Pensions Arena

October 2020

Governance actions

Pandemic “normal”

Operational

Trustees and advisers

Corporate actions

Covenant funding

Investment

DC

Pension developments

Dashboard data

GMP equalisation 

Tax relief for low earners

CDC schemes

Climate risk

Minimum pension age

DC consolidation

Pandemic mortality

Small pots

PPF levies for 2021/22

Pensions tax relief

Company news

De-risking

Funding

Plan design

Article

Endgame planning comes of age

Whilst journey plans have been around for many years, there’s now an increased focus from both companies and trustees, not least because of the Pensions Regulator’s views.

Whilst the impact of the Covid-19 pandemic may slow down formal implementation of the new funding code, it seems inevitable that “endgame” planning will be enshrined in future funding standards.

In this article, which summarises our recent Pensions Perspective, we look at how long-term funding and investment plans are evolving and why companies are increasingly taking the lead in designing an endgame strategy.

What has changed?

In 2020 most DB schemes are maturing rapidly, whilst there is a wider range of solutions allowing sponsors to pass on their liabilities to another financial institution. This has created an increased focus on what the endgame is likely to be – will it be long-term run-off, insurance buyout or transfer to one of the new DB consolidators? Almost as important, what is the planned timeframe?

The answers to these questions can have a profound effect on future investment strategy and the pace of sponsor funding. New designs usually have some key features in common – features that look different from “first generation” journey plans.

If implemented as expected, TPR’s new funding framework will provide helpful guidance for developing strategies that will support what it calls Fast Track approval. However, whilst there is likely to be a little scope for design flexibility within Fast Track, some schemes will naturally want to choose the Bespoke route.

Company interest

In the past, the main stumbling block to implementing journey plans was company concerns about being locked into a strategy that could create unwelcome cash and accounting issues in the future. However, with increased Regulator interest in the relative levels of deficit contributions and dividends, volatile scheme funding levels have never looked less attractive to sponsors. The pandemic and resulting economic fallout are only likely to reinforce this mindset.

The challenge is to find a solution that balances the higher cash contributions or accounting pain against the reduction in volatility. New approaches to setting funding targets and designing recovery plans can help. Whilst this does not mean that companies will develop solutions that appeal to trustees, the growing level of corporate engagement in the endgame debate is helping trustees and companies develop strategies that reflect a consensus position.

Investment strategies

Historically, some companies would not engage with a long-term investment de-risking strategy because of a concern that very low gilt yields were an aberration. However, over time, the weight of economic evidence has led many sponsors to accept that a quick and significant rise in gilt yields is unlikely to happen.

Many schemes have considered alternative investments to the main asset classes – for example other forms of high-quality debt, multi-asset credit, infrastructure and other illiquid assets. Through the use of various credit and illiquidity premiums, these strategies can typically expect to achieve returns of gilts plus 50-100 basis points a year.

There is a big prize here for a trustee board that has previously failed to gain traction with the sponsor on de-risking targets. From the company’s perspective, whilst de-risking still comes at a cost, it has the comfort of knowing that its cash is being invested intelligently to target a return in excess of gilts.

However, a word of warning. Alternative investments can be attractive and helpful, but they are not always easy to sell quickly. Some schemes have been caught out when they unexpectedly have an opportunity to transact with an insurer, only to find that they are locked into assets that are not acceptable to that insurer.

Funding targets

A low risk funding target which reflects an expected investment return in excess of gilt yields can greatly increase the likelihood of the company being prepared to sign up to a long-term de-risking plan. However, it also presents the trustees with two key concerns:

  • how to quantify the additional investment risk?
  • even when fully funded, won’t the scheme be some way from buyout?

The first concern needs to be addressed by good quality investment advice and sound risk modelling. The second is unlikely to prove true in practice because a plan that targets being fully funded on a low risk target after, say, 15 years is likely to comprise mainly current pensioner liabilities by that time.

It is helpful that the Regulator has suggested a long-term discount rate in the range from gilts + 0.25% to gilts + 0.5%, as this provides a useful reference point for companies and trustees.

The solutions described earlier are effective at managing down expected costs but in the short term, whilst the scheme may still be running material investment risk, volatile contributions remain a serious issue. Without finding a way to manage this volatility, companies will be concerned about signing up.

One solution is for the funding target to include margins for prudence that can be flexed depending on when actual investment de-risking happens. Another is to adopt a flexible recovery period, capable of changing in a pre-defined manner to help stabilise contributions. At present, such flexibilities require the low risk target to be introduced as a secondary funding target, rather than the technical provisions.

