“Unprecedented” feels like the only word that really fits the bill for the world in 2022. Certainly in my living memory at least, as inflation, energy costs and rising interest rates put pressure on many businesses and households; it appears to be only a matter of time before another recession takes grip of the country.

However, and in contrast to some previous periods of economic difficulty, many schemes have seen their funding levels improve rapidly, as gilt yields rise from historically low levels. For example, one scheme that I act for has seen its funding level increase from 90% to 120% since the beginning of March. Add rising credit spreads and a competitive buy-out market into the mix, and many schemes have seen the timescale to buy-out fall substantially.

Challenges and Opportunities

Current market circumstances present significant opportunities, as well as some challenges, for both trustees and employers in relation to their pension scheme strategy. See below some of the actions that I and other 20-20 Trustees colleagues have taken, with some thoughts around trends that could emerge in the next 6 to 12 months:

• Compressing valuation timetables – triennial valuation dates falling in late 2021/early 2022 have largely been good news stories. We have put in place accelerated timetables for a number of schemes, particularly where the scheme has moved into a surplus position on a technical provisions basis. There may well be other situations where trustees or employers move to bring forward triennial valuation dates in order to avoid the risk of trapped surpluses where material contributions are still being made.
• Considering contingent funding mechanisms – the volatility in funding levels may lead to a resurgence of contingent funding mechanisms in order to avoid the risk of overfunding. This can be achieved, for example, through mechanisms being built into the schedule of contributions or other structures such as escrow accounts or reservoir trusts being put in place.
• Implementing investment strategy changes – for the scheme mentioned above, we have taken steps to de-risk its investment strategy and increase interest rate and inflation hedging levels in order to lock-in the current strong funding position. This is a fairly extreme example where hedging levels were very low to begin with. However, most trustee boards will benefit from a review of how assets and liabilities have moved in the recent turbulent months. This could identify the need to recalibrate investment strategy and hedging instruments or to reassess long term strategy more holistically.
• Bringing forward an approach to the buy-out market – at least two of my schemes, and a number of others in the 20-20 Trustees portfolio, are looking to approach the buy-out market in the next few months as funding levels and buy-out pricing are much better than originally anticipated. Others are seeking indicative pricing whilst potentially revisiting strategies. An approach to the insurance market doesn’t happen overnight and insurers will be far more likely to engage when schemes are well prepared. Data cleansing and GMP equalisation are key areas to address but there are capacity constraints in the industry to contend with. Recent experience suggests that in some cases it can take up to two years to properly prepare a scheme for buy-out. See our Risk Transfer Factsheet for an overview of our extensive experience of risk transfer projects.

The trends and actions above are likely to be in the interest of sponsors as well as trustees.  There may also be sponsor-specific opportunities: for example, where a scheme with a large deficit has been a blocker to a corporate transaction. This may now not be the case. In a small number of cases where the sponsor has a material risk of insolvency, it may be that a compromise of scheme liabilities by an employer (via a regulated apportionment arrangement or company voluntary arrangement, subject to appropriate mitigation) has become more affordable. I am part of a group within 20-20 Trustees who specialise in acting in corporate transaction and restructuring scenarios.

There is a lot for trustees and sponsors to think about right now. In my view, the benefits of appointing an independent trustee who can bring their broad market experience to the table have never been clearer.

It is a fascinating time to be a trustee and I look forward to seeing what lies ahead in the next few months.

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