De-risking DB pension schemes

John Towner explains how sponsoring companies are increasing the affordability of buy-ins and buyouts.

Over the past ten years companies have put on the order of £150 billion into their respective schemes to plug deficits. This is a number that is roughly equivalent to one year’s profits of the FTSE 100. Today there are still £2 trillion of DB pension liabilities sitting on companies’ balance sheets in the UK.

Despite this apparent lack of progress, sponsoring companies continue to take steps to address their pension obligations. In addition to making significant cash contributions, many companies have worked with their trustee boards to manage down risk and have increasingly closed their schemes to new members and future accrual. The Purple Book 2017 reported that 86% of the 5,588 pension schemes in the UK are now closed to either new entrants or future accrual.

When a pension scheme closes to new accrual, this is often the moment that the scheme truly becomes a legacy issue for the sponsoring company, as it shifts from being a recruitment or retention tool to being more of a financial management exercise. As this occurs, control and management of the pension scheme often shifts from the HR department to the corporate treasury.

While the ultimate goal for many corporate treasuries will be to transfer these legacy DB obligations to an insurance company, we frequently hear companies say that a buy-in or buyout is an unachievable aim. Many companies' - and indeed trustees' - expectations of the cost of a buy-in or buyout are often anchored around the scheme actuary's solvency estimate and it is important to recognise that this figure is exactly that - an estimate.

Our experience has been that the actual cost of a buy-in or buyout can be significantly less than anticipated. In fact, transactions, such as automotive safety firm TRW's £2.5bn partial buyout, have demonstrated that in addition to thorough preparation, such as ensuring membership data is up-to-date, companies and trustees can take a more dynamic approach to increase affordability further.

Phased buy-ins

Although the traditional view of the route to buyout is of a smooth increase in the scheme's funding level to the point at which a buyout becomes affordable, the journey, in reality, is often more volatile.

The upside of this volatility is that opportunities may present themselves over time as scheme assets increase in value relative to insurer pricing, which opportunistic schemes can capture by putting in place a buy-in covering a proportion of the liabilities. Rather than waiting to transfer all of the risk to an insurance company at a single point in time, this approach enables companies to take risk off the table gradually, in line with the scheme's journey plan.

Liability management

Increasing numbers of companies are running liability management exercises, such as transfer value or pension increase exchange offers, in conjunction with a buy-in or buyout project. Through these exercises, the scheme is able to offer members greater choice and flexibility in how they take their pensions, while reshaping the scheme's benefit obligations in preparation for transfer to an insurance company. Companies that have schemes with more complex benefit structures are adopting this approach more frequently both to increase affordability and transfer a larger proportion of their liabilities to an insurance company than they otherwise could.

These are just a few examples of how insurers are helping sponsoring companies and trustees achieve and accelerate their de-risking plans.

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John Towner

Article written by:

John Towner

Head of Origination

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