The Autumn Statement should cause DB schemes to review their future plans

When the Facts Change, I Change My Mind. What Do You Do, Sir?¹

The Autumn statement 2023 brought in factors that has raised questions over whether buyout is the best route for every DB scheme. It also brings in some questions about what is the aim of running on? So, it is perhaps good governance that all schemes review their plans and that previously held beliefs be reconsidered.

About 18 months ago, the unchallenged presumption was that “insurance is the gold standard”. In fact, some companies built up a business based entirely on that “fact”: Clara was one and its CEO said just recently on 6 November 2023 “Insurance remains the gold standard for any pension scheme member.” 

Today, opinions are different: every investment consultant has new a “run-on” group and, far more importantly, HMG appears to have realised there are £-billions trapped in what might be under-risked or even over-funded DB pension schemes. HMG seems also to be thinking that perhaps some of that money may be put to more productive use in UK plc rather than providing profits to insurers.

We would advocate that all DB pension scheme’s long-term strategies need to be reviewed to make sure that the current perceived path is indeed the right one given the changed options. 

So, what has changed?

Higher yields and the chancellor’s Mansion House speech in July: rising bond yields mean the funding levels for many schemes have greatly improved. The outright reliance on sponsors has reduced dramatically: the covenant exposure is significantly smaller.

There is the notion from advisers that the insurance “premium” (~12%) effectively gifted to insurers’ retained earnings (aka capital) could instead be captured by both members and sponsors.  And that taking the decision to run-on now would not, of course, exclude reverting back to the insurance market at a later date (at a lower proportionate premium). But the reverse is not true.

Run-on reconsidered

Run-on is no longer to be dismissed by CFO’s². It might make for some awkward questions at the sponsor’s AGM when, despite HMG looking at ways to return trapped surplus to sponsors and members, it is observed that the excess funding has been handed to an insurers’ shareholders. For a long time, pension schemes have been seen by a sponsor as a liability: now some are looking at the (potentially over-funded) scheme and seeing “asset”.

Members might receive larger benefits (such as more inflation-linkage when CPI is above the cap). Trustee discretions, eliminated by a risk transfer, can also have an impact if they are funded by, for example, a (trapped) surplus. Add into your considerations that a sponsor, because of the proposed reduction of surplus “tax” from 35% to 25%³, may be inclined to be more supportive of a scheme since it is no longer a “roach motel” as far as the economics of funding contributions go.

And if you include the concept that regardless of more support, the DB scheme could itself support the sponsor, that opens up a complete conversion of the scheme from “liability” into potential “asset”.

These potential benefits (which have been flagged for quite some time) are significant, but the legislative and regulatory framework has been seen as a significant barrier to realising these ambitions.

In the Autumn Statement 2023, the government set out several landmark proposals designed to open up DB schemes’ options. That is not to say the current course already decided upon by trustees is not the right one. However, the government has proposed a mechanism by which previously outlandish, but positive, concepts are now open for discussion and could potentially be the right path, even if different from the existing direction.

The Governments economic goals

The chancellor wants greater amounts of capital directed towards growing UK businesses, and the government believes encouraging DB schemes to run on for longer is one way to achieve this. Whether you agree with this wisdom or its achievability the fact that the concept and mechanisms are being put in place means that your situation has also changed. After all, the unintended consequence of the government’s intentions might be a  windfall for your members and sponsors. Unless you explore these avenues thoroughly (and without biased predisposition), you will never know.

The proposals include the aforementioned tax cut on surplus refunds to the sponsor and the opening up of a consultation process to explore:

• the regime under which surpluses can be repaid,

• a PPF protection of 100% of liabilities in exchange for a higher levy,

• the role of the PPF as a consolidator for certain DB schemes; and

• proposing clearer funding standards to encourage alternatives to de-risking and buy-out.

We quote from the letter from Jeremy Hunt & Mel Stride to Nausicaa Delfas dated 22 November 2023 on two particular focus areas:

“Encouraging alternatives to DB de-risking and buyout, where schemes are well-funded with a strong employer covenant – making their assets work harder and enabling continued investment in a broad range of assets, through clearer funding standards in Regulations, a Code of practice and guidance, and making it easier to share investment returns between sponsors and scheme members

Increasing the standards of investment expertise and trustee skills, enabling pension funds to create diversified investment strategies and build stronger links with specialist UK investors.”

With that in mind, the majority of schemes could be well advised to check that their current path is indeed in line with their statutory aims: it is just good governance and, usefully, a recordable action.

When the facts change, it is ok to change your mind.

Disclaimer

The above content is my opinion. If anyone would like more information or would like to discuss further, please feel free to contact Dalriada.

Footnotes

¹ In 1924 John Maynard Keynes published an essay titled “Investment Policy for Insurance Companies” in “The Nation and Athenaeum” of London. Keynes contended that an insurance company must employ an active investment policy. The company must maintain constant vigilance and revise preconceived ideas in response to changes in external situations.

² A simple test for a CFO would be to decide if the company cares about making a payment of anything up to 12% to a third-party insurer. Or another way is that the sponsor has handed its own trapped surplus to an insurer just when HMG is looking at ways to return it to. e sponsor.  Why was that option not fully taken into account as the previously decided upon risk transfer deal was being negotiated?  For instance, between Boots and Co-op (buy-in deals announced 24Nov23) ~£1bn has been taken from members and the sponsors and handed to the insurers’ shareholders.  Could make for an awkward question at the sponsor’s AGM.

³ In line with the prevailing corporate tax rate.