The last word

By adopting some of the more creative approaches described in this article, it should be possible to keep de-risking strategies on track within a framework that significantly increases the chance of the company’s costs remaining affordable and reasonably stable over time. And to do so within the constraints of the new funding code.

The prize for getting this right is simply too big for either the company or the trustees to ignore. For more details on how bac can support you cost-effectively in developing a flexible long-term strategy, please contact one of our senior team at contact us.

Dashboard

Investment returns by asset class

Investment yields

Annual rate of inflation (%)

30/09/2019 31/12/2019 31/03/2020 30/06/2020 30/09/2020
Expected RPI inflation over 20 years
3.46%
3.36%
3.00%
3.23%
3.26%
Index-linked gilts
-2.21%
-1.85%
-1.93%
-2.39%
-2.30%
Fixed interest gilts
0.95%
1.30%
0.83%
0.64%
0.74%
Corporate bonds
1.81%
2.00%
2.31%
1.46%
1.54%

Investment yields

30/06/19 30/09/19 31/12/19 31/03/20 30/06/20
Expected RPI inflation over 20 years
3.55%
3.46%
3.36%
3.00%
3.23%
Index-linked gilts
-1.90%
-2.21%
-1.85%
-1.93%
-2.39%
Fixed interest gilts
1.44%
0.95%
1.30%
0.83%
0.64%
Corporate bonds
2.25%
1.81%
2.00%
2.31%
1.46%
  • 30/09/19    ~    3.46%
  • 31/12/19    ~    3.36%
  • 31/03/20    ~    3.00%
  • 30/06/20    ~    3.23 %
  • 30/09/20    ~    3.26%
  • 30/09/19    ~    -2.21%
  • 31/12/19    ~    -1.85%
  • 31/03/20    ~    -1.93%
  • 30/06/20    ~    -2.39%
  • 30/09/20    ~    -2.30%
  • 30/09/19    ~    0.95%
  • 31/12/19    ~    1.30%
  • 31/03/20    ~    0.83%
  • 30/06/20    ~    0.64%
  • 30/09/20    ~    0.74%
  • 30/09/19    ~    1.81%
  • 31/12/19    ~    2.00%
  • 31/03/20    ~    2.31%
  • 30/06/20    ~    1.46%
  • 30/09/20    ~    1.54%

Annual rate of inflation (%)

Sources for market indices​

  • UK equities: FTSE Actuaries All-Share Index
  • Global equities: FTSE All-World Index (Large/Mid Cap) – in sterling
  • Index-linked gilts: FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
  • Fixed interest gilts: FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
  • Corporate bonds: iBoxx over 15 years AA corporate bond index
  • Expected RPI inflation over 20 years: Bank of England RPI implied inflation spot curve at 20 years (force of interest)
UK equities
FTSE Actuaries All-Share Index
Global equities
FTSE All-World Index (Large/Mid Cap) - in sterling
Index-linked gilts
FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
Fixed interest gilts
FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
Corporate bonds
iBoxx over 15 year AA corporate bond index
Expected RPI inflation over 20 years
Bank of England RPI implied inflation spot curve at 20 years (force of interest)

Almanac

Governance actions

Pandemic “normal”

  • Some pension administrators have struggled to meet acceptable service levels due to new working pattens – are you monitoring the performance for your scheme?
  • Have the trustees reviewed their risk register in the last six months? The economic fallout from the pandemic will have moved some key risks significantly.
  • Have you identified any key person risks and taken appropriate action to mitigate them?

Operational

  • Have furlough and other corporate cost control measures meant a reduction in the scheme’s resources and, if so, has this affected delivery?
  • Trustees need to ensure that their scheme is appropriately resourced and raise any concerns with the employer at an early stage.

Trustees and advisers

  • An increasing number of trustee boards are looking at the possibility of introducing one or more independent trustees as an option for strengthening their boards.
  • Pressure to manage adviser fees is high – have you reviewed your scheme’s advisers within the last three years?

Corporate actions

Covenant and funding

  • Make sure your trustees are not jumping to false conclusions about how the pandemic has and is affecting the sponsor’s covenant, nor what a no-deal Brexit might mean. Be on the front foot – communicate, communicate and communicate!
  • Companies will need to balance the requirements of lenders, shareholders and trustees when developing their business recovery plans.

Investment

  • Depending on the impact of the pandemic, you may need to review the company’s risk appetite and what this means for your scheme’s investment strategy.
  • Illiquid investment classes, such as property and infrastructure, should be carefully reviewed.

