protect the PPF. Upon hitting the trigger, the superfund scheme will be wound-up and members either transferred to the PPF or an insurance company if a higher level of benefits compared to PPF compensation can be bought out.
The winding-up trigger will ultimately determine when a superfund fails and is used in the modelling to determine the likelihood of failure. We also look at the likelihood of a “Level 1” trigger as this, too, will be of interest to policy makers and regulators.
The main purpose of this modelling is to assess the impact of adopting different TP discount rates (expressed as a margin above gilts yields) and the level of profit trigger (expressed as a multiple of the ACR) that form part of the proposed regulatory requirements. These are two important factors that will have a bearing on whether superfunds will meet the superfund policy objectives set out in the 2018 Superfund Consultation for security and affordability, whilst still allowing superfunds to remain commercially viable.
The example modelled superfund
The superfund’s long-term objective is an important factor in the proposals affecting its likelihood of meeting the superfund policy objectives. It was therefore necessary for GAD to set a long-term objective for an example modelled superfund and then to design such a superfund to achieve it. The long-term objective chosen for the example modelled superfund in discussion with DWP was for the superfund scheme to reach a buyout level of funding when most non-pensioners in the example modelled scheme have retired.
We make no recommendation or suggestion as to how a superfund should be set up in practice. The example modelled superfund is a theoretical construct designed to test the proposals set out in the 2018 Superfund Consultation and its response.
Although the 2018 Superfund Consultation response did not mandate a long-term objective to buyout, this nevertheless underpins the objective of the example modelled superfund. We assume that once the superfund scheme reaches a buyout level of funding, the Trustee of the superfund will buyout. We therefore treat this as a successful outcome in the modelling and assume the superfund is no longer a risk to the PPF. However, we look at the impact of extending the long-term objective on the modelled likelihood of superfund failure, for a superfund intending to run on for a longer period.
The example modelled superfund scheme starts with a level of funding typical of a current defined benefit scheme to facilitate an ordinary bulk transfer of members from their transferring scheme to the superfund scheme. We then model an increase over time in the scheme funding requirement for the superfund scheme as it moves towards meeting the long-term objective. This ensures that the superfund scheme will comply with a Scheme Funding requirement to reach a low dependency funding level after a certain period. Chart 1 overleaf illustrates the increase in the scheme funding requirement over time and that it is expected to eventually exceed the cost to buyout the scheme.
Chart 1: Scheme funding target relative to buyout
The aggregate of TPs and capital requirements set the overall level of funding for the superfund. At outset, it is assumed the sponsor and investors fund the capital buffer so that scheme assets and capital buffer together meet the authorisation requirements. The capital buffer is the capital over and above the assets required to cover the expected cost of providing the scheme benefits. Similarly, for the superfund to pay profits, the aggregate of superfund scheme assets and the capital buffer would need to meet the profit requirements. This structure is illustrated visually in Chart 2.
Chart 2: illustrating the regulatory requirements
Having designed the superfund scheme to meet the long-term objective we then modelled different approaches for the TPs and profit taking according to the proposals for assessing financial adequacy of superfunds. To do this we looked at the impact of different TP discount rates (gilts + 0.5%, +0.75%, +1.0% pa). We also looked at different levels of profit trigger based on multiples (125%, 150%, 175%) of the ACR.
As different approaches have been looked at for assessing TPs and profit trigger, we have set a measurement basis against which the different approaches can be more easily compared. This is helpful to understand the relative difference in the level of funding and capitalisation in each case.
Defining a measurement basis
Throughout this report we use a gilts-based liability (GBL) as the measurement basis for comparing different requirements. This is intended to be consistent with the authorisation basis detailed in the 2018 Superfund Consultation. The GBL is based on the same liability cash flows as the regulatory TPs; however, the discount rate used to calculate the GBL is based on an unadjusted gilt-yield curve. For the avoidance of doubt, the GBL does not include a reserve for member expenses or longevity risk.
Modelling approach
The modelling approach maintains consistency between buyout pricing and the superfund scheme’s winding-up trigger that is based on the scheme’s PPF liabilities. The PPF liability is based on published assumptions at the calculations date and buyout is based on similar, albeit slightly more conservative, assumptions. Between the 2018 consultation being published, and the December 2022 effective date for the modelling this report, buyout prices have fallen, primarily due to an increase in gilt-yields.
The modelling is intended to inform the broad parameters that might apply to a framework for regulating the financial adequacy of superfunds as set out by DWP in its response to the 2018 Superfund Consultation. It has been calibrated against market conditions and other factors affecting buyout prices as at 31 December 2022.
When establishing a suitable regulatory framework, it should be recognised that market conditions will change regularly over time which will affect modelling outcomes carried out at any particular date. Accordingly, any framework should recognise and reflect this, and be designed to be robust over time. We would be happy to discuss updating the modelling to current market conditions.
Results of the modelling
Setting the modelling objectives
We include further detail of the modelling approach and objectives in the Appendices.
The GAD modelling illustrates the trade-off in the superfund policy objectives for affordability for sponsors, security for members, and commercial viability for investors:
Affordability: the modelled cost to the sponsor of settling its pension liabilities. This includes the assets in its scheme that are transferred to the superfund, and the top-up to the capital buffer required from the sponsor. Making superfunds more affordable makes them less secure and/ or less viable.
Security: the modelled likelihood of a superfund failure for members. Failure is defined as when the aggregate superfund assets fall below the superfund winding-up trigger proposed in the 2018 Superfund Consultation and members are either transferred to the PPF or reduced benefits secured with an insurance company if these exceed PPF levels of compensation. This is measured over the full future lifetime of the superfund. Making superfunds more secure makes them less viable and/ or less affordable.
Commercial viability: the modelled annual future profits emerging from the superfund for investors. These are discounted at the assumed Return-on-Capital (RoC) to estimate the amount of capital to be provided by the investors. The sponsor is then assumed to top-up the capital buffer for the superfund to meet the authorisation requirements. The sponsor’s share of the capital buffer is included in the cost calculation used to assess affordability. Making superfunds more viable, that is attractive to investors, makes them less affordable and/ or less secure.
DWP asked GAD to assess the outcome of the modelling against the superfund policy objectives discussed in the 2018 Superfund Consultation for affordability and security, and a superfund policy objective for commercial viability that would encourage a dynamic superfund market. An assumption was therefore made for an appropriate RoC (12.5% pa) for investors to achieve this. We appreciate that different investors will have their own requirements for targeted return on capital and 12.5% pa may be considered to be at the lower end of the range of viable returns. We cover this further on page 41.
Assessing outcomes relative to objectives
DWP asked GAD to compare modelled outcomes for each of the superfund policy objectives on a traffic light basis:
The parameters chosen to assess the relevant objectives are as follows:
| Objectives for the relevant parties | Green | Amber | Red |
|---|---|---|---|
| Affordability for sponsors - Cost relative to buyout | < 91% of buyout | 91-93% of buyout | > 93% of buyout |
| Security for members - Likelihood of superfund failure | < 1% modelled superfund failure rate | 1-3% modelled superfund failure rate | > 3% modelled superfund failure rate |
| Commercial viability for investors - Return-on-capital | > 24% pa | 12-24% pa | < 12% pa |
Modelling of results against the superfund objectives
Initial modelling
Table 1 sets out the results of the modelling assessed against the superfund policy objectives. These results assume a TP discount rate of gilts plus 0.5% pa (consistent with the funding parameters TPR were consulting on in 2020) with various levels of profit trigger. This illustrates that under this approach, it appears that superfunds would be too expensive to achieve the desired superfund policy objectives of having a viable business model, whilst being financially sustainable and having a high probability of being able to pay members’ benefits as they fall due.
TPs based on gilts plus 0.5% pa
Table 1: Assessment of initial modelled outcomes - TPs based on a gilts plus 0.5% pa discount rate
| Approach to profit-taking | 175% of ACR | 175% of ACR | 175% of ACR | 150% of ACR | 150% of ACR | 150% of ACR | 125% of ACR | 125% of ACR | 125% of ACR |
|---|---|---|---|---|---|---|---|---|---|
| Modelled investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| Security - Modelled failure rate | 0.5% | 1.9% | 0.9% | 0.7% | 1.9% | 0.9% | 1.1% | 2.5% | 1.6% |
| Affordability - Modelled price (% buyout) | 96% | 97% | 97% | 95% | 97% | 97% | 94% | 95% | 96% |
| Viability - Return-on-capital | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa |
Impact of modelling alternative discount rates
To understand the potential impact of changing the TP discount rate we show alternative sets of modelled outcomes in Tables 2 and 3. They are based on a TP discount rate of gilts plus 0.75% pa and gilts plus 1% pa respectively. They also illustrate the same levels of authorisation and profit-taking capital requirements relative to TPs as for the initial modelling.
TPs based on gilts plus 0.75% pa
Table 2: Assessment of alternative modelled outcomes - TPs based on a gilts plus 0.75% pa discount rate
| Approach to profit-taking | 175% of ACR | 175% of ACR | 175% of ACR | 150% of ACR | 150% of ACR | 150% of ACR | 125% of ACR | 125% of ACR | 125% of ACR |
|---|---|---|---|---|---|---|---|---|---|
| Modelled investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| Security - Modelled failure rate | 1.0% | 2.9% | 1.3% | 1.7% | 3.1% | 1.9% | 3.1% | 4.8% | 3.0% |
| Affordability - Modelled price (% buyout) | 94% | 95% | 95% | 93% | 95% | 95% | 92% | 93% | 94% |
| Viability - Modelled return-on-capital | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa |
In the case of a TP discount rate of gilts plus 0.75% pa, a PTCR ratio of 150% of the ACR might be considered as best meeting the superfund policy objectives, especially investment strategy 1, which has 3 amber ratings. However, a PTCR ratio of 175% of the ACR, may also be deemed a sensible approach since the modelled price only marginally increases and the failure risk reduces materially. That said, security and affordability might still be stretched for the riskier investment strategies.
