Isio has produced a helpful survey of the attitude of professional trustees to the sharing of the surpluses that are emerging from triennial valuations of private occupational DB pension schemes. . You can download it here
Professional Trustees are the new power-brokers of the DB pension scheme, well resourced, well organised and beloved of the Pensions Regulator. Their value is in their title, they are the dominant force in the fiduciary management of our DB pension system.
Their views matter because they control the key decisions on pension management right down to who owns the surplus. So I turned the pages of isio’s survey with more than usual interest (being both a member of one of these schemes and involved in supplying the capital to help one of isio’s clients – run on).
For those who don’t download or read the survey for themselves, here are excerpts from the Executive Summary
• To date it has been extremely rare for trustees to
release surplus to sponsors before schemes enter
wind-up. Professional trustees believe that balanced
and comprehensive guidance from the Pensions
Regulator would be most effective in removing
behavioural barriers to sharing surplus between
sponsors and members for ongoing schemes. The report
shows the other changes that professional trustees
believe would facilitate ongoing release of surplus.• The most important factors for professional trustees in
deciding whether to run schemes on for the medium to
long term after reaching full funding on a buy-out basis
are the strength of the sponsor’s covenant and the
views of the sponsor• The proportion of the surplus used to improve member
benefits was important to professional trustees for
deciding whether to run on, but less so than the two
factors above. Of those that have already formed a
view, more than two-thirds of professional trustees
are comfortable that a member share of 40% of the
surplus would be sufficient to justify running on
over the medium to long term after insurance first
becomes affordable, with 35% of professional trustees
believing that the minimum member share of
surplus to justify running on is less than 20%.• Whilst more permissive legislation for releasing
surplus from ongoing surplus would be welcome, in
practice over half of professional trustees would only
be comfortable to return surplus to an employer in
ongoing schemes that are overfunded on a buy-out
basis. Many schemes can do this today using isio’s
Purposeful Run On (PRO) framework• Of those that have already formed a view, nearly 80%
of professional trustees would expect to target an
investment return of gilts + 1.5% p.a. or less for a
run on strategy. This is understandable given the de-risking journeys that many UK DB schemes have been on, but isio’s modelling suggests that a target between gilts + 1.5% p.a. and gilts + 2.0% p.a. will typically give a better balance between
targeting sufficient expected upside for members and
employers whilst maintaining a very low probability of
moving into a technical provisions deficit – it will be
interesting to see what market practice emerges in
this area.• Three-quarters of professional trustees would consider
run on for schemes with at least £250m of assets and
over half would consider it for schemes with at least
£100m of assets• Employers with strong covenants can be encouraged
that most professional trustees have an open mind to
different ‘end games’ and see the employer’s views as
key for deciding an approach. It can be easier to agree
the sponsor’s preferred approach if it is raised early,
so it is important for sponsors to model and assess
different options
Turning to the body of the report we find that while buy-in/out remains the favored option for trustees, running the scheme on is now getting close to parity in popularity
The fate of members is very much about the opinions of trustees
It’s a covenant thing
As the quotes above suggest the likely success of the covenant backing the scheme is key to whether trustees want a scheme to run on
This paper from isio was published too late to fully reflect the new guidance on covenant support from the Pensions Regulator , published late last week, but I suggest that the increasing support from TPR for schemes to run on is linked with the Government’s promotion of the pension superfunds and for now, capital backed journey plans.
It is good to see the increasing confidence amongst professional trustees , not just in running on, but in the strength of covenants.
Isio’s research is published on the day when another leading consultant issued a bullish analysis of the UK defined benefit market
PwC head of pensions funding and transformation John Dunn said: The position of the UK’s 5,000 DB schemes has never looked stronger and we are pleased to see the new government has put pension schemes at the heart of its mission to ‘boost growth and make every part of Britain better off’.
“DB pension schemes can play a part in this growth, particularly if the initiatives around surplus sharing as an incentive for schemes to run-on are pushed forward. There is appetite from a number of schemes to seriously consider this model and, as we’ve explored previously, it could unlock £340bn for sponsors and members.
This seems entirely sensible – EXCEPT for the use of Gilts as the valuation basis.
Gilt yields have absolutely no significance to the cost of paying the pension benefits as they fall due. The critical values are the investment return achieved against the expected inflation of those benefits and the capital proceeds obtained when the capital asset pool is depleted. In a run on situation you are trying to minimise asset sales, and this can be controlled by limiting surplus distributions in a “purposive run-on” or with a “surplus distribution plan”.
Gilts have been the most volatile asset class over the past 20 years and have significant short term (even intra-day) movements that make significant differences to liability measures which have no other significance to the pension scheme.
Surely the appropriate target investment return should be expressed as forecast inflation plus x%. This will also reduce the significance of mortality assumptions, such that never again will year 21 pension add a multiple of year 1 pension to the discounted present value liability value (as happens with an inflation minus discount rate).
You may say that surely the important thing is to consider the cost of buying the remaining liabilities over the lifecycle of the scheme and that the buy-out cost is based on the gilt yield. This is not necessarily the case – it is only s75 of 1995 Pension Act which indicated that the appropriate measure to establish a deficit debt should be the actuary’s estimated cost of buying-out the liabilities with an insurance company and that debt value is not subsequently adjusted to match the actual cost. It is the actuarial professional standards, probably appropriately based on previous insurance company practices, that suggested that the buy-out cost should be based on gilt yields. As we now know in practice insurance companies do not match their liabilities with gilts and therefore the pricing of the buy-out contract does not match the cost of the provision of the service.
I cannot think of any other situation where the customer effectively tells the supplier how much to charge!