Pension Funding : Not as Difficult as it Looks

Companies sponsoring final salary schemes are being pushed to fund schemes to insurance buy-out levels.  Regulators are annexing greater powers to apply pressure; carrying out raids for data and using criminal sanctions.  If schemes are to be funded beyond the accounting numbers, the case grows for the liability being on the balance sheet.

Hard cases have resulted in debatable rules.  Still, what should Boards do when pension funding eats into their free cash flows?

• Tackle the arguments head on.  The main risk to members is the failure of the company.  To mitigate this risk, the company provides insurance which addresses the gap between assets held and the asset value needed to transfer the scheme to a regulated insurer.
• If the insurance policy is not maintained, it then becomes payable: the insurer having recourse to the company.
• In exchange, the scheme can agree to move to and keep a sound, long-term investment strategy.  Actuaries can set assumptions that do not need further derisking.

Much talk is underway about creating consolidated schemes providing ‘annuitisation light’.  Yet for those corporates with good cash flows and balance sheets – or with parents that have them – the answer is to use that financial capacity to provide a ‘life insurance’ policy payable in the event of death.  Then the investment pool already available can be used to generate sound returns that one day achieve the same end that the Regulator wants, and members expect.

At present, commercial banks and insurers have an interest in becoming involved and are bemused that they are not asked – but the pensions profession has not found a way to use that capability effectively.

A creative, positive Boardroom session on the subject can produce solutions:

• A carve-out from its financial capacity to cover the contingent costs.
• Press for reduced Pensions Protection Levies because the scheme is already insured to a level above the PPF offer.
• Expectation that more of any deficit will be covered by asset returns.
• Reduced cash contributions to meet deficit that was being generated by derisking assumptions.
• Greater certainty over cash and balance sheet impacts.
• For directors of the company, peace of mind that they have actually derisked the scheme for members.

Corporates are being dragged, reluctantly and expensively, towards funding the transfer of legacy pension schemes to a level that insurers will take them on and very profitably run them off. 

Corporates can get a grip on pension funding and use their financial strength to derisk members’ position if trustees will agree to sound, long-term investment plans.  Everyone is a winner.

The mix of governance and financial concerns should finally mean Boards recognise responsibility for decommissioning final salary pension schemes.  They should join in with work to manage investments well and consider the interests of past and current employees better.
 
“Perhaps the real cost of doing the right thing is not so high for soundly financed Groups.  Make it possible for market returns, not corporate cash flows, to make the difference”  William McGrath, C-Suite Pension Strategies