The companies we surveyed had aggregate pension liabilities in excess of £100 billion. Despite the very different circumstances facing individual companies, the survey reveals a surprisingly consistent picture of the actions proving most attractive to companies.
Companies are continuing to focus on the two main options which can be introduced at the time when an employed or deferred member retires:
- a pension increase exchange (PIE) offer
- a partial or full transfer out of benefits.
Almost all schemes make an explicit assumption within their funding basis for the proportion of members that will exercise the cash commutation option. This principle is now routinely extended to PIE options at retirement (which are usually designed to help improve a scheme’s funding position). The same is not true for transfers, although a small number of companies have told us that their recovery plan includes an allowance for the impact of future transfers out.
These retirement options continue to prove attractive to companies (and relatively easy for trustees to agree) because they do not involve a bulk exercise or a cash injection from the company. Around 75% of the companies we surveyed said they have already introduced or are planning to introduce a PIE option at retirement.
Introducing a PIE option can lead to some knock-on issues. For a start, the implementation process means that retirement calculations need to be looked at in a lot of detail. In some cases, this can highlight a potential problem with current administrative practices. Another common issue is that the discussion with the trustees about the introduction of a PIE option tends to shine a spotlight on the current cash commutation terms.
A major focus for companies and trustees is how best to communicate and support their members who are considering retirement options. There is a wide spectrum of support that can be offered and this will naturally affect member take-up. Over 50% of respondents plan to provide some form of member modeller and a panel of IFAs.
A combination of the maturing nature of DB liabilities, good governance and regulatory pressure has meant sponsors and trustees are now carefully considering the strategy and timeframe for running off their DB arrangements. There are essentially three options: continue to run off with the sponsor, transfer to an insurer, or work with the new DB consolidators (this final option is still very much in its infancy, but nevertheless could become mainstream over the coming years).
Over 90% of companies surveyed, whether they have an existing long-term strategy or not, are reviewing what the endgame should look like and the implications for investment strategy and member options. In some cases, this is leading to longer term deficit recovery plans (targeting a low risk funding target, rather than technical provisions). These are designed to produce relatively stable cash contributions and are often backed by guarantees and/or asset-backed security.
Interestingly, there are quite divergent views amongst companies about whether or not it would be helpful to finalise any new strategies before or after seeing the two funding consultations from the Pensions Regulator expected in 2020. Some are taking the view that the funding regime in the UK will continue to be built on the premise of scheme-specific
decisions. Others are concerned that it would be premature to implement fundamental changes to investment or funding strategies before having more understanding of future Regulator thinking.
Alternatives to gilts
About 30% of companies surveyed have either introduced or are at an advanced stage of considering a move away from a “gilts plus” methodology for funding their DB scheme. Alternative funding approaches are focused on having a clear view about how the investments are likely to evolve as the scheme matures. They need to reflect a prudent view of expected returns, taking into account expected changes in the investment strategy over time.
This can lead to some very interesting discussions. If the sponsor and trustees agree a scheme is heading towards buyout, what view do they take on the portfolio of assets that an insurer may want 15 years from now? Equally, if you decide the scheme should not target buyout and instead will run off benefits for the foreseeable future, you are effectively operating the scheme as a mini insurer outside the insurance regulatory framework.
It is not straightforward to move away from a “gilts plus” methodology but can be well worth the effort. It requires the trustees and the company to be closely aligned in funding and investment principles and, if necessary, to be willing to present a joined-up position in response to any Pensions Regulator challenge. This approach works best when integrated with a clear “endgame” strategy, as described above.
Virtually all companies surveyed expect to seek an insurance solution for some or all of their scheme liabilities within the next 10 years (over 50% of respondents are looking at a 5-year timeframe). As a result, companies and trustees are now developing long-term project plans to get their schemes “deal ready”, i.e. data cleansing, benefit audits and adjustments to investment strategy.
Overhaul of risk management
Tougher pension regulation and rising pension costs have meant that pension risk has moved up the corporate agenda. As a result, companies are now far more focused on improving their pension scheme risk metrics and risk monitoring frameworks.
Increasingly, sponsors are taking a much greater interest in trustee risk registers. In particular, companies want to ensure that:
- they have a clear understanding of how their trustees are assessing and managing risk
- how the company assesses pension risk is aligned with the trustees’ risk assessment, so they share a common framework and language to manage pension risk.
The first concerns how best to improve their governance to meet the increasing complexity and regulatory demands of DC pension provision. Here we are seeing three solutions:
- the strengthening of DC trustee boards via the use of professional trustees and reviews of advisers
- the introduction of a company governance committee for contract-based arrangements, in order to provide proper oversight of the DC plan
- a move to a master trust, possibly combined with a new governance committee.
bac has written a number of in-depth articles on the actions covered in this BAC Briefing, so please see our website for more details. Alternatively, if you would like to discuss any of the findings of the survey, please contact a member of the BAC team.
In the news this week, the second Lloyds judgement says that historic transfer payments need to reflect GMP equalisation, the Pension Schemes Bill moves back to the Lords, TPR gets tough on AE compliance, the FCA surveys DB transfer advisers again and another buy-in is completed.
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