Ps based on gilts plus 1% pa
Table 3: Assessment of alternative modelled outcomes - TPs based on a gilts plus 1.0% pa discount rate
| Approach to profit-taking | 175% of ACR | 175% of ACR | 175% of ACR | 150% of ACR | 150% of ACR | 150% of ACR | 125% of ACR | 125% of ACR | 125% of ACR |
|---|---|---|---|---|---|---|---|---|---|
| Modelled investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| Security - Modelled failure rate | 2.0% | 5.3% | 3.5% | 3.6% | 6.9% | 4.2% | 7.6% | 9.1% | 6.2% |
| Affordability - Modelled cost (% buyout) | 92% | 93% | 93% | 92% | 93% | 93% | 91% | 92% | 92% |
| Viability - Return-on-capital | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa | 12.5% pa |
In the case of a TP discount rate of gilts plus 1% pa, a PTCR ratio of 175% of the ACR may best be considered as meeting the superfund policy objectives. However, the modelled failure rates are significantly higher than with the other TP discount rates approaches and are mainly well above the target maximum of 2%, giving a relatively high probability of superfund failure.
Overall, the results of the alternative modelling suggest that it is challenging to meet the full range of superfund policy objectives and some compromise across all the objectives may be required. Achieving the superfund policy objectives might be done through adjustments to the derivation of the TP discount rate (e.g. to gilts + 0.75% pa or maybe even to gilts +1.0% pa) and then setting an appropriate level at which profits can be taken relative to the amount required for authorisation (e.g. at 150% or 175% of the ACR).
There is a heightened level of long-term risk pursuing some investment strategies. As we see below, some strategies are likely to result in a heightened risk of TPR intervention. In such cases where the capital buffer support has been significantly depleted resulting in a “Level 1” trigger event, one option might be to de-risk the investment strategy even if this is expected to reduce profitability.
The risk of regulatory involvement
Another risk that might be relevant to policy makers and regulators is the risk of regulatory involvement in the future running of the modelled superfund. The response to the 2018 Superfund Consultation refers to a “Level 1” trigger at or around 100% of TPs. The “Level 1” trigger is the level of funding at which “any remaining funds in the capital buffer are tipped into the scheme assets, under full control of the superfund Trustees, and the section or superfund would be allowed to then run on without a substantive sponsor or to transfer liabilities to another superfund, if such a transfer is available”.
We assume this level of funding includes allowance for per member expenses and the longevity risk reserve broadly consistent with the regulatory TPs as we have modelled. The “Level 1” trigger we have modelled is 105% of the present value of member liabilities based on the assumed TP discount rate. The additional allowance for member expenses and longevity risk reserve of 5% of the present value of member liabilities is slightly lower than the 6% we have assumed at outset as we expect this allowance will fall relative to the present value of member liabilities over time.
We have assessed the likelihood of the funding level falling below the “Level 1” trigger over 10 years and 25 years. The results are detailed in Tables 4, 5 and 6. These show the likelihood of the funding level falling below the “Level 1” trigger on at least one occasion during the period of projection.
The modelling suggests that for the setups that come closest to achieving the objectives set out in the 2018 Superfund Consultation for the example modelled superfund, there is a 10%-15% risk of TPR involvement over a period of 25 years for a superfund set up to meet the superfund policy objectives. TPR involvement does not mean there will be superfund failure – rather, such intervention would be expected to help manage the risk of a superfund failing.
Table 4: Level 1 trigger risks for TPs based on gilts plus 0.5% pa
Proportion of scenarios in which the modelled funding level falls below the Level 1 trigger at least once during the relevant period
| PTCR ratio | 175% | 175% | 175% | 150% | 150% | 150% | 125% | 125% | 125% |
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| Over 10 years | 2% | 4% | 2% | 2% | 5% | 2% | 5% | 6% | 4% |
| Over 25 years | 4% | 8% | 4% | 8% | 10% | 6% | 18% | 17% | 13% |
Table 5: Level 1 trigger risks for TPs based on gilts plus 0.75% pa
Proportion of scenarios in which the modelled funding level falls below the Level 1 trigger at least once during the relevant period
| PTCR ratio | 175% | 175% | 175% | 150% | 150% | 150% | 125% | 125% | 125% |
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| Over 10 years | 2% | 5% | 3% | 3% | 6% | 3% | 6% | 7% | 5% |
| Over 25 years | 6% | 10% | 6% | 10% | 13% | 9% | 22% | 21% | 18% |
Table 6: Level 1 trigger risks for TPs based on gilts plus 1.0% pa
Proportion of scenarios in which the modelled funding level falls below the Level 1 trigger at least once during the relevant period
| PTCR ratio | 175% | 175% | 175% | 150% | 150% | 150% | 125% | 125% | 125% |
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| Over 10 years | 3% | 7% | 5% | 4% | 8% | 5% | 7% | 10% | 7% |
| Over 25 years | 8% | 13% | 10% | 15% | 17% | 14% | 26% | 26% | 25% |
Timely intervention will be necessary to stop a failing superfund taking undue investment risk, thereby reducing the likelihood of ultimate superfund failure.
Comparing results against the 2018 Superfund Consultation
The 2018 Superfund Consultation proposed a long-term sustainability objective of being at least 107.5% funded against a GBL by 2040 with a high level of probability (97.5% provided as an example). Although the current modelled approach is based on an annual stress test to determine the solvency of the superfund, we have assessed the outcome of such an approach against the long-term sustainability objective set out in the 2018 Superfund Consultation. The results in graphical form are illustrated in Charts 3, 4 and 5 below.
As previously noted, throughout this report we use GBL as a measurement basis for comparing different requirements consistent with the authorisation basis set out in the 2018 Superfund Consultation. The GBL is based on the same liability cash flows as the regulatory TPs; however, the discount rate used to calculate the GBL is based on an unadjusted gilt-yield curve. In addition, the GBL does not include a reserve for member expenses or longevity risk. It is only the present value of member liabilities on a gilts basis.
Chart 3 (page 21) shows the relationship between the Superfund failure rate and the modelled 97.5th percentile funding level on a GBL at year 20 for the different approaches to TPs and investment strategy. Each individual line shows the range across the different approaches to profit-taking (represented by the dots on the line, respectively PTCR of 125%, 150% and 175% of ACR). So for example, consider investment Strategy 2, with TPs calculated on a discount rate of gilts + 1.0% (the light green line). A superfund framework allowing profit taking based on 150% of the ACR is represented by the middle green dot. From the chart, this particlar modelled superfund has a 97.5% likelihood of a funding level after 20 years of at least around 80% which in turn correlates to a superfund failure rate of around 7%.
The chart suggests a fairly strong correlation between the 97.5th percentile funding level at year 20 on the GBL and the probability of superfund failure:
- the strategies with the lowest / highest funding levels at year 20 have the greatest / lowest risk of failure.
- A modelled superfund failure of 1% now corresponds to a modelled 97.5% likelihood of being at least around 104% funded against a GBL at year 20.
- A modelled superfund failure of 2% now corresponds to a modelled 97.5% likelihood of being at least around 97% funded against a GBL at year 20.
If a long-term sustainability objective like that proposed in the 2018 Superfund Consultation were to be used, then it is likely the target funding level after 20 years would need to be reassessed, perhaps at around 97.5%-102.5% of a gilts-based liability as this is likely to give rise to a sufficiently low failure rate of less than 2%.
Chart 3: a graph of superfund failure rate versus 97.5th percentile funding level at time 20
Chart 4 below shows the relationship between the Superfund price and the modelled 97.5th percentile funding level on a GBL at year 20 for the different approaches to TPs and investment strategy. Each individual line shows the range (represented by the dots, as noted above) across the different approaches to profit-taking. As noted earlier, to give a sufficiently high level of funding (say 97.5% funding level) after 20 years with 97.5% likelihood, an entry cost of over circa 93% is likely to be required, the amount varying with the particular superfund framework, as described in the chart.
Chart 4: a graph of cost relative to buyout versus 97.5th percentile funding level at time 20
Chart 5 below shows the relationship between the Superfund failure rate and the cost relative to buyout for the different approaches to TPs and investment strategy. Each individual line shows the range across the different approaches to profit-taking. It can be seen, for example, that to achieve a sufficiently low probability of superfund failure, a price of more than 93% of buyout is likely to be required and it may be necessary to only allow profit taking at 150% or more of the ACR. It also indicates that Investment Strategy 1 generally gives the best security / price metrics.
Chart 5: a graph of superfund failure rate versus cost relative to buyout
Comparing results against TPR’s interim requirements for authorisation
We also looked at whether the example modelled superfund might pass TPR’s interim authorisation requirement of at least a 99% likelihood of being at least 100% funded on TPR’s minimum TPs basis - based on a discount rate of gilts + 0.75% pa - after 5 years. Being over 100% funded on TPR’s minimum basis is broadly equivalent to being over 96% funded on the superfund’s GBL basis, which we have used for our comparisons below.
The results for each approach to the modelled TPs are shown in Tables 7, 8 and 9.
