DB scheme trustees are being called to reassess strategies, including buyout, consolidation, and surplus generation, to align with member interests and pension system health as most schemes see improvements in funding levels.
According to The Pension Regulator’s 2024 Annual Funding Statement, defined benefit (DB) schemes with significant funding have a number of options including targeting surplus generation, consolidation or buy-out with an insurance company.
Half of these schemes are expected to exceed their buy-out financing criteria, giving employers and trustees an opportunity to reevaluate their long-term objectives. Meanwhile, around a quarter of schemes are expected to remain in deficit on a technical provision basis.
As financing improves, TPR and experts call on DB scheme trustees to take action. They suggest reevaluating objectives and tactics and taking buyout, consolidation, and surplus generation into account. Member welfare, covenant strength, investment resilience, and sustainability should be the trustees’ top priorities.
TPR interim director of regulatory analysis and advice Louise Davey says: “Where funding levels have improved significantly, trustees should review objectives and strategies, set during a period of low-interest rates, to ensure they remain in the best interests of members. If they are not, trustees should look to redirect some of their funding level improvements towards a funding and investment strategy that is aligned with their plans for the scheme.
“Options range from moving to a long-term target with the potential to generate additional surplus, to entering a consolidator or insurance arrangement.”
Cardano director Chris Heritage says: “The Annual Funding Statement serves as a helpful reminder for trustees to proactively review their journey plan to ensure that it remains appropriate in the context of the scheme’s funding position and the latest view of covenant strength.
“We are pleased to see reference to the importance of considering climate change and wider sustainability issues as part of this reassessment of scheme strategy; in particular the impact on the employer covenant or prospective insurer counterparties (an area which often can be overlooked).
“Similarly it is reassuring that TPR is encouraging trustees to robustly assess the growing number of options available in the market (including run-on, insurance solution, consolidators, and capital-backed journey plans) based on the specific risks and benefits in the context of the security of members’ benefits.”
Aon partner and head of UK retirement policy Matthew Arends says: “It’s reassuring that The Pensions Regulator (TPR) has recognised the very significant improvement in most schemes’ funding levels in recent years. This has been reflected in the Annual Funding Statement which is much shorter than previous years – 1,700 words instead of 4,200. That is to be applauded but is also probably a reflection of it being something of a stopgap before the Funding Code comes out.
“It may place an even stronger spotlight on the question of why TPR is still implementing a new Funding Code and funding regime that will be brought in later in 2024.
“There is also a confirmation that run-on – with the generation of surplus – as well as consolidators and other vehicles, are now reasonable options for schemes, alongside buyout. It may be that it is larger schemes that are more likely to run on because they can afford to and can access economies of scale, but this guidance reflects the now increased likelihood of that approach.
“There is also mention of value from private market investments – although only in the section in respect of schemes funded between Technical Provisions and Buyout funding levels – and which could be a nod to the wider initiatives proposed by the Government and in the Mansion House Compact”.
Hymans Robertson head of DB actuarial consulting Laura McLaren says: “With DB funding holding strong and a new funding code coming later this year, it’s not a surprise to see this year’s statement significantly scaled back.
“Whereas past statements have centred on repairing deficits, fewer schemes remain in those regulatory crosshairs. Therefore, most of the statement is about encouraging trustees to develop endgame strategies. The content echoes the shift in schemes starting to think beyond being funded on a solvency basis – as we’ve also seen reflected in the recent ‘options for DB’ consultations.
“Schemes are positioned to make decisions that could materially affect member outcomes. So it’s good that TPR is highlighting the growing range of endgame and consolidation options, and directing trustees to robustly consider the full spectrum, including alternative arrangements where appropriate.
“We agree with TPR that the economics of running on are likely to be more attractive for larger schemes. We support the broader steer to explore a scheme’s own circumstances, objectives and beliefs.
“Risks, ongoing expenses and discretionary increases are all sensible factors to consider. It was surprising, however, to see very little emphasis on the importance of building consensus between the sponsoring employer and trustees, as this approach is likely to lead to the best outcomes.
“Given how much the DB landscape has changed, trustees and sponsors are going to need a lot of support to carefully weigh up a decision between run-on, buy-out or an alternative.”
ACA chair Steven Taylor says: “Today’s Annual Funding Statement will be eerily familiar to those who have followed the evolution of TPR’s approach and guidance in recent years. With funding levels now significantly better than in the past, TPR builds on last year’s statement by adding further “endgame” focus with Trustees now expected to articulate clearly how they will navigate the key strategic options available to them. TPR also makes notable new reference to considering how discretionary increases might be impacted by insurance transactions and also adds further focus on climate risk and sustainability.
“Overall though today’s statement remains a “holding page” to new guidance expected soon on the new funding regime. This is where it will hopefully become clear how TPR’s approach could change for the next tranches of valuations.”
Broadstone head of market engagement Simon Kew says: “The Regulator’s latest update on the DB market suggests that half of schemes are likely to have surpassed their estimated buy-out funding levels. Whilst this estimate sounds slightly optimistic, it nevertheless demonstrates the radical transformation in the funding position of many pension schemes over the past couple of years.
“The insurance market is running hot with new entrants, a freshly active commercial consolidator and an ongoing consultation into a public sector consolidator. Many larger schemes may also consider the potential for running on as a viable alternative to buy-out after reaching low dependence on the employer’s support if they can get access to the surplus.”