Running on pays off.
Made possible by third party guarantees
Stable long term investment strategies.
Directing resources in the interests of all stakeholders.
The pension industry has decided that the best thing for a defined benefit pension scheme is for it to transfer to a regulated insurer. That is the Gold Standard.
The Pension Schemes Act 2021 introduces further powers to support the “tough” stances of the Pensions Regulator. Trustees are to set a long term objective, heavily directed to journeys to buyout as an “end game”. The pre-cursor is aligning with presumed life insurers’ requirement for the investments to assist the transfer. The derisking ship has long sailed.
But the Gold Standard was an economic disaster ahead of its abolition in 1931. Returns can end up being counter productively low and below the rate of inflation driving up long term costs as calculated today. Buyouts are unambitious end games, They may not be the best way forward for more than life insurers.
There should be a mainstream alternative to buyouts. There is the regulatory improved option of “running on”. It beats buy out when low dependency is available by other means under a bespoke solution.
Model the average scheme’s cashflow and you wonder what the problem is. It arises from the low asset returns assumed and from reaching the destination too quickly. The reason to derisk investment is fear for the future of the sponsor. Sponsors in their turn can worry about volatility caused by DB schemes and resort to a “get rid ASAP” view.
Trustees should indeed be ultra risk averse about sponsors – but all the covenant reviews you can pay for are palliatives. The sponsor should put substance behind its declared support for a scheme. It is for its financiers (who can stand surety – banks, insurers, parents) to provide risk diversifying guarantees that obligations to eliminate dependency on the sponsor will be met come what may. That enables trustees to maintain sound, long term, low risk investment policies.
Sponsors can then also reassess their expectations. Returns are likely to closely align to accounting assumptions. A result is that on net assets; on profits and on cash the pension burden is lifted. With the new perspective the scheme is a long term asset not a volatile risk factor. All stakeholders benefit.
So journey plans to buyout may often be the way forward. But that should not be on the only way. Our approach packages surety and asset management together. The value to financial institutions of having a long term, fixed income portfolio to run is to be factored in. The cost of available surety products for good credit are modest against the benefits of sustained returns which let schemes run on and actuarial prudence true up.
The follow on question is whether DB schemes can be reactivated to support CDC or straight forward DC schemes and in so doing help provide a high standard of provision for today’s employees. A tough task but a journey with a worthwhile destination respecting the past and the future.
Fast track to buyout. One possibility. But running on pays off to meet all stakeholders’ interests.