Table 7: TPR authorisation risks – TPs based on gilts plus 0.5% pa
| PTCR ratio | 175% | 175% | 175% | 150% | 150% | 150% | 125% | 125% | 125% |
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| 99th perc. F/L vs GBL at year 5 | 106% | 96% | 102% | 104% | 96% | 102% | 101% | 96% | 99% |
| Pass (>96% vs GBL) | Yes | Maybe | Yes | Yes | Maybe | Yes | Yes | Maybe | Yes |
Table 8: TPR authorisation risks – TPs based on gilts plus 0.75% pa
| PTCR ratio | 175% | 175% | 175% | 150% | 150% | 150% | 125% | 125% | 125% |
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| 99th perc. F/L vs GBL at year 5 | 102% | 92% | 97% | 100% | 92% | 97% | 97% | 92% | 95% |
| Pass (>96% vs GBL) | Yes | No | Yes | Yes | No | Yes | Yes | No | No |
Table 9: TPR authorisation risks – TPs based on gilts plus 1% pa
| PTCR ratio | 175% | 175% | 175% | 150% | 150% | 150% | 125% | 125% | 125% |
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 | Strategy 1 | Strategy 2 | Strategy 3 |
| 99th perc. F/L vs GBL at year 5 | 98% | 88% | 93% | 97% | 88% | 93% | 94% | 88% | 92% |
| Pass (>96% vs GBL) | Yes | No | No | Yes | No | No | No | No | No |
From the above modelling, the indication is that a superfund based on a profit trigger of 150% of ACR might be able to pass TPR’s interim requirements for superfunds with some adjustment to the TP discount rate reflecting the downside risks of the modelled investment strategy. Although a discount rate of gilts plus 0.75% pa might be appropriate for Strategies 1 and 3, a more prudent approach to the TP discount rate of less than gilts plus 0.5% pa for Strategy 2 may be required.
Exploring some risks and understanding impacts
In this section we explore some sensitivities in the modelling and the risks facing the example modelled superfund. We do this by varying some of the assumptions used in the modelling to understand the impact the choice of the assumptions has on the modelled outcomes. This will also help the reader understand the impact of the assumptions and their materiality in terms of affecting outcomes relative to the objectives. To do this, we first set out the Base Case, as a standard against which we compare each sensitivity run.
The Base Case modelled scenario
For modelling purposes, we assume a Base Case based on a TP discount rate of gilt plus 0.75% pa and a PTCR ratio of 150%. This is one of the setups that currently comes closest to meeting the superfund policy objectives. It is also the setup with TPs closest to those used by TPR in its latest interim requirements for superfunds.
Buyout pricing assumptions
The modelling is sensitive to the assumptions made for buyout pricing. These impact both the assessment of affordability relative to buyout and when the superfund scheme is expected to reach a buyout level of funding after which it is no longer considered a risk to the PPF in modelling the superfund failure rate.
The modelled buyout discount rate has been calibrated against the adjustments to the gilt-yield curves in the latest PPF guidance note B10 for Section 143 valuations albeit adjusted to make it slightly more expensive as the PPF assumptions are intended to be deliberatively competitive and if anything could lead to an underestimate of the buyout cost. We have illustrated the sensitivity of the results to changes in the modelled buyout costs in Table 10 equivalent to a 2% reduction in cost at outset and a 1% reduction in the assumed future buyout cost to reflect the term related impact of changing the assumptions. If buyout costs reduce during the operation of a superfund, the likelihood of reaching a buyout position increases and hence the risk to members will reduce.
Table 10: Sensitivity modelling different buyout assumptions
| Modelled investments | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 |
|---|---|---|---|---|---|---|
| Scenario | Base Case | Reduced buyout costs | Base Case | Reduced buyout costs | Base Case | Reduced buyout costs |
| Security - Modelled failure rate | 1.7% | 1.4% | 3.1% | 3.1% | 1.9% | 1.8% |
| Affordability - Modelled cost (% buyout) | 93% | 95% | 95% | 96% | 95% | 96% |
| Viability - Return-on-capital (pa) | 12.5% | 12.5% | 12.5% | 12.5% | 12.5% | 12.5% |
Operational or regulatory risks
The next set of sensitivities in Table 11 reflect the assumptions made for some of the operational or regulatory inputs to the example modelled superfund. These look at how the superfund might be setup and how profit might be extracted. Each variable is changed in isolation and the effect on Security / Affordability / Viability are calculated, to be compared to the base case.
1. Annual management charge (AMC): currently this is 0.2% pa. For simplicity, this rate applies to all modelled investment strategies. It is intended to cover some of the on-going expenses of administering the superfund as well as annual investment management expenses, and potential PPF levies. We illustrate the outcome assuming the AMC is increased by 0.3% pa, for example, if there is additional profit-taking through excessive charging.
2. Return-on-capital (RoC): currently this is 12.5% pa in the base case. We illustrate the outcome assuming investors target a 25% pa RoC, for example, if there is not a competitive market for superfunds or investors require a higher return than we have modelled, particularly as we have not explicitly allowed for the taxation of profits or surpluses emerging from the superfunds.
3. Long-term funding objective: currently this is to buyout after 15 years. Once a superfund scheme achieves this level of funding it is assumed to buy out and is no longer considered a risk to the PPF. We explore the risks to the PPF should the targeted term to buyout be extended to around 20 years.
Table 11: Sensitivity modelling of operational risks
| Modelled investments | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 | Strategy 3 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Scenario | Base Case | AMC = 0.5% pa | RoC = 25% pa | LTO = 20 years | Base Case | AMC = 0.5% pa | RoC = 25% pa | LTO = 20 years | Base Case | AMC = 0.5% pa | RoC = 25% pa | LTO = 20 years |
| Security - Modelled failure rate | 1.7% | 2.2% | 1.7% | 2.9% | 3.1% | 5.8% | 3.1% | 4.9% | 1.9% | 2.9% | 1.9% | 2.8% |
| Affordability - Modelled cost (% buyout) | 93% | 95% | 100% | 94% | 95% | 96% | 102% | 95% | 95% | 96% | 100% | 95% |
| Viability - Return-on-capital (pa) | 12.5% | 12.5% | 25.0% | 12.5% | 12.5% | 12.5% | 25.0% | 12.5% | 12.5% | 12.5% | 25.0% | 12.5% |
The results of this sensitivity modelling suggest that:
- Excessive charges increase the risk of superfund failure assuming there is no corresponding increase in the expenses reserve included in the TPs. It will therefore be necessary to ensure excessive charging does not impact on the security for members. If higher AMCs are allowed for in the pricing, then this will of course increase the modelled cost either as an increase in the expenses reserves or reduced modelled profits for the investors.
- Some investors might be put off from setting up superfunds if they cannot sustain profits at a higher level than we have modelled. Although increased profit loadings would not necessarily impact on security, superfunds will be a much less attractive option for sponsors if higher returns are required.
- Running on the superfund longer than is necessary, and long after the last member has retired, increases the likelihood of superfund failure perhaps well beyond what might be considered acceptable. This is because the superfund would be exposed to risk of superfund failure for a longer period. Also, over time, with PPF drift and as liabilities are settled and the superfund matures, the PPF funding level converges with the other funding measures making it more likely that a superfund failure event will occur. This appears to be more of a risk for the riskier investment strategies.
- Adopting a shorter period to reach a buy-out target will reduce the risk of superfund failure but is also likely to have implications for affordability.
Longevity shock
The next risk we look at is a longevity shock. A longevity shock would be a significant improvement in life expectancies, perhaps through a medical breakthrough. This is an external risk and one which is not allowed for explicitly in the modelling even though the TPs and capital requirements allow for longevity risks in their calculation.
We looked at the impact of a longevity shock by modelling the superfund assuming it had a lower capital buffer. For these purposes the initial buffer was reduced by the longevity shock reserve. In this case, the reduction to the ACR is equivalent to around 3-4% of GBL, which is broadly equivalent to an increase in life expectancies of around 1.5 years after the superfund has been set-up. The results of the sensitivity modelling are shown in Table 12.
Scheme risks
We have modelled a scheme that is intended to be broadly typical in benefits and liability profile. We accept that some schemes will not provide as generous benefits, for example, for pension increases on pension earned before 6 April 1997. We illustrate the potential impact of a PPF winding-up underpin of 113.5% of PPF Section 179 liabilities. This could be analogous to the relative impact of a scheme that does not provide increases to pensions in payment earned before 6 April 1997. This is clearly a significant approximation to illustrate the impact of different benefit structures, which illustrates an order of magnitude in the modelled failure rate of potentially greater than 10% for schemes providing benefits much closer to PPF benefits.
The results of the additional sensitivity modelling are shown in Table 12.
Table 12: Sensitivity modelling of longevity and scheme risks
| Modelled investments | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
|---|---|---|---|---|---|---|---|---|---|
| Scenario | Base Case | Longevity shock | Scheme risks | Base Case | Longevity shock | Scheme risks | Base Case | Longevity shock | Scheme risks |
| Security - Modelled failure rate | 1.7% | 2.0% | 6.6% | 3.1% | 4.6% | 9.5% | 1.9% | 2.8% | 6.2% |
| Affordability - Modelled cost (% buyout) | 93% | 93% | 93% | 95% | 95% | 95% | 95% | 95% | 95% |
| Viability - Return-on-capital (pa) | 12.5% | 12.5% | 12.5% | 12.5% | 12.5% | 12.5% | 12.5% | 12.5% | 12.5% |
The modelling of these other risks suggests that:
Although not immune to a longevity shock, a superfund may be resilient to such a shock assuming the profit-taking requirements and TPs reflect the increased longevity post the shock versus original assumptions. In effect, the superfund would be required to build up additional reserves at the expense of the actual Return-on-Capital achieved by the investors.
Increasing the winding-up trigger relative to the value of TPs can serve to illustrate the potential increase in failure risk for a scheme providing benefits much closer to PPF levels of compensation. This increased level of risk may put off superfunds acquiring schemes providing benefits close to PPF levels, at least until a considerable number of more generous schemes have been consolidated.
