The endgame for defined benefit schemes - Every cloud has a silver lining
May 15, 2019
I can vividly remember the time in my life when I have felt most cold. As a teenager, I joined my Dad in climbing up Snowdon one November day and the higher we went into the cloud the more damp and cold I got. Eventually we had to stop and use up all our supplies of Kendal Mint Cake (other sugar-based snacks are available) to recharge before the final push for the summit. My other vivid memory is that after that emergency snack stop we reached the summit all of one minute later! – with the cloud cover we had no idea where the summit was and were 50 metres away from a warm cafe whilst we shivered on the slopes below.
In recent years many UK pension schemes may feel like they have been a one-way journey to the summit of an insurance buyout, driven by positive financial impacts from scheme asset performance, member movements and reduced buy-out pricing. In the two years from September 2016 to September 2018 the total buy-out funding level across UK Defined Benefit pension schemes improved by c15% (see graph below). This improved position has been reflected in practice by the much-publicised increase in schemes investigating and entering buy-in and buy-out transactions during 2018 and 2019.
UK pension schemes historical buyout funding level
One interesting feature about this rush to buyout is that a number of schemes have reached buy-out with funds remaining – i.e. reaching the summit earlier than expected and seeing a return of funds to the sponsoring employer (with an associated tax charge). Much like my experience at the top of Snowdon, hindsight is a wonderful thing and pension schemes need to be considering the route to exit well in advance of being in the place where it becomes affordable.
This is where seemingly bad news isn’t all bad news. In the last 6 months we have seen a fall-back in scheme buy-out funding positions – since 30 September 2018 a typical scheme would have seen a fall of up to 5% in their buyout funding level. Rather than taking their eyes off the buyout goal, we are seeing our clients embracing the breathing space to get much better visibility of the end point and the opportunity to plan an efficient route through to full de-risking.
As noted in our Pensions Endgame introduction article, taking a few steps backwards enables pension schemes to set a clear strategy that takes the right steps, in the right order at the right time. This message is even more pertinent following the Pension Regulator’s Annual Funding Statement which expects all schemes to set a ‘Long Term Funding Target’.
With more options than ever available for the routes which schemes can take through to full de-risking, approaching this from lower down the slopes means the optimal outcome for a scheme is much more likely. Pension scheme trustees and sponsors shouldn’t take a drop back in buy-out funding level as a reason to put endgame thinking back to another day.
Take the opportunity to set the best strategy now from beneath the clouds!
Please contact myself or my team members (contact details below) for more information.