This is a blog inspired by a snip from First Actuarial’s briefing to trustees and sponsors of their DB clients.
For many years trustees have had to focus on a prudent funding plan based on the scheme valuation at a point in time. Now , the trustees need to develop a financial strategy for the scheme – a longer term plan
Employers have done their bit and shouldn’t become the insurer of last resort. The established view is that the Pensions Regulator is looking for a funding strategy which locks down liabilities with matching assets. I am sure that this is what most trustees will think of as “achieving low dependency”.
But there is an alternative view, which sees sponsors inviting in co-sponsors to the scheme to partner with and maybe eventually take over from the current sponsor. This may involve a capital backed sponsor whose value comes not just from the money it brings but its capacity to manage both risk and assets. Such a sponsor is engaged on the basis of track record and capacity going forward.
The Pensions Regulator, has recently launched new guidelines for such capital backed sponsors,
I have written about this before and quoted the key “Appendix E”
The guidance on introducing in Appendix E concerns a capital backed co-sponsor. It is detailed and well-considered
Typically, capital-backed arrangements entail a commercial contract where third-party capital supports the delivery of a range of agreed outcomes for the scheme at the end of an agreed period. The capital supports investment risk being taken and generates returns for the investor.
The extent to which we expect such arrangements to comply with our superfund guidance, depends on their design, whether the scheme retains the link with the existing employer, and the circumstances in which they are being implemented. For further information on what aspects of our superfund guidance apply to groups 2 and 3 (below), we would encourage trustees to engage with us once there is a firm commitment to consider an arrangement.
Group 1 – Provides capital to support investment performance
The employer remains in place and its obligations in respect of the scheme are unaltered. We view these as investment products. We view these as investment products.
Group 2 – Substitutes for solvent employer covenant
The original employer is substituted with a SPV employer while it is still a solvent, ongoing entity. The scheme is separated at the outset of the arrangement from its existing covenant support, which is replaced by a capital buffer. The transaction could be a Type A event under our clearance guidance.
Group 3 – Enables scheme to run on following insolvency
A SPV employer is introduced to enable the scheme to run on after an insolvency event has occurred, supported by a capital buffer.
Position of the SPV employer under a capital-backed arrangement
Typically, the SPV employer will:
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have no connection (present or historic) to the scheme’s members, in any real sense
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be connected in some way with the providers of capital, with whom the scheme is in a commercial relationship involving conflicting financial interests
Capital Backed Pensions; An option when considering your FIS
For the majority of trustee boards, arriving at a position of self-sufficiency is an achievement, a chance to draw breath and consider further options. Where buy-out is an option, then the FIS need not be long or sophisticated. Preparing for buy-out is a process that is well documented on all consultancy websites.
But actuarial advisers need , under TAS300 (V2) , to get their clients to consider all options and many trustees will run on the scheme, if only to avoid the high cost of risk transfer. The larger the scheme, the lower the fixed costs of running it , which eat into these savings.
The attraction of co-sponsorship is that risk and potential reward are retained with the longer term prospect that the original sponsor may be ditched and the trustees can make decisions about the scheme when the options of running the scheme into a superfund are more developed
Of course, co- sponsoring means recognising not just the upside of the capital backing , but the commercial interests of the co-sponsor, potentially transferring risk to a private equity firm (acting as co-sponsor) could be as expensive as buy-out, which is why choosing the right sponsor matters.
The Funding and Investment Strategy, introduced by the new DB funding code could be a game-changer for many schemes. Rather than taking decisions based on a moment in time funding position, they will be required to think into the future and – thanks to the new actuarial guidelines, they will need to consider all options.
While the Government establishes a Pension Review for workplace DC plans and LGPS, it has made it clear that reforming the way corporate DB schemes are funded is ongoing. Capital backed pensions are a thing of the future, but the future is not far away!