Compliance statement
The Government Actuary’s Department (GAD) completed stochastic modelling and analysis on the scheme funding and capitalisation requirements for superfunds at the request of the Department for Work and Pensions (DWP). The modelling and this report are intended to support DWP in its development of superfunds policy.
The modelling and analysis outlined in this initial report have been carried out in accordance with the applicable Technical Actuarial Standard: TAS 100 issued by the Financial Reporting Council (FRC). The FRC sets technical standards for actuarial work in the UK.
Although we have provided some narrative in the report to help interpret the results, we make no recommendations or actuarial judgement regarding the nature of the regulatory requirements for superfunds.
This report has been prepared for the use of the DWP and must not be reproduced, distributed, or communicated in whole or in part to any other person without GAD’s prior written permission. No other person or third party is entitled to place any reliance on the contents of this report, except to any extent explicitly stated herein, and GAD has no liability to any person or third party for any act or omission, taken either in whole or part based on this report.
This report must be considered in its entirety, as individual sections, if considered in isolation, may be misleading, and conclusions reached by review of some sections on their own may be incorrect.
Limitations in the modelling
The assumptions and methodology set out in this report are appropriate as at the date of calculation, 31 December 2022. The outcomes should be considered within the context of the economic position as at that date. Any changes or movements in economic conditions since this date have not been factored into the modelling or analysis. One key driver of the affordability of the modelled superfund (relative to buyout) is the additional yield on credit investments above gilts. If this additional yield is lower than at the modelling date (as has been the case in the recent past) it is likely to make the modelled superfund price closer to buyout, for the same amount of risk.
When establishing a suitable regulatory framework, the framework should be designed to be robust to such changes in market conditions over time. We would be happy to advise DWP on the impact of varying the different elements of the regulatory framework at the same time as updating the modelling to current market conditions. Please note however that market conditions are currently particularly volatile and the future outlook remains uncertain.
The outcome of the model is dependent on the profile of the underlying modelled scheme, both in terms of the shape of the cashflows and liability run-off, but also the sensitivity to changes in economic conditions under the ESG. We have selected proxy data which we believe is likely to be a representative shape and sensitivity profile of an average scheme; however, it will not be representative for each individual scheme entering a superfund or for a particular superfund in aggregate.
The modelling uses economic scenarios supplied from a third-party and all modelling is a simplification of real life. There are some risks not allowed for in the modelling including, but not limited to, idiosyncratic risks / non-investment risks, which includes trustee or employer behaviours. The effect of climate risk on scheme investment strategies is not considered or modelled within the context of this analysis, although the underlying economic scenarios implicitly include some allowance for potential climate effects on future investment returns.
The modelling is a simplification of reality and does not allow for any consideration of liquidity for instance. The modelling assumes that assets can be realised when needed at returns in line with the economic scenarios.
The same demographic assumptions are assumed to broadly apply across all liability measures on a consistent basis given the intention to model an average scheme and regulatory requirements in a macro sense. In practice, different mortality and dependent assumptions are likely to apply to different schemes. The mortality assumptions used make no specific allowance for the impact of COVID-19 on mortality rates.
The modelling makes no explicit allowance for PPF levies. These are assumed to be included on the AMCs. In the normal course of events, we would expect PPF levies for superfunds to be minimal given the level of aggregate funding above PPF Section 179 liabilities. In the worst modelled cases, as a funding level approaches PPF Section 179 liabilities, we might expect the PPF levies to scale up very quickly, almost driving the superfund into wind-up. To some extent, the superfund winding-up trigger anticipates this, being based on a threshold above PPF Section 179 liabilities. So, before this has a chance to happen, the superfund is assumed to have failed and is wound-up.
Appendix A: Approach to modelling and objectives
As discussed in the Introduction, the example modelled superfund was designed to meet the requirements set out in the 2018 Superfund Consultation by defining a long-term objective for the superfund, designing the superfund to achieve it, and then setting minimum regulatory requirements for authorisation and profit-taking. The modelled superfund may therefore help to set a framework for Regulations. We describe more details of the approach below.
Long-term objective and modelled superfund structure
The modelled superfund consists of a superfund scheme and a capital buffer. The superfund scheme is made up of deferred and pensioner members with benefits intended to be typical of defined benefit schemes. The modelled flow of monies between the superfund scheme and capital buffer are an internal mechanism of the modelled superfund designed to meet the long-term objective and to allow the superfund to pay profits if the minimum requirements for solvency have been met.
The modelled long-term objective is for the superfund scheme to reach a buyout level of funding after 15 years. The original timeframe for achieving the long-term objective in the 2018 Superfund Consultation was around 20 years. At that time, this was considered a suitable period over which most non-pensioners would have retired. A shorter period of 15 years is now targeted because most schemes are now closed and the typical pension scheme membership will have aged since the 2018 Superfund Consultation.
Given the approach to modelling, and because of how the example modelled superfund has been set up to achieve this, the long-term objective will only be achieved in around half the modelled scenarios by year 15. In most of the other half of modelled scenarios, it will take a little longer for the superfund to achieve its objective, as the superfund will have underperformed up to this point. In a small number of scenarios, the superfund will have been modelled to fail through significant underperformance either before or after year 15. The modelling horizon therefore needs to be extended beyond 15 years to capture all eventual modelled outcomes.
The modelled superfund was designed to make it accessible for a typical defined benefit pension scheme to bulk transfer its members to the superfund scheme. It is also intended for the superfund scheme to comply with Scheme Funding legislation and reach a low dependency funding level over time through progress towards the long-term objective. It is assumed the sponsor and investor will provide the necessary capital buffer at outset to support the superfund scheme and to ensure the superfund meets the modelled regulatory requirements for authorisation.
The set-up is therefore intended to illustrate some flexibility for investors to determine the internal structure and objectives of their superfund whilst still having to comply with minimum regulatory requirements for the aggregate of superfund assets for authorisation and profit-taking.
Regulatory requirements
The modelled regulatory requirements are based on a set of Technical Provisions and additional risk-based capital requirements. These work in tandem to ensure a superfund should remain solvent in nearly all scenarios, with solvency being defined as still retaining sufficient assets to cover a prudent set of low dependency scheme funding liabilities. The regulatory requirements together set the aggregate requirements for the superfund for authorisation and profit-taking, and to make any necessary regulatory intervention. It is these aggregate requirements that will ultimately determine whether the modelled superfund will succeed or fail. The long-term objective will determine when the superfund is assumed to no longer be a risk to the PPF.
The approach taken to the two components making up the regulatory requirements is as follows:
-
Technical Provisions based on best estimate liability cashflow assumptions and a prudent discount rate relative to the expected return on the superfund assets that is used to calculate the present value of member liabilities. They also include an additional loading for per member expenses and a longevity risk margin. A TP discount rate of gilts plus 0.5% pa was first modelled consistent with the proposals set out in the 2018 Superfund Consultation. Alternative TP discount rates of gilts plus 0.75% pa and 1.0% pa were then modelled. In each case, the capital requirements were the same relative to TPs. In every case, the modelled superfund was set up to achieve the same long-term objective for the superfund scheme which is to reach a buyout level of funding after 15 years.
-
Capital requirements based on a 1-in-100 one-year stress test rather than assessed against a long-term modelling approach as originally envisaged in the 2018 Superfund Consultation. However, stochastic modelling is used to assess the impact of an annual stress test approach on the long-term sustainability of the superfund and particularly the impact of taking profits over an extended period. The stress test is based on a standard Solvency II Solvency Capital Requirement recalibrated to a 1-in-100 likelihood. It includes an allowance for market, longevity and operational risks and sets the additional requirements above the regulatory TPs as follows:
The initial authorisation requirement was set at TPs plus 100% of the 1-in-100 stress test requirement. It is equivalent to the “Level 2” trigger discussed in DWP’s response to the 2018 Superfund Consultation. The additional capital requirement above TPs at outset is referred to in this report as the ACR.
Different levels of profit trigger were modelled and referred to in aggregate as the profit-taking requirement. The additional capital requirement required for profit-taking above TPs is referred to as the profit-taking capital requirement (PTCR). The PTCR is generally expressed as a percentage of the ACR, for example 150% of the ACR. A PTCR of 150% of ACR is equivalent to having funding to withstand a stress test based on a 1-in-4,000 one-year event compared to the 1-in-100 likelihood required for authorisation.
Modelled investment strategies
Three different investment strategies were modelled each with their own capital requirements to reflect their different risks. The first was a credit-based strategy, the second a diversified strategy and the third is an alternative credit-based approach with greater diversification across credit type assets. Each strategy is intended to illustrate how superfund investment could make a more significant contribution to the productive finance initiative through greater investment in UK infrastructure, high yield bond funds, and private debt.