DC

  • Employees will have seen huge volatility in the value of their DC funds since March 2020. Make sure you are engaging with employees, to avoid them making rash decisions.
  • Seek to provide the maximum protection possible for your employees against pension scams, which have risen significantly during the pandemic.
  • Some DC providers have had delivery issues due to new working patterns – are you monitoring your provider’s performance?

Pension developments / Company news

Pension developments

July

Dashboard data

  • the Pensions Dashboards Programme launched a call for input on the data standards required for dashboards, with the aim of publishing a first version of the standards in the autumn.

GMP equalisation

  • HMRC published guidance to clarify the treatment of previously paid lump sum benefits and the future payment of lump sums required as a result of GMP equalisation. GMP conversion was not covered.

Tax relief for low earners

  • the Treasury published a call for evidence on the administration of pensions tax relief, looking at the impact on low earners of their employer’s scheme using either the net pay or relief at source methods.

CDC schemes

  • the Treasury published draft tax legislation that would allow Collective Defined Contribution schemes to operate as UK registered pension schemes from 6 April 2021.

August

Climate risk

  • the DWP published a consultation with proposals to require larger schemes to address the risks and opportunities from climate change, including calculating their carbon footprint. Schemes with £5 billion or more of assets and all master trusts will need to comply from October 2021 and report by the end of 2022.

September

Minimum pension age

  • the Government confirmed that it plans to legislate to increase the minimum age at which people can access their pension from 55 to 57 in 2028.

DC consolidation

  • the DWP published a further consultation on value for money in DC occupational schemes and draft legislation to take effect from 5 October 2021. The proposals are designed to improve outcomes for members, specifically of DC schemes with assets of less than £100 million which cannot demonstrate good value. Such schemes will be required to wind up and consolidate.

Pandemic mortality

  • the CMI consulted on how to allow for 2020’s exceptional mortality data within the next annual update of its model. The proposal is for the core version to exclude the 2020 data entirely, although users will be able to place more or less weight on individual years.

Small pots

  • the DWP launched a cross-sector working group to look at the problems caused by the growth in the number of small DC deferred pension pots. The aim is to report this autumn.

PPF levies for 2021/22

  • the PPF expects to collect £520 million in levies in 2021/22, some £100 million less than this year. It is proposing an adjustment that halves the risk-based levy for small schemes (those with less than £20 million in liabilities). Overall it estimates that 89% of schemes will see a reduction in their levy next year, with the main impact from Covid-19 being felt via an increases in levies in 2022/23.

Pensions tax relief

  • the Government disagreed with the Public Accounts Committee’s recommendation that it should evaluate the impact of pension tax reliefs, arguing that it has undertaken several consultations on aspects of pension tax relief over recent years.

Company news

De-risking

  • UBS’s UK scheme completed a £1.4 billion longevity swap involving a passthrough insurance contract with Zurich, with the longevity risk then reinsured with Canada Life.
  • The Littlewoods Pension Scheme transacted a buy-in with Rothesay Life for £930 million covering 6,500 members, of whom more than 90% were deferred pensioners.
  • The Marathon Service (GB) scheme completed a £610 million buy-in with Rothesay Life, securing benefits in full for its members.
  • The LV= scheme agreed an £800 million buy-in with Phoenix Life, which involved converting an existing longevity swap with ReAssure.
  • The Siemens Benefits Scheme agreed a £530 million pensioner buy-in with Legal & General.
  • The Hitachi UK scheme completed a £275 million buy-in with Legal & General.
  • The TI Group Pension Scheme transacted a £142 million buy-in with Aviva, the sixth bulk annuity it has secured.

Funding

  • Covid-19 led Capita to delay a £31.7 million deficit contribution, due in June 2020, until the second-half of 2020.
  • Coats deferred the payment of 9 months of 2020 deficit contributions, amounting to £13 million, until an 18-month period starting in mid-2021.
  • The Barclays scheme used a deficit contribution of £500 million, plus £250 million of scheme assets, to subscribe to a bond, which was backed by gilts but issued by an entity within the Barclays Group.
  • The Universities Superannuation Scheme’s trustee launched a consultation with Universities UK on the proposed methodology and assumptions for its 2020 valuation. The proposals cover a wide range of outcomes, with total contributions (a shared responsibility of sponsor and members) ranging from 41% to 68% of payroll!

Plan design

  • Rolls-Royce consulted on bringing forward the closure of its DB scheme to future accrual by 4 years, as a result of the pandemic.