It has become very clear that all sponsors and Trustees of pension schemes should now be well on the way to formulating the pensions “end-game” if they haven’t already. The majority of UK defined benefit (DB) pension schemes are well passed the stage in their lives where moving from valuation to valuation without knowing the ultimate direction is viable. Indeed the introduction of the DB chair statement in 2019 will force strategy planning on the trustees of even the minority of pension schemes that might still have time on their side.
Planning the end-game is now more complex, with an increasing number of destinations (such as commercial consolidators), investment techniques to utilise (for example, Cashflow Driven Investing, Liability Driven Investing, cashflow buy-ins and equity derivatives) and a larger number of transition vehicles now being available (like DB Master Trusts, “Insured self-sufficiency”, and Clara).
Indeed, the concept of strategy planning itself needs to be re-examined in some cases. I can point to the common strategy of “self-sufficiency” as an example. Defining self-sufficiency used to be as easy as choosing a discount rate between Gilts +0.25% and Gilts +0.5%, and hey-presto, the strategy had been set. Firstly, self-sufficiency is rarely going to be a final destination in itself for smaller schemes – asset availability and scheme shrinkage means that in most cases, self-sufficiency is merely part of a low-risk strategy to allow schemes to mature safely before they are ultimately secured with an insurer. Secondly, setting the right actuarial basis requires first selecting the right investment strategy, and then solving for an appropriate discount rate. Merely choosing a “house-view” discount rate won’t cut it.
A strategy should also have a time dimension – merely having a secondary funding target that you aim for isn’t sufficient to ensure the strategy is appropriate. For example, a scheme rarely has a sponsor that is able to offer a stable covenant over extended periods of time. Visibility of covenant strength reduces over time, and confidence in forecasts typically drop significantly after 5 years. This doesn’t mean the end-game needs to be reached within 5 years, but aligning planned scheme risk with covenant visibility within the funding plan makes sense – Trustees can always retain risk within the scheme as visibility improves as time passes.
The Department for Work & Pensions (DWP) has very recently put out a consultation which attempts to set some operating parameters around commercial consolidators. One such parameter set by the DWP is the need for the consolidator to demonstrate 99% safety. As clarity increases, Trustees will need to be able to consider the full spectrum of destinations and paths to those destinations to be able to demonstrate that they are considering all the options, and once defined, the tools available to get to those destinations with increased certainty where possible.
Using asset-side tools to help reach the end-game seems obvious, but a number of schemes should be thinking about liability side tools too, not least because in a lot of cases, liability side tools provide members with enhanced communication, subsidised or paid-for advice and options to adapt their benefits for their own planned lifestyles.
So setting a pensions strategy may well be more complicated than sponsors and trustees expected, but staying on top of the options and being nimble to change these as new opportunities arise or sponsor circumstances change is critical to ensure the best outcome for members.