“The Government encourage sound sponsors and trustees of well financed DB schemes to run on and modernise them to be ESG Flagships in all stakeholders’ interests.” That is the C-Suite recommended line responding to DWP / Treasury’s Call for Evidence on DB schemes. The consequences are:
Replace the Death Wish Statement of Investment Principles with a positive objective of running on for good. The Death Wish SIP is the source of the downward spiral in DB schemes’ investment returns. Replace it with Run On For Good. Go for stable, long term, higher productive asset allocations. No severance and as needed surety bonds provide safety nets. The sponsors and trustees have ESG flagships. The objective is to improve the pensions of past and present employees at little or no cost to the sponsor. The technology is available. An ESG Flagship - Take a Look Around for your Pension Scheme Repurpose Your DB Pension Scheme to Benefit All Stakeholders A Proposal to embrace the role as long term sponsor and ensure scheme supports Group’s S172 Statements and ESG Commitments As the Board considers employee loyalty, wage inflation and its ESG ethos, adopt a C-Suite Pensions Strategy to:
Steps to implement
Boards can replace the DB pension “get rid” mindset with a forward looking “run on” policy which works for sponsors, pensioners, employees and shareholders. An ESG Flagship benefits all stakeholders. A Flagship ESG Initiative Campaign for one year less on life expectancy to mean one more years worth of pension related payments for past and present employees An Exercise in Discretion to Benefit All Stakeholders Backdrop Life expectancy assumptions are coming down further in actuarial tables. Liabilities will fall by around 3% to 5% for most DB schemes. Current annual payments to pensioners represent typically around 3% to 5% of assets after recent falls in value (and greater falls in liabilities for the better financially managed). Trustees and sponsoring employers can decide to distribute additionally benefits to past and present employees in response to changed information. This is a straight improvement to the scheme’s finances. The assets are not affected by the assumption changes – as happened when interest rates increased. Standard industry thinking is to accelerate Risk Transfer Transactions. Analysis of the real risks and values is needed. Proposal The benefit of discretionary payments can be split. Increased payments can be made directly to past and present employees. These comply with tax and legislative requirements. C-Suite has worked through the detailed requirements. Sponsoring companies can also benefit from reduced contributions.
The principle of discretionary payments is established. The time over which they are made and the delivery mechanisms are then scheme specific. Campaign Objectives The objective is to help past and present employees in the tough current economic circumstances. The over funding of pension liabilities makes this practical. Sponsors and trustees may then see their pension schemes as Flagship ESG policies not a legacy problem. That results in having a long term investment strategy for the scheme and having a modernised tier within it. Pension scheme members and current employees can put the case to sponsors and trustees for “one less one more” HR as well as finance teams of corporates should take up the opportunity. Member nominated trustees are particularly relevant. Here is a break point where intergenerational unfairness is on the agenda and there is an action plan. The Powerful ESG, S172 and HR Cases for Sponsors Backing “Running On” Their Defined Benefit Schemes Old DB pension schemes can re-emerge as assets supporting their sponsor’s ESG commitments, S172 statements and HR strategies. Members’ benefits can improve through C-Suite’s Discretionary Step Up mechanism, and from there surpluses generated. Better pension provision can help address today’s wage inflation and staff turnover issues as was the case a generation ago. If the scheme is left to run on long term with steady investment policies, sound governance and with prudence truing up, it is possible for surpluses to arise. Plan for the upside now – as pensions reconnect with their HR purpose. A Board policy adjustment has a big impact. It resets the agenda. The Board can ask the trustees for a 10/15 year plan as an option with stable return assumptions. Trustees then reset the Statements of Investment and Funding Principles. Best membership data (to increase confidence in payment schedules) is gathered. A new financial model is produced. It is much more attractive for everybody. A fantastic ESG opportunity emerges. Here are large sums available to make a difference to the ESG agenda because the sponsor and the trustees do not have a “get rid ASAP” mindset. Asset managers with long term horizons and running fixed income led plans can provide the predictable, stable returns which transform the assessment of the scheme. Sponsors running on can go back to the basic purpose of the scheme when it was established - to provide good pensions for employees. Surpluses generated can, on discretionary and supplemental bases, be used to improve pensions of current members and fund pensions of current employees in a new tier for the scheme. For members worrying about inflation above contractually committed levels of, say, 5%, discretionary improvements have a new significance. Surpluses used to cover current provision can reduce current DC costs to the employer and improve the pensions provided to key workers. That brings cash and earnings benefits to sponsors. It also is a concrete example of a Board taking action aligned to Section 172 policy statements to take employee interests into account in Board decisions. Reality not rhetoric. To run on, trustees may want added third party back up of any future gap to self-sufficiency. A capital buffer is needed against sponsor failure. Contingent third party cover is readily available. As its purpose is directly aligned to S172 and ESG parameters, for which funds are specifically available, it would be on attractive terms. It is a good use of finance capacity. Allocating a maximum sum to meet the objective of providing time to the pension scheme to operate in all stakeholders interest looks absolutely “on message” for a modern corporate. It should again attract equity investors interested in ESG strategies. At present, Solvency II regulations for insurers are under review. The Treasury wants to see costs fall and more return seeking assets held. Life expectancy assumptions are in doubt because of Covid. Both factors make the value of risk transfer speculative. A ‘timeout’ in such transfers should follow. The timing of a switch to running on is good. A Board stating it wants to “run on” an old scheme to benefit all stakeholders can expect positive employee, trustee and investor engagement. A proactive response to recruitment and retention issues is timely. A clear cut action by the Board can be taken. It has long term upsides - financially and ethically. |
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September 2023
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