Table A1: Modelled investment strategies
| Asset class | Strategy 1: Credit-based | Strategy 2: Diversified | Strategy 3: Alternative credit-based |
|---|---|---|---|
| Global equities | 0% | 6% | 0% |
| Euro high yield bonds | 0% | 0% | 5% |
| UK property | 0% | 4% | 5% |
| Hedge funds | 0% | 2% | 0% |
| Private equity | 0% | 6% | 0% |
| UK infrastructure | 0% | 6% | 5% |
| UK high yield bonds | 0% | 6% | 0% |
| Private debt | 25% | 0% | 10% |
| LDI fund | 30% | 45% | 40% |
| UK corporate bonds | 45% | 25% | 35% |
| Annualised return (above gilts) over 10 years | 1.6% pa | 1.8% pa | 1.4% pa |
| Average annual funding volatility over 10 years | 5.1% | 5.2% | 4.1% |
| Hedging ratio (interest and inflation) | ~ 90% | ~ 90% | ~ 90% |
| LDI leveraging | ~ 2.4 times | ~ 1.8 times | ~ 1.9 times |
| Assessed authorised capital requirement | 14.1% of TPs | 16.8% of TPs | 13.1% of TPs |
| AMC | 0.2% pa | 0.2% pa | 0.2% pa |
Steps in the modelling of the GAD superfund
In each year of our modelling, we consider 1,000 economic scenarios. The superfund assets and liabilities are projected forward, and cash-flow is paid out based on the randomly generated economic scenarios being modelled and the benefits to be provided by the superfund scheme. Member expenses equivalent to 2.5% of liability cash-flow in each year are deducted from assets when cash-flow is paid out. At the end of each year in every modelled scenario the following additional actions are taken:
First. The AMC is applied to the aggregate superfund assets (scheme funding plus capital buffer) at each year end to cover remaining per member costs and to cover investment costs and any potential PPF levies.
Second. A superfund scheme deficit is assessed against the increasing scheme funding requirement to achieve the end-game objective. If the deficit in the superfund scheme assets exceeds the capital buffer, then the capital buffer is paid into the superfund scheme.
Third. If the aggregate of superfund assets has fallen below the Superfund winding-up trigger of 105% of PPF Section 179 liabilities including an allowance for winding-up expenses the superfund is wound up.
Fourth. Profits are extracted if the aggregate of superfund assets exceed the profit taking requirement. The Scheme funding requirement and capital buffer are rebalanced in line with the end-game target each time profits are taken. If no profits are taken, then no rebalancing takes place.
Fifth. Scheme assets are compared with the assessed value of buyout liabilities including allowance for PPF winding-up expenses. The modelling assumes the scheme will be wound-up, having successfully met its target, if scheme assets exceed buyout liabilities including an allowance for expenses of winding-up.
Defining success and failure in the modelling
A successful outcome in the modelling is if the superfund scheme can buyout benefits at any time in which case the superfund is assumed to be wound-up and any assets in the capital buffer returned to the investors. A failure is assumed to occur if at any time the aggregate superfund assets fall below the superfund winding-up trigger (105% of PPF Section 179 liabilities) in which case the superfund is assumed to be wound up and members transferred to the PPF, or benefits bought out at less than full scheme entitlements.
If the superfund has not been modelled to wind-up at the end of 40 years, then it is assumed it will be wound up at that point and if there are sufficient assets to buyout full benefits then this is considered a success. Otherwise, the outcome is deemed a failure. Having defined success and failure for the modelling we can use this to inform the objectives of the modelling and how this can support the assessment of outcomes against the superfund policy objectives.
Appendix B: Model data and assumptions
Details regarding the modelled scheme
The modelled scheme is intended to be typical in terms of member benefits and liability profile. The present value of member liabilities is split roughly 60% deferred members and 40% pensioners. The duration of the liabilities is around 15 years at outset.
Individual schemes vary significantly in terms of their make-up of members and the benefits provided. Modelled outcomes could therefore be very different for particular schemes. A modelled superfund scheme providing benefits much closer to PPF levels of compensation that have a greater proportion of pensioner members might exhibit significantly increased modelled failure rates, perhaps greater than 10% over a 20-year period as shown in the earlier sensitivity analysis. This is because the liabilities to cover PPF levels of compensation are much closer to the TPs and cost to buy-out the scheme. In the Exploring some risks and understand impacts section of the report, we illustrated how varying the superfund winding-up trigger relative to the PPF liabilities can have a significant impact on modelled outcomes if it is used as a proxy for schemes that provide benefits much closer to PPF compensation levels.
The intention of modelling a “typical scheme” is to assess requirements for a superfund taking on a scheme that exhibits broadly the same characteristics as the aggregate of all defined benefit pension schemes. In that way, assessing requirements against the modelled outcomes for the typical scheme could help in setting requirements for superfunds taking on a wide selection of schemes that together exhibit properties like the example modelled scheme.
Key information regarding the example modelled scheme is set out as follows in Table B1.
Table B1: Basic superfund scheme details
| Benefit indexation | Fixed 3% pa for Pre 1997 benefit accrual; RPI pension increases capped at 5% for Post 97 benefit accrual |
|---|---|
| Benefit revaluation | CPI linked deferred pension revaluation |
| Members | c.7,000 Deferred pensioners; c.3,000 Pensioners |
The modelled liability measures and TPs at outset for the example modelled superfund are shown in Table B2 together with the modelled median nominal cash-flows and liabilities over the next 40 years in Charts B1 and B2. From the modelled cash-flows, we can see they reach their peak just before year 16 and are therefore in run-off at the point the scheme is intended to meet the long-term objective.
Table B2: Liability measures and TPs
| Best estimate liabilities on “gilts-flat” basis (GBL) | £780m - 100% of GBL |
|---|---|
| Buyout (Excluding expenses) | £810m - 104% of GBL |
| PPF Section 179 (Excluding expenses) | £595m - 76% of GBL |
| TPs @ gilts plus 0.5% pa | £766m - 98% of GBL |
|---|---|
| TPs @ gilts plus 0.75% pa | £738m - 95% of GBL |
| TPs @ gilts plus 1% pa | £712m - 91% of GBL |
The liabilities are shown relative to a GBL. Throughout this report we use GBL as a measurement basis for comparing different requirements consistent with the authorisation basis set out in the 2018 Superfund Consultation. The GBL is based on the same liability cash flows as the regulatory TPs; however, the discount rate used to calculate the GBL is based on an unadjusted gilt-yield curve. In addition, the GBL does not include a reserve for member expenses or longevity risk.
Charts B1 and B2: Modelled median nominal cash-flows and liabilities over the 40 years
The modelled approach to scheme funding and capital buffer requirements
The mechanism for distributing assets within the Superfund varies over time and does not reflect the strict regulatory apportionment of scheme assets = TPs and capital buffer = capital requirements.
In the example modelled superfund, scheme assets are initially equal to the present value of member liabilities excluding the expense reserve and longevity risk margin. The latter are assumed to be included in the capital buffer. For this purpose, we simply refer to this as the scheme liabilities. Over time, surplus is expected to emerge, some of which will be retained in the scheme, and some transferred to the capital buffer to be taken as profits. The amount of surplus retained in the scheme is determined by the planned scheme funding requirement, which increases over time relative to scheme liabilities to ensure the superfund scheme meets the long-term objective. Thus, as profits are taken, scheme assets are increased relative to the scheme liabilities so that the scheme can be expected to reach a buyout funding level after 15 years. However, the aggregate of scheme assets and capital buffer should always equal the profit-taking requirement for profits to be taken.
Table B3 shows the modelled scheme funding requirements for the different modelled TP discount rates as well as the buyout values relative to GBL. The figures in brackets underneath show the modelled scheme funding requirement as a percentage of scheme liabilities. The scheme liabilities converge at around year 15 on both the GBL and buyout liability measures.
Table B3: Scheme funding requirements and buyout funding levels relative to GBL
| Year | 0 | 5 | 10 | 15 | 20 |
|---|---|---|---|---|---|
| Liabilities @ gilts plus 0.5% pa | 93% (100% of liabilities) | 95% (102% of liabilities) | 97% (103% of liabilities) | 100% (105% of liabilities) | 102% (107% of liabilities) |
| Liabilities @ gilts plus 0.75% pa | 89% (100% of liabilities) | 93% (103% of liabilities) | 96% (105% of liabilities) | 100% (108% of liabilities) | 103% (110% of liabilities) |
| Liabilities @ gilts plus 1% pa | 86% (100% of liabilities) | 91% (104% of liabilities) | 95% (107% of liabilities) | 100% (111% of liabilities) | 104% (114% of liabilities) |
| Buyout (Including expenses) | 104% | 102% | 100% | 99% | 98% |
Table B4 shows how the scheme funding and capital buffer requirements vary over time for the Base Case discussed in previous chapters assuming a TP discount rate of gilts plus 0.75% pa and a PTCR ratio of 150%. In this case, we also assume Strategy 1 to determine the capital requirements. The chart also shows the PPF winding-up trigger as well as the equivalent regulatory TPs (split by liabilities and expense and risk margin) and capital requirements that make up the overall regulatory requirements.
Table B4: One example of scheme funding and capital buffer requirements relative to GBL
| Year | 0 | 5 | 10 | 15 | 20 |
|---|---|---|---|---|---|
| Buyout (inc. expenses reserve) | 104% | 102% | 100% | 99% | 98% |
| Scheme funding requirement | 89% | 93% | 96% | 100% | 103% |
| Capital buffer required for authorisation | 20% | N/A | N/A | N/A | N/A |
| Capital buffer required for profit-taking | 7% | 24% | 22% | 19% | 16% |
| Total regulatory requirement for profit-taking | 116% | 117% | 118% | 119% | 119% |
The Economic Scenario Generator
A bespoke Economic Scenario Generator (ESG) has been used in the analysis and the economic scenarios are modelled over a 40-year projection period. The underlying ESG was supplied by a market-leading provider, and it has been calibrated based on a “best views” approach. The calculation date of the analysis is 31 December 2022, and the economic scenarios correspond to this date. Chart B4 plots the ESG fixed gilt and real yields over future simulation years as at 31 December 2022. The solid lines show the market implied fixed and index-linked gilt yields and the dashed lines show the ESG median yields at various time points.
Chart B4: market implied 20-year yields at 31 December 2022 and comparable modelled median yields
The ESG contains 1,000 scenarios with projected returns for various indices of asset classes, including projected nominal and real gilt spot rates over a full range of terms at each future projection year. Outcomes are simulated stochastically by running through the 1,000 future economic scenarios and then distributions of possible annual asset returns and economic factors such as price inflation are produced.
