Long term planning
It is increasingly common (and a key focus of the Pensions Regulator) for schemes to have a long term funding and investment strategy. The concept is that the sponsor and the trustees sign up to a plan to reach full funding over a specified period with targets and triggers for:
- funding – typically a buy-out or self-sufficiency measure is used
- asset allocation – how to de-risk over time.
Companies can be put off by both the nature of the commitment and the fees and management time needed to explore the concept. Whilst for some companies there can be a significant advantage in agreeing a long term plan, the funding and investment strategy needs to be simple to manage and flexible enough to address corporate objectives.
Our team will help you to develop your plan and make sure it is practical to implement. We understand the issues which the trustees and their advisers will need to work through, so we can ensure that the design of your plan avoids any unnecessary hurdles to agreement.
The trustees of a £5 billion pension scheme were keen to introduce a long-term investment de-risking strategy with an associated secondary funding target. The trustees proposed a de-risking strategy involving switching from equities into long-dated gilts and a secondary funding target based on unadjusted gilt yields and a 12 year recovery period.
This proposal resulted in expected company contributions of £100 million a year, which was more than the company was prepared to pay. However, of at least equal concern to the company was the exposure to the risk of much higher contributions if scheme experience was poor. In rough terms there was a 1 in 20 chance of annual contributions increasing to £160 million at the next valuation, if the company signed up to the trustees’ proposals.
Faced with not securing any type of longer-term funding deal, the trustees were open to exploring alternative de-risking strategies, overlaid with derivatives in the early years to increase interest rate and inflation hedging. With our support, the company reached an agreement with the trustees that the secondary target would use a discount rate of gilts + 0.3%, reducing expected annual contributions from £100 million to £60 million over a 15 year period. However, the risk of highly volatile contributions remained, so the next step in the design was to introduce a flexible recovery period.
The design involved the following features:
- the company committed to always pay at least £60 million a year, until the secondary target was fully funded. This meant that, if scheme experience was favourable, the scheme would be fully funded within 10 years
- the company committed to ensuring the secondary target was met within 18 years, so the initial 15 year period could be “flexed up” if there was poor experience in the short term.
With this investment and recovery plan design, the 1 in 20 risk was reduced from £160 million to £100 million.
In the news this week, the pensions world continues to be dominated by the impact of the Covid-19 pandemic, with the Regulator publishing more guidance for employers, the FCA delaying the implementation of its drawdown investment pathways and two household name companies deferring (or missing) their deficit recovery contributions.
Over the autumn of 2019, BAC conducted an extensive survey of the actions which companies are taking to manage their defined benefit (DB) and defined contribution (DC) pension arrangements.
2019 marked 50 years since Neil Armstrong walked on the moon and this was obviously on the Queen’s mind in her Christmas message as she talked about a bumpy year but one with small steps of progress as well. In terms of pensions, it also felt like a year of small steps and occasional bumps. In this quarter’s Arena, we take a positive look back at 2019, as well as looking forward to some expected pension developments over 2020.
Despite the very different circumstances facing individual companies, bac‘s autumn 2019 survey reveals a surprisingly consistent picture of the actions which companies are finding most attractive to manage their DB and DC pension arrangements.
As DB liabilities have become legacy issues to be managed, governance has become the umbrella term for a broad range of risk management tools. In this publication, we look at the DB governance solutions we have helped our clients to implement.