I apologise to all who have been waiting to see Hymans Robertson’s presentation on how to de-risk your DB pension. I am afraid my partner is abroad with the keys to the technical cupboard so you may have to wait till next week -but it will come!
But what is much better is that Linda Jardine, the Hymans consultant who gave the presentation has answered the questions put to her in a most satisfactory fashion. Here are the responses.
The big one!
Q Why should schemes still be aiming for buy-out – the justification for buy-out (the effect of reporting a pension scheme liability on the sponsor’s balance sheet on its future) has disappeared if there are sufficient assets in the scheme to complete a buy-out.
A We may not have captured the essence of this question correctly so if it is helpful for us to follow up further, do let us know. On the working assumption this question was about Buy Out versus Run On we have provided some high-level pros / cons of each approach below as we see them. It is however important to note that the decision between a Buy Out and Run On is very scheme specific and will depend on the schemes funding position, the strength of the sponsor covenant, and the trustees’ risk appetite. Regular review of the scheme’s strategy and market conditions is key to ensure that whatever approach is taken continues to remain appropriate.
| Pros | |
| Buy Out | Run On |
| Risk Transfer – effective you remove the schemes exposure to longevity, investment and other risks. | Surplus – potential for schemes to generate a surplus over time which is then used to enhance member benefits. |
| Clean break – assets and liabilities are transferred to the insurer. | Flexibility – ability to retain control over investment strategy and respond to changing market conditions accordingly. |
| Member security – benefits secured with insurer providing greater security of pension benefits. | Cost – potential more cost effective short term. |
| Cons | |
| Buy Out | Run On |
| Cost – can be expensive as insurers charge a premium to take on the liabilities. | Ongoing risk – schemes continue to bear longevity, investment and other risks which over the long term can be significant. |
| Timing – cost is influenced by market conditions (interest rates / inflation etc). Poor timing = higher cost. | Sponsor Covenant – scheme remains reliant on sponsors financial health. |
| Preparatory work – preparing for a Buy Out can take several years e.g. data cleanse, benefit review etc. | Regulatory burden – continued requirement to meet regulatory requirements which can be complex and time consuming. |
More Technical Questions and answers
Q A related issue – how should schemes provide for residual risks associated with a whole scheme buy-in? Put another way why buy-in rather than buy-out?
A We have responded to this question based on it being about the key considerations for Trustee’s when it comes to residual risk.
Residual risk cover is a key area for the scheme and sponsor to decide on as it insures against the risk that data or benefit specifications provided to the insurer contain errors. There will be steps taken during the Buy In / Out journey to mitigate against these risks e.g., conducting a full benefit review to ensure the benefit specification shared with the insurer is consistent with scheme rules and administration practice.
In addition, residual risk cover adds a further layer of protection and typically comes three different forms:
1) Sponsor indemnity – obtaining sponsor indemnity can be a valuable protection so an important area for consideration early in the project is strength of the company indemnity. Engaging the support of the Covenant Advisor by them conducting a robust review and assessment is key.
2) Trustee indemnity insurance – useful in protecting trustees against personal liability arising from their duties. Typically, the scheme’s legal advisor will support with the activity needed to assess and put in place the most appropriate level of insurance.
3) Residual risk insurance – consideration of an insurer specific product designed to cover residual risk. Typically, the scheme’s risk transfer advisor will be well abreast of insurer products and provide advice on how best to pursue.
Q Given it takes min 1, up to 3 years to complete buy out or whole scheme buy in, what’s the relevance of today’s pricing?
A Today’s insurer pricing is a critical reference point for DB schemes planning for Buy Out. In short, regular monitoring and strategic planning is essential to ensure a scheme takes full advantage of favourable pricing when it is ready to move to full Buy Out.
Insurer pricing today provides a snapshot of the cost to secure the scheme’s liabilities at the current time. This pricing is influenced by various factors, including interest rates, inflation expectations, and the insurer’s view on longevity risk. It is important that schemes regularly review insurer pricing as part of the schemes de-risking strategy as this ensures they remain aware of current market conditions and can make more informed decisions about the timing of a Buy Out.