The ESG includes assumptions about the pattern of key economic variables including interest rates and inflation as well as a wide range of asset class returns. There are assumptions incorporated into the scenarios in the ESG over the range of asset classes to take account of the distributions of returns and the divergence of scenarios. The calibration is based upon expert views of the long-term behaviour of interest rates, inflation and asset class returns in different interest and inflation scenarios. Chart B5 shows the median asset returns, yields and RPI inflation over the 40-year projection period.
Chart B5: Median projected returns
Gilts-matching is an asset class based on a portfolio of UK government bonds intended to provide asset cash-flows that broadly match liability cash-flows. It is therefore intended to behave in a similar way to the gilts-based liability. An LDI Fund is also used in each of the modelled investment strategies. This is modelled as a notional asset that provides assumed returns broadly a multiple of the gilts-matching asset class less cash costs based on a multiple of one less than the gilts-matching multiple. The gilts-matching multiple is referred to as the LDI leveraging. Further information on the modelled investment strategies is shown in Table B6 overleaf.
Table B6: Modelled investment risk and returns
| Strategy 1: Credit-based | Strategy 2: Diversified | Strategy 3: Alternative credit-based | |
|---|---|---|---|
| Annualised returns (relative to GBL) | |||
| 1 year | 3.5% pa | 2.5% pa | 2.5% pa |
| 3 years | 2.4% pa | 2.2% pa | 1.9% pa |
| 5 years | 2.0% pa | 2.0% pa | 1.7% pa |
| 10 years | 1.6% pa | 1.8% pa | 1.4% pa |
| 20 years | 1.3% pa | 1.6% pa | 1.2% pa |
| Average funding volatilities (relative to GBL) | |||
| Over 10 years | 5.1% | 5.2% | 4.1% |
| LDI leveraging and approximate hedging ratios (year 1) | |||
| LDI leveraging | 2.4 times | 1.8 times | 1.9 times |
| Interest rates | ~ 90% | ~ 90% | ~ 90% |
| Inflation | ~ 90% | ~ 90% | ~ 90% |
Note 1: The hedging ratios of c. 90% should be considered against an overall target funding level of around 115-120% of TPs
A discussion of the Return-on-Capital (RoC)
The cost is the initial authorisation requirement less an amount provided by the investors equal to the present value of emerging profits discounted at an assumed RoC of 12.5% pa. For the avoidance of doubt, it is assumed that 100% of emerging profits are returned to the capital provider. Also, if the superfund scheme reaches a buyout level of funding, it is assumed the scheme is bought out, the superfund wound-up, and 100% of the remaining assets in the buffer are returned to the investors.
The approach to calculating the RoC is a simplified internal rate of return based on cash financing. We acknowledge there are more sophisticated approaches for calculating a RoC, but we still consider this to be a reasonable approach for the purpose of assessing commercial viability. We have not explicitly considered the tax position of the superfund on the taxation of emerging profits or refunds of surplus. There is, however, an implicit assumption within the RoC assumption for taxation and that taxation could be a significant drag on profits. The assumption of 12.5% pa might be considered at the limit of what could be acceptable and might restrict the attractiveness to investors.
Sample modelled outputs for the superfund
Charts B6 and B7 show the modelled outputs versus a GBL for the example modelled Base Case superfund based on investment Strategy 1, a TP discount rate of gilts plus 0.75% pa and a PTCR ratio of 150%.
Chart B6: Fan chart showing modelled aggregate funding levels relative to GBL 10th to 90th percentile outcomes
Chart B7: Fan chart showing modelled aggregate funding levels relative to GBL 1st to 20th percentile outcomes
Illustrating success and failure
Chart B8 illustrates the incidence of successful outcomes where the example modelled Base Case superfund scheme with a productive finance investment strategy reaches a buyout level of funding and is therefore assumed to buyout. It also shows the alternative accumulated modelled superfund failure rate. The chart shows that by year 25 the modelled fate of the superfund has largely been determined. The median term to buyout is 15 years, and by year 20 around 90% of scenarios are assumed to have reached buyout.
Chart B8: Illustrated success and failure for example modelled Base Case superfund
Appendix C: Comparison of initial superfund setups and levels of profit taking over time
The first set of tables provide a break-down of:
- The approach taken to authorisation
- The initial approach to scheme funding and capital buffer requirements
- The cost to the sponsor based on its contribution to the capital buffer requirements
- The approach taken to profit taking at commencement
- The cost to the sponsor expressed relative to buyout
The second set of tables show how the modelled profit-taking requirement changes over time.
Comparison of initial superfund setups
TPs based on gilts plus 0.5% pa
First, we set out the initial authorisation requirements. TPs are the same regardless of investment strategy; however, the ACR reflects the assumed risk in the investment strategy.
Table C1: Approach to authorisation
Figures subject to rounding
| TPs based on gilts plus 0.5% pa | |||
|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 2 | Strategy 3 |
| Technical Provisions | Present value of member liabilities = 92.7% of GBL | Expenses and longevity risk margin = 6% of present value of member liabilities = 5.6% of GBL | Technical Provisions = 98.2% of GBL |
| 2018 Superfund Consultation | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL |
| Authorisation capital requirement based on investment strategy | 15.1% of TPs = 14.8% of GBL | 17.7% of TPs = 17.3% of GBL | 13.6% of TPs = 13.3% of GBL |
| Authorisation requirement | 113.0% of GBL | 115.6% of GBL | 111.6% of GBL |
| 2018 Superfund Consultation | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL |
Second, we set out the assumed initial allocation of assets to the superfund scheme and the capital buffer. The amount assumed to be invested in the superfund scheme is the present value of member liabilities excluding any allowance for per member expenses and longevity risk margin. The allowance for per member expenses and longevity risk margin are included in the capital buffer. The sponsor cost is the initial scheme funding requirement plus the sponsor’s contribution to the capital buffer, which changes slightly depending on the PTCR ratio. The higher the PTCR ratio the longer it takes for profits to emerge. This means the present value of investor profits discounted at the investor’s Return-on-Capital is lower and so therefore is the investor’s share of the capital buffer. This makes it correspondingly more expensive for the sponsor who must provide a greater proportion of the capital buffer.
Table C2: Approach to initial funding and costing
Figures subject to rounding
| TPs based on gilts plus 0.5% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| PTCR ratio | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| Initial scheme funding relative to GBL | 92.7% | 92.7% | 92.7% | 92.7% | 92.7% | 92.7% | 92.7% | 92.7% | 92.7% |
| Sponsor contribution to capital buffer relative to GBL | 7.8% | 6.8% | 5.6% | 9.1% | 8.1% | 7.0% | 9.1% | 8.2% | 7.1% |
| Cost relative to GBL | 100.5% | 99.5% | 98.3% | 101.8% | 100.8% | 99.6% | 101.7% | 100.9% | 99.8% |
| Investor contribution to capital buffer relative to GBL | 12.5% | 13.5% | 14.7% | 13.8% | 14.8% | 15.9% | 9.8% | 10.7% | 11.8% |
| Authorisation requirement relative to GBL | 113.0% | 113.0% | 113.0% | 115.6% | 115.6% | 115.6% | 111.6% | 111.6% | 111.6% |
We next out set the initial profit-taking capital requirements, which are dependent on the PTCR ratio, i.e., the multiple applied to the authorisation capital requirement to determine the threshold above which profits can be taken.
Table C3: Approach to profit-taking
Figures subject to rounding
| TPs based on gilts plus 0.5% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| Authorisation capital requirement based on investment strategy | 14.8% of GBL | 14.8% of GBL | 14.8% of GBL | 17.3% of GBL | 17.3% of GBL | 17.3% of GBL | 13.3% of GBL | 13.3% of GBL | 13.3% of GBL |
| PTCR ratio | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| Authorisation requirement - Relative to GBL | 113.0% | 113.0% | 113.0% | 115.6% | 115.6% | 115.6% | 111.6% | 111.6% | 111.6% |
| Additional profit-taking capital requirement relative to GBL | 75% * 14.8% = 11.1% | 50% * 14.8% = 7.4% | 25% * 14.8% = 3.7% | 75% * 17.3% = 13.0% | 50% * 17.3% = 8.7% | 25% * 17.3% = 4.3% | 75% * 13.3% = 10.0% | 50% * 13.3% = 6.7% | 25% * 13.3% = 3.3% |
| Profit requirement relative to GBL | 124.1% | 120.4% | 116.7% | 128.6% | 124.3% | 119.9% | 121.6% | 118.3% | 114.9% |
| 2018 Superfund Consultation | Implies around 117% of GBL | Implies around 117% of GBL | Implies around 117% of GBL | Implies around 120% GBL | Implies around 120% GBL | Implies around 120% GBL | Implies around 116% GBL | Implies around 116% GBL | Implies around 116% GBL |
Finally, we show below how costs relate to estimated buyout as well.
Table C4: Costs relative to buyout
Figures subject to rounding
| TPs based on gilts plus 0.5% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| PTCR ratio | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| Cost relative to GBL | 100.5% | 99.5% | 98.3% | 101.8% | 100.8% | 99.6% | 101.7% | 100.9% | 99.8% |
| Cost relative to buyout | 96.2% | 95.3% | 94.1% | 97.5% | 96.5% | 95.4% | 97.4% | 96.6% | 95.6% |
TPs based on gilts plus 0.75% pa
A similar break down is given for the alternative modelling based on a TP discount rate of gilts plus 0.75% pa.
