03292017Wed
Last updateFri, 24 Mar 2017 12pm

 

Setting a pension strategy that lasts

 

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By Simon Taylor, Partner and Corporate Consulting, Barnett Waddingham LLP

The ultimate goal for most defined benefit (DB) scheme sponsors will involve removing as much risk as possible. The strategy for achieving this goal will differ depending on the particular circumstances, for example, depending on the maturity of the scheme and the affordability of ongoing support. All existing strategies will have been set to be 'future proof' – with the expectation that short-term changes in circumstances can be negotiated successfully.

The past 12 months has seen a 'once-in-a-generation' political change. As a sponsor of a DB pension scheme, you may have thought you had a pension strategy which lasts. However, can it survive Brexit? Can it cope with a potential 'Trump Dump', rather than the current 'Trump Bump'?

Given the economic and regulatory uncertainties that prevail, now is a good time to revisit your DB strategy to make sure it remains robust.

Tactical manoeuvres

Most finance directors will recognise that 'smaller is better' in DB pension terms. At the current time, government bond yields remain low and transfer values (TVs) are elevated, making it a more attractive option for members. This may provide an opportunity for a transfer exercise in the near term, focusing on members over the age of 55 who are able to access their benefits immediately. Meanwhile, the government is developing plans to facilitate employer-led and member-led pension advice, the aim is to improve member outcomes in the new 'freedom and choice' landscape.

Another option to manage risk is to look at the buy-in market. Despite the volatility since the EU referendum, this remains attractive for schemes looking to exchange gilts as part of a full or partial pensioner transaction. The potential to 'top slice' your DB obligation by targeting large liability members is also worth investigating. The latter would be an effective way to mitigate any concentrations of longevity risk.
The above constitutes short-term steps which can turn unfavourable circumstances, in this case, elevated gilt prices and corresponding low yields, into opportunities. The next step is to focus on longer-term actions to manage the liabilities which remain.

Formulating a longer-term strategy

Once the 'quick wins' are identified and acted upon, the asset-side of the equation will become clearer. The resulting shape of the liabilities represents the benefit cashflows expected to crystallise in due course. However, there should still be allowance made for routine liability settlement exercises in the future, including flexible options at retirement offered, as standard.

With growth assets performing well, there is some potential to lock-in recent gains. Rather than de-risking in the sense of swapping such gains into matching assets, it might be preferable to use the gains to pay down liabilities, such as paying higher transfer values or purchasing a bulk annuity.

It is also important to make allowance for ongoing de-risking activities as part of the triennial valuation process. Although scheme-funding liabilities are calculated with an emphasis on prudence, there is greater focus on realistic expectations when setting the recovery plan. As such, it is important to account for ongoing exercises, for example, building flexibilities relating to liability settlement into the recovery plan, in addition to other typical best-estimate assumptions.

There is an onus on scheme sponsors to be proactive, recognising likely future risks. The tone of the government's recent Green Paper would suggest there is unlikely to be a material change in the DB regulatory regime although it is important to consider potential opportunities that might arise.

A pension strategy that is future proof should help DB sponsors continue to make progress towards their ultimate goal, at least until the next 'once-in-a-generation' event. This advocates ongoing monitoring that enables rapid responses where and when it is appropriate.

 

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