Furthermore, the pricing of a Buy Out can change significantly over time due to fluctuations in market conditions. Additionally, the scheme’s funding position may improve or deteriorate over time, affecting the affordability of a Buy Out. For these reasons regular monitoring and updating of the scheme’s funding position are essential so that the scheme is best placed to act when pricing is favourable.
Here are the slides , Linda used
Thanks Linda
Among the “pros”
Surplus – potential for schemes to generate a surplus over time which is then used to enhance member benefits.
But what about the potential for employers to reduce their future costs from surplus too?It’s not all about the members.
Among the “cons”
“Ongoing risk”
No mention of opportunity.
This presentation summary shows us the mindset of consultants.
I really wish they would leave the room, and not come back again until they have a more balanced mindset in favour of employers/sponsors some of the time.
EY gave us as a risk the possibility that a group of members might outlive the money (M&G event last week)! I did object to the thought of a scheme going into the PPF because members were outliving the mortality tables being considered a risk.
The test applied by many small employers with super mature residual DB schemes is is the pot money in the Scheme decreasing by more than {say} 5% p.a. per annum. If not, the fund is likely to run out with a surplus to be returned to the employer.
If it the fund is decreasing by more than the appropriate target then the employer considers itself [similar to the FSCS with regard to annuities} as being on the hook to pay the residual annual pensions after the fund has run out. Given that this is likely to be a number of years into the future and will be affected by scheme experience and investment returns, they consider these future annual “contributions” as their deficit recovery plan. To capitalise these contributions by requiring an accelerated capital cash injection into the pension fund to match some actuarial estimate based on a volatile and irrelevant discount rate is both currently putting and has historically put the company at risk.
The matter that really annoys them is the high level of unnecessary administration costs forced on them
– Why do they need administrators costing £000s per annum when they could much more efficiently just add a couple of score pensioners to their existing payroll and then take a corresponding (or smaller) “dividend” out of the pension fund?
– Why do they need to pay for actuaries to provide them with a largely meaningless and now proved as historically inaccurate estimates of the future pension liabilities?
– Why do they need to pay upwards of £1000 per member to undertake a GMP reconciliation exercise to show that the maximum difference to any pension is less than £1 per week? Would it not be more cost effective just to increase all potentially affected pensions by £50 p.a.?
– Why do they have to pay for very costly and largely meaningless to the member or the employer:
– Implementation statements
– Own Risk Assessments and documented Effective Systems of Governance
– Investment Consultants, when they have purchased a managed pooled fund many years ago on which they have been drawing for decades.
– Professional Trustees or Trustee training when they have all the appropriate skills to run out the pension fund in house?
– Do any of these costs improve the members’ experiences? After all in most small firms the pensioner or their relatives first port of call when they have a query about their pension is their former employer.
Has the employer not already paid unnecessarily inflated Pension Protection Fund levies to ensure that the pensioner can continue to receive their (albeit with increased future inflation risk) pensions should the employer no longer be around? After all those employers whose pension schemes are subject to this onerous and costly regime have by now survived for at least 20 years.
SME employers feel they have been regarded as the enemy by the regulators and are being taking as suckers by a large and very powerful “pensions industry” for ever increasing administration costs. Why should employers wish to pay even more administration costs to prepare data for any form of consolidation or capital injection that results in the loss of the prospect of a future residual surplus distribution out of the “their” pension fund.
At present SME employers appear to be on the hook for every increasing DC contributions which do not improve the employer’s business prospects one iota and are effectively yet another employment tax. No wonder they are looking to see if they could not use their existing DB scheme assets in a more efficient way. Given they are already incurring all these administration costs, re-opening DB accrual seems a very attractive option to allow the company to recover some element of control.
SME employers are struggling to have their voices heard. Even on the CBI’s pensions board there is currently only one representative out of 19 of an SME employer; and of the other 18 half are themselves in the pensions industry! How are they being consulted in pensions reviews and legislative changes that are key to the growth prospects of their businesses and ultimately to UK growth?