Table C5: Approach to authorisation
Figures subject to rounding
| TPs based on gilts plus 0.75% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| Technical Provisions | 94.7% of GBL | 94.7% of GBL | 94.7% of GBL | 94.7% of GBL | 94.7% of GBL | 94.7% of GBL | 94.7% of GBL | 94.7% of GBL | 94.7% of GBL |
| 2018 Superfund Consultation | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL |
| Authorisation capital requirement based on investment strategy | 14.3% of GBL | 14.3% of GBL | 14.3% of GBL | 16.7% of GBL | 16.7% of GBL | 16.7% of GBL | 12.9% of GBL | 12.9% of GBL | 12.9% of GBL |
| Authorisation requirement | 109.0% of GBL | 109.0% of GBL | 109.0% of GBL | 111.4% of GBL | 111.4% of GBL | 111.4% of GBL | 107.6% of GBL | 107.6% of GBL | 107.6% of GBL |
| 2018 Superfund Consultation | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL |
| PTCR multiple | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| Initial scheme funding relative to GBL | 89.3% | 89.3% | 89.3% | 89.3% | 89.3% | 89.3% | 89.3% | 89.3% | 89.3% |
| Sponsor contribution to capital buffer relative to GBL | 9.2% | 8.2% | 7.0% | 10.3% | 9.4% | 8.2% | 10.3% | 9.5% | 8.5% |
| Cost relative to GBL | 98.5% | 97.5% | 96.4% | 99.6% | 98.7% | 97.6% | 99.6% | 98.9% | 97.8% |
| Investor contribution to capital buffer relative to GBL | 10.5% | 11.4% | 12.6% | 11.8% | 12.7% | 13.8% | 7.9% | 8.7% | 9.7% |
| Authorisation requirement relative to GBL | 109.0% | 109.0% | 109.0% | 111.4% | 111.4% | 111.4% | 107.6% | 107.6% | 107.6% |
Table C6: Approach to profit taking
Figures subject to rounding
| TPs based on gilts plus 0.75% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| Authorisation capital requirement based on investment strategy | 14.3% of GBL | 14.3% of GBL | 14.3% of GBL | 16.7% of GBL | 16.7% of GBL | 16.7% of GBL | 12.9% of GBL | 12.9% of GBL | 12.9% of GBL |
| PTCR multiple | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| Authorisation requirement - Relative to GBL | 109.0% | 109.0% | 109.0% | 111.4% | 111.4% | 111.4% | 107.6% | 107.6% | 107.6% |
| Additional profit-taking capital requirement relative to GBL | 10.7% | 7.1% | 3.6% | 12.5% | 8.4% | 4.2% | 9.6% | 6.4% | 3.2% |
| Profit requirement relative to GBL | 119.7% | 116.1% | 112.5% | 124.0% | 119.8% | 115.6% | 117.2% | 114.0% | 110.8% |
| 2018 Superfund Consultation | Implies around 117% of GBL | Implies around 117% of GBL | Implies around 117% of GBL | Implies around 120% GBL | Implies around 120% GBL | Implies around 120% GBL | Implies around 116% GBL | Implies around 116% GBL | Implies around 116% GBL |
| Cost relative to GBL | 98.5% | 97.5% | 96.4% | 99.6% | 98.7% | 97.6% | 99.6% | 98.9% | 97.8% |
| Cost relative to buyout | 94.3% | 93.4% | 92.3% | 95.4% | 94.5% | 93.4% | 95.4% | 94.7% | 93.7% |
The following is a similar assessment based on a TP discount rate of gilts plus 1% pa.
TPs based on gilts plus 1% pa
| Table C7: Approach to authorisation - Figures subject to rounding | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa | TPs based on gilts plus 1% pa |
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| Technical Provisions | 91.4% of GBL | 91.4% of GBL | 91.4% of GBL | 91.4% of GBL | 91.4% of GBL | 91.4% of GBL | 91.4% of GBL | 91.4% of GBL | 91.4% of GBL |
| 2018 Superfund Consultation | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL | Suggested at least 95% of GBL |
| Authorisation capital requirement based on investment strategy | 13.8% of GBL | 13.8% of GBL | 13.8% of GBL | 16.1% of GBL | 16.1% of GBL | 16.1% of GBL | 12.4% of GBL | 12.4% of GBL | 12.4% of GBL |
| Authorisation requirement | 105.1% of GBL | 105.1% of GBL | 105.1% of GBL | 107.5% of GBL | 107.5% of GBL | 107.5% of GBL | 103.8% of GBL | 103.8% of GBL | 103.8% of GBL |
| 2018 Superfund Consultation | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL | Suggested at least 107.5% of GBL |
| PTCR ratio | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| Initial scheme funding relative to GBL | 86.2% | 86.2% | 86.2% | 86.2% | 86.2% | 86.2% | 86.2% | 86.2% | 86.2% |
| Sponsor contribution to capital buffer relative to GBL | 10.3% | 9.4% | 8.3% | 11.3% | 10.4% | 9.4% | 11.3% | 10.6% | 9.7% |
| Cost relative to GBL | 96.6% | 95.7% | 94.5% | 97.5% | 96.6% | 95.6% | 97.6% | 96.8% | 95.9% |
| Investor contribution to capital buffer relative to GBL | 8.6% | 9.5% | 10.6% | 10.0% | 10.9% | 12.0% | 6.2% | 6.9% | 7.9% |
| Authorisation requirement relative to GBL | 105.1% | 105.1% | 105.1% | 107.5% | 107.5% | 107.5% | 103.8% | 103.8% | 103.8% |
| Additional profit-taking capital requirement relative to GBL | 10.3% | 6.9% | 3.4% | 12.1% | 8.1% | 4.0% | 9.3% | 6.2% | 3.1% |
| Profit requirement relative to GBL | 115.5% | 112.0% | 108.6% | 119.6% | 115.6% | 111.5% | 113.1% | 110.0% | 106.9% |
| 2018 Superfund Consultation | Implies around 121% of GBL | Implies around 121% of GBL | Implies around 121% of GBL | Implies around 123% GBL | Implies around 123% GBL | Implies around 123% GBL | Implies around 120% GBL | Implies around 120% GBL | Implies around 120% GBL |
| Cost relative to GBL | 96.6% | 95.7% | 94.5% | 97.5% | 96.6% | 95.6% | 97.6% | 96.8% | 95.9% |
| Cost relative to buyout | 92.5% | 91.6% | 90.5% | 93.4% | 92.6% | 91.5% | 93.4% | 92.7% | 91.9% |
Comparison of modelled profit requirements over time
The following table shows the modelled profit requirements at years 0, 10 and 20 for the credit-based and diversified strategies based on a TP discount rate of gilts plus 0.5% pa.
Table C8: Modelled profit triggers
Figures subject to rounding
| TPs based on gilts plus 0.5% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| ACR | 15.1% of TPs | 15.1% of TPs | 15.1% of TPs | 17.7% of TPs | 17.7% of TPs | 17.7% of TPs | 13.6% of TPs | 13.6% of TPs | 13.6% of TPs |
| PTCR multiple | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| TPs based on gilts plus 0.5% pa (all figures relative to GBL) | |||||||||
| Year 0 | |||||||||
| Profit requirement | 124.1% | 120.4% | 116.7% | 128.6% | 124.3% | 119.9% | 121.6% | 118.3% | 114.9% |
| Year 10 | |||||||||
| Technical Provisions | 98.9% | 98.9% | 98.9% | 98.9% | 98.9% | 98.9% | 98.9% | 98.9% | 98.9% |
| PTCR | 26.1% | 22.3% | 18.6% | 30.6% | 26.2% | 21.8% | 23.5% | 20.1% | 16.8% |
| Profit requirement | 125.0% | 121.2% | 117.5% | 129.4% | 125.1% | 120.7% | 122.4% | 119.0% | 115.7% |
| Year 20 | |||||||||
| Technical Provisions | 99.2% | 99.2% | 99.2% | 99.2% | 99.2% | 99.2% | 99.2% | 99.2% | 99.2% |
| PTCR | 26.1% | 22.4% | 18.7% | 30.6% | 26.3% | 21.9% | 23.6% | 20.2% | 16.8% |
| Profit requirement | 125.3% | 121.6% | 117.9% | 129.8% | 125.5% | 121.1% | 122.8% | 119.4% | 116.0% |
The following table shows the modelled profit requirements at years 0, 10 and 20 for the credit-based and diversified strategies based on a TP discount rate of gilts plus 0.75% pa.
Table C9: Modelled profit triggers
Figures subject to rounding
| TPs based on gilts plus 0.75% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| ACR | 15.1% of TPs | 15.1% of TPs | 15.1% of TPs | 17.7% of TPs | 17.7% of TPs | 17.7% of TPs | 13.6% of TPs | 13.6% of TPs | 13.6% of TPs |
| PTCR ratio | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| TPs based on gilts plus 0.75% pa (all figures relative to GBL) | |||||||||
| Year 0 | |||||||||
| Profit requirement | 119.7% | 116.1% | 112.5% | 124.0% | 119.8% | 115.6% | 117.2% | 114.0% | 110.8% |
| Year 10 | |||||||||
| Technical Provisions | 96.0% | 96.0% | 96.0% | 96.0% | 96.0% | 96.0% | 96.0% | 96.0% | 96.0% |
| PTCR | 25.3% | 21.7% | 18.1% | 29.7% | 25.4% | 21.2% | 22.8% | 19.6% | 16.3% |
| Profit requirement | 121.3% | 117.7% | 114.1% | 125.7% | 121.5% | 117.2% | 118.9% | 115.6% | 112.3% |
| Year 20 | |||||||||
| Technical Provisions | 97.0% | 97.0% | 97.0% | 97.0% | 97.0% | 97.0% | 97.0% | 97.0% | 97.0% |
| PTCR | 25.6% | 21.9% | 18.3% | 30.0% | 25.7% | 21.4% | 23.1% | 19.8% | 16.5% |
| Profit requirement | 122.5% | 118.9% | 115.2% | 126.9% | 122.7% | 118.4% | 120.0% | 116.7% | 113.4% |
The following table shows the modelled profit requirements at years 0, 10 and 20 for the credit-based and diversified strategies based on a TP discount rate of gilts plus 1% pa.
