Endgame innovation

Frankie Borrell examines how endgame approaches have evolved with new innovation available for DB pension schemes

Endgame planning will likely come into sharper focus for many defined benefit (DB) pension scheme trustees this year, driven by improving funding levels and The Pensions Regulator’s planned consultations on a clearer framework for setting a long-term funding target (LTFT).
Indeed, the regulator’s 2019 annual funding statement states that trustees and their corporate sponsors should not only agree a LTFT but also be prepared to evidence that their short-term investment and funding strategies are aligned with it.
For any given DB pension scheme, the journey to the LTFT or even the LTFT itself will depend on many factors. The strength of the employer covenant, scheme funding level and maturity are key factors.

As the regulatory landscape evolves, so have the de-risking tools and solutions available to trustees, to help them better secure and protect their members’ benefits. Both established providers and new entrants are rising to the challenge of providing greater access and choice for the £1.9 trn of DB pension liabilities remaining in the UK.

The buyout market: From strength to strength

The transfer of all or part of a pension scheme’s liabilities to an insurer has been a tried and tested staple of the endgame management toolkit for more than 30 years. Recent demand has been unprecedented, with ever more trustees attracted to the security that a bulk annuity delivers.

Insurers have increased their capacity significantly. Across 2019, it’s estimated that more than £40bn of liabilities were entrusted to UK insurers via the use of buy-ins or buyouts1. This is a staggering 325% increase on the volume just two years prior. Employee benefit consultants and other advisors who work with pension schemes on buy-ins and buyouts estimate that this level of demand will continue for at least the next ten years.

Investment and governance solutions

From an investment perspective, de-risking has evolved from hedging interest rate and inflation risk to the use of holistic, cashflowmatched investment strategies. This refined approach to managing risk involves aligning income and principal receipts to meet cash outgo. Historically associated with insurers, we’ve seen adoption of this low-risk approach among cashflow-negative pension schemes nearly double from 2018 into 2019.

Solutions aimed at enhancing governance frameworks appear to be a further natural by-product of the growing need for a joined-up approach to managing pension related risks. Nearly one in five pension schemes have now adopted a fiduciary management framework for their investments3. We have also observed the advent of more efficient multi-employer occupational schemes, known as DB master trusts, and professional trustees.

Insurance-led innovation

Keen to widen their remit, insurers have shown themselves open to innovation: one example is an Assured Payment Policy (APP), which allows a pension scheme to lock down investment risk by providing protection against changes in asset yields, interest rates and inflation.

APPs and the more established use of longevity insurance contracts effectively mean that a pension scheme can be more selective in the choice and timing of the risks to insure along its journey. The AIB Group UK Pension Scheme was the first to make use of an APP in its de-risking journey, completing a transaction with Legal & General at the end of last year.

The elephant in the room: Sponsor insolvency

Of course, even the best run pension scheme, with effective de-risking solutions in place, can find itself in an unenviable place upon the insolvency of its sponsor: a PPF+ buyout, or entry into the PPF.

The recent debate around pension consolidation vehicles – such as Clara Pensions or the Pensions Superfund – has focused on the challenge of making risk transfer more accessible. This challenge is particularly pertinent for a pension scheme which cannot yet afford a buyout and where there is a weak sponsor covenant, meaning that the risks associated with achieving and then maintaining the LTFT are too high.

Insured Self-Sufficiency (ISS) is another example of a new combined investment and insurance de-risking solution that can also protect against sponsor insolvency risk. The main contrast between ISS and the consolidator options is that ISS enhances, rather than replaces, the sponsor covenant. The two central building blocks include a low-risk, cashflow-matched investment strategy and insurance in the form of a capital buffer to protect against adverse asset or liability experience.

Looking ahead

The endgame debate is set to continue as we see commercial consolidators, insurers, investment managers and consultants develop and refine solutions. There is more choice than ever before, and if a greater number of DB members receive their benefit promises in full as a result, then this focus should be welcomed as great news for the pensions industry.

Frankie Borrell

Article written by:

Frankie Borrell

Head of Client Solutions