Table C10: Modelled profit triggers
Figures subject to rounding
| TPs based on gilts plus 1.0% pa | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Investment strategy | Strategy 1 | Strategy 1 | Strategy 1 | Strategy 2 | Strategy 2 | Strategy 2 | Strategy 3 | Strategy 3 | Strategy 3 |
| ACR | 15.1% of TPs | 15.1% of TPs | 15.1% of TPs | 17.7% of TPs | 17.7% of TPs | 17.7% of TPs | 13.6% of TPs | 13.6% of TPs | 13.6% of TPs |
| PTCR ratio | 175% | 150% | 125% | 175% | 150% | 125% | 175% | 150% | 125% |
| TPs based on gilts plus 1.0% pa (all figures relative to GBL) | |||||||||
| Year 0 | |||||||||
| Profit requirement | 115.5% | 112.0% | 108.6% | 119.6% | 115.6% | 111.5% | 113.1% | 110.0% | 106.9% |
| Year 10 | |||||||||
| Technical Provisions | 93.3% | 93.3% | 93.3% | 93.3% | 93.3% | 93.3% | 93.3% | 93.3% | 93.3% |
| PTCR | 24.6% | 21.1% | 17.6% | 28.8% | 24.7% | 20.6% | 22.2% | 19.0% | 15.8% |
| Profit requirement | 117.9% | 114.4% | 110.9% | 122.2% | 118.1% | 113.9% | 115.5% | 112.4% | 109.2% |
| Year 20 | |||||||||
| Technical Provisions | 94.8% | 94.8% | 94.8% | 94.8% | 94.8% | 94.8% | 94.8% | 94.8% | 94.8% |
| PTCR | 25.0% | 21.4% | 17.8% | 29.3% | 25.1% | 20.9% | 22.5% | 19.3% | 16.1% |
| Profit requirement | 119.8% | 116.2% | 112.7% | 124.1% | 119.9% | 115.7% | 117.3% | 114.1% | 110.9% |
Appendix D: Glossary of terms
| Term | Definition |
|---|---|
| 2018 Superfund Consultation | 7 December 2018 consultation: Consolidation of defined benefit pension schemes |
| Annual management charge (AMC) | These are a way of recouping costs applied as a percentage deduction to the assets of the fund every year. |
| Best estimate | An un-biased assessment of liability payments that is neither intentionally prudent nor optimistic and equally likely to lead to an over or underestimate of the future payments. |
| Buyout | A process in which scheme assets are transferred to an insurance company to purchase an insurance contract guaranteeing to pay the members’ benefits and allowing the Trustees to discharge their liabilities to the members and wind-up the pension scheme. |
| Capital requirements | A capital requirement is the amount of capital a bank or other financial institution must have as required by its financial regulator. These requirements are put into place to reduce the risk of these institutions becoming insolvent. |
| Discount rate | This is the rate of interest used to convert future cash-flows into a single present value. In this report, the discount rate is expressed as a margin above gilts – so using the same gilt-yield curve as the GBL (see below) but adding a margin or outperformance allowance, in this case between 0.5% pa and 1% pa. |
| Economic Scenario Generator (ESG) | A mathematical model that simulates possible future paths of economic and financial market variables. More information on the ESG used in this analysis can be found in Appendix B. |
| Gilts-based Liability (GBL) | An assessment of the present value of member liabilities (see below) determined by discounting projected future member benefit cash flows based on UK government gilt-yield curves. This reflects the cost of purchasing gilts to match the future member cash flow payments. It is used as a measurement basis or a yardstick against which different approaches can be compared. |
| Gilts-matching | In the context of an investment class, a portfolio of UK government bonds intended to provide cash-flows broadly matching liability cash-flows. |
| Hedging ratio | A measurement of how well the assets move in line with the liabilities when interest rates and inflation expectations change. It is defined as the percentage change in assets divided by the percentage change in liabilities due to changes in interest rates or inflation expectations. A hedging ratio of 100% implies that market value of assets moves broadly in line with changes in liabilities as interest rates or inflation expectations change. |
| Liability Driven Investment (LDI) | In practice, usually means using assets such as swaps and bonds to construct an investment strategy that closely matches the behaviour of the relevant pension liabilities. |
| Long-term objective | In this analysis, it is intended to meet the requirements set out in the 2018 Superfund Consultation for a superfund to have an explicit objective to be met when most non-pensioners are assumed to have retired. |
| Low dependency | Defined by TPR in their 2020 DB funding consultation as where a scheme’s funding and investment strategies are such that there is a low chance of requiring further employer support and the amount of any required support is low relative to the size of the scheme. |
| PPF drift | Defined by the PPF in its PPF Drift Guidance Note (PDF, 154KB) as the increase in the PPF’s potential liability exposure as a result of a delay in a pension scheme entering the PPF. |
| Present value of member liabilities | An assessment of the current value of future benefits payable to members determined by discounting projected future member benefit cash flows at an appropriate discount rate (see above). |
| Regulatory requirements | The combination of TPs and capital requirements that will determine the minimum superfund assets that will apply for a superfund to be authorised or to be able to pay out profit. |
| Return-on-capital (RoC) | In this case, an assumed “patient capital” return used to discount emerging profits for the purpose of determining the cost of a superfund. A measure of the commercial viability of the superfund. |
| Solvency II | The EU Directive that sets out regulatory requirements for insurance companies, covering financial resources, governance and accountability, risk assessment and management, supervision, reporting and public disclosure. |
| Solvency Capital Requirement (SCR) | A technical assessment under Solvency II of the capital required to ensure that an insurance company will be able to meet its obligations over the next 12 months with a probability of 99.5%. |
| Stochastic modelling | A tool for estimating probability distributions by allowing for random variation in one or more inputs over time. In this case we use a market-leading provider’s ESG (see above) to provide a probability distribution for the main economic factors and market returns from 1,000 randomly generated scenarios over a 40-year time horizon. |
| Superfund policy objectives | As set out in the 2018 Superfund Consultation, the proposed authorisation regime will assess whether a superfund has a viable business model, is financially sustainable, is well governed, and has a high probability of being able to pay members’ benefits as they fall due. |
| Technical Provisions (TPs) | A technical measurement of the value of the liabilities under both insurance and pension scheme funding legislation. However, the principles underlying the respective calculations are different between the two regimes. For insurers, it is the amount required to transfer the business to another insurer. In pensions, it is the amount required, on an actuarial calculation to make provision for the scheme’s liabilities on a prudent basis. |
Appendix E: Additional notes on assumptions
Liability assumptions
Part 1. The modelling is based on market conditions and longevity assumptions as at 31 December 2022 having been prepared in direct response to the 2018 Superfund Consultation. The 1,000 modelled scenarios were provided by a market-leading provider based on their “best views” calibration of their ESG as at 31 December 2022. The key assumptions are as follows:
Assumptions
Liabilities and margins
Discount rate = gilts plus 0.5% pa, 0.75% pa and gilts plus 1% pa Market implied RPI RPI-CPI wedge of 0.9% pa pre 2030 and 0.1% pa post 2030 Commutation = 90% of maximum at 17.5 at scheme NRA Mortality = PPF S179 based on A10 Guidance
Combined allowance for per member expenses and longevity risk reserve equivalent to 6% of liabilities at year 0 reducing geometrically to 4% of liabilities at year 20. Per member expenses of 2.5% of cash-flow are deducted from assets each year when benefits are paid out. Any remaining per member costs as well as investment management and PPF levies are then included in the AMC deducted from assets at each year-end
Part 2. The buyout basis is based on the same best estimate cash-flows as the TPs; however, the discount rate is based on the same gilts curve with straight line adjustment: +0.85% at the short end; and -1.125% at the long end. This is broadly equivalent to a discount rate of gilts plus 0.3% pa for pensioners and gilts minus 0.10% pa for deferred members. The assumption for the buyout discount rate reflects the approach taken by the PPF in the guidance note B10 for PPF Section 143 valuations issued after the modelling date. Further adjustments have been applied to the buyout liabilities to allow for:
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a slightly more prudent discount rate for buyout compared to PPF liabilities given PPF assumptions are intended to be competitive;
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more prudent commutation terms that are cost neutral versus buyout adding c. 3.4% to the initial buyout liabilities; and
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a pre-2030 CPI assumption based on a 0.2% pa deduction to market implied RPI rather than 0.9% pa used in TPs adding c. 1.1% to the initial buyout liabilities.
Part 3. A similar term structure approach has been used to value PPF liabilities as for buyout with the term structure being set so that the buyout value of PPF benefits is broadly equivalent to the PPF S179 valuation at outset based on A10 assumptions. The 2018 Superfund Consultation proposed a PPF winding-up trigger of 105% of the PPF S179 liabilities. To reflect the fact that the PPF updated their guidance on financial assumptions to use for PPF S179 valuations following the modelling date, and the fact the buyout valuation financial assumptions are more consistent with the updated PPF guidance, we have assumed a superfund winding-up trigger of 103.5% of the estimated PPF S179 liabilities to make an allowance for the change in the valuation guidance after the modelling date. A similar allowance has been made for winding-up expenses of 0.5% of liabilities.