SlideShare a Scribd company logo
1 of 13
Download to read offline
INVESTMENT MANAGEMENT
Strategies for
Winning the
Endgame
April 2024
Capital at risk
INVESTMENT MANAGEMENT
Contents
Executive summary 2
Introduction 4
Insurance Buyout 5
Superfunds 6
Alternative capital-backed risk transfer options 7
Does full funding mean you have reached the end? 8
Facilitating other forms of running-on 10
Conclusion 11
Executive summary
In recent years, the pensions landscape has changed drastically. Particularly relevant has been the rise in gilt
yields that was experienced over the past two years, which has significantly accelerated the time to reach
buyout for many schemes. However, does being 100% funded on a buyout basis automatically mean that a
scheme should complete a buyout of scheme liabilities? This paper aims to broaden the thinking around the
pensions endgame, acknowledging that buyout is the Gold Standard, but simultaneously raising the question “is
it the be-all and end-all?”
For decades, defined benefit (DB) pension scheme trustees and sponsors
have strived to reach the Holy Grail of endgames – Buyout. The security
that comes with transferring scheme liabilities to well-capitalised, strictly
regulated insurance companies has resulted in this particular ‘endgame
option’ being recognised as the ‘Gold Standard’ across the pensions
industry.
12 | 23 DB Endgame Options ǀ 3
Key considerations for trustees and sponsors
– Despite the sizeable improvement in scheme funding positions across the UK DB pensions market, we expect many
schemes will encounter difficulties securing benefits with an insurer due to capacity constraints across the market.
– Beyond this, we believe that a number critical developments will prompt trustees and sponsors to consider alternative
endgame options. For example, the completion of the first two DB Superfund transactions has given proof of a concept to
an idea that has been in development for years, and one that could help many schemes in difficult positions ensure that
they deliver full member benefits by acting as a bridge to buyout.
– Furthermore, the development of legislation that focuses on expanding the way scheme surpluses can be used will be
enticing to both trustees and sponsors alike, who may be interested in the prospect of enhancing member benefits, be that
defined contribution or defined benefit members or extracting surplus after decades of deficit contributions.
– In December 2023 the Financial Reporting Council (FRC) published version 2.0 of Technical Actuarial Standard 300:
Pensions (TAS 300), stating that “practitioners providing advice to trustees and employers, must consider credible
alternatives to the potential transaction for the long term provision of members’ benefits.”
This paper discusses these considerations in greater detail, and highlights some of the potential
benefits (and risks) that come with alternative endgame strategies such as Superfunds, Capital Backed
Journey Plans (CBJPs) and scheme run-on.
12 | 23 DB Endgame Options ǀ 4
Introduction
Over the past two years, the UK defined benefit pensions market has undergone significant structural changes – from the
major changes in the design of the Liability Driven Investment (LDI) market, driven by the 2022 UK Gilts crisis, to various
pensions policies outlined in the Chancellor of the Exchequer’s Statements and the 2023 Mansion House speech. Amidst all of
this, there has also been significant volatility across financial markets, with the most important (for the UK pensions market)
being the sharp rise in gilt yields over the period.
This rise in yields has drastically improved the funding positions of many DB pension schemes. According to data from the
Pension Protection Fund’s (PPF) 2023 Purple Book, (The Purple Book 2023 – ppf.co.uk) the aggregate buyout funding level of
the UK pensions market was roughly 112% as at 31 March 2023, equating to a surplus of c.£150 billion.
Chart 1: PPF aggregate buyout funding position estimate
Source: PPF Purple Book (2023 Edition)
This improvement in scheme funding positions has led to trustees, sponsors and advisers engaging in earlier conversations on
potential endgame options for their schemes, with the landscape now including a number of options that aim to capture
different segments of the pensions market. This paper explores these different options and aims to highlight some of the key
considerations trustees and sponsors should keep in mind when thinking about the right endgame for their schemes.
(3,000)
(2,500)
(2,000)
(1,500)
(1,000)
(500)
0
500
1,000
1,500
2,000
£bn
Total Assets Total Liabilities (Buyout Basis) Surplus / (Deficit)
12 | 23 DB Endgame Options ǀ 5
Insurance buyout – the industry’s ‘gold standard’
endgame option
Endgame planning is a key part of a DB pension scheme’s journey, with trustees seeking the assistance of their advisers and
support of their sponsoring employers to determine the most effective means of securing the long-term benefits of their
schemes’ members.
For over a decade, transferring a scheme’s liabilities to an insurance provider (i.e. an insurance buyout) has been viewed as the
‘gold standard’ approach for securing members’ benefits. This is largely due to the strict capital adequacy requirements that
insurers are required to adhere to, requirements that aim to provide purchasers of insurance policies with a greater sense of
security and maintain the stability of the market. However, the significant rise in gilt yields over recent years has resulted in a
large fall in the value of DB pension scheme liabilities, which, on average, has resulted in a drastic shrinking of schemes’
(buyout) funding deficits.
With significantly lower deficits, many schemes find themselves much closer to buyout. However, two crucial questions
then arise:
1) Does the current insurance market possess sufficient capacity to handle this sudden spike in demand for bulk annuity
policies?
2) With surpluses, and ongoing covenants, are insurers always the better option than running-on outside of the insurance
regime in all cases?
According to a 2024 report published Hymans Robertson (Risk Transfer – Buy In, Buy Out, Longevity Swaps – Hymans
Robertson) insurers have been bolstering their businesses through new hires and greater technological innovation to cater to
this increased demand. However, we believe the sheer number of schemes looking to secure a buyout is likely to put a strain
on the bulk annuity market for the next five years.
Furthermore, there has been some concern voiced by the UK’s Prudential Regulation Authority (PRA) around the increased
use of funded reinsurance and some of the potential risks this poses to the market. When annuity providers insure liability
risk, they often repackage this risk to a range of reinsurers. The PRA have identified a structural shift in the global life
insurance sector, with insurers increasingly making use of cross-border funded reinsurance arrangements. Newer
counterparties are more focussed on returns, with investment in private markets and limited appetite for insurance risks.
Additionally, trustees and sponsors may also choose to not to buyout immediately to allow their schemes to mature and
continue to build up surpluses, thereby making the prospect of buyout more affordable. We believe this together with the
previously mentioned constraints will trigger trustees to consider alternative endgame options. Vehicles such as Superfunds
offer trustees a cost-effective route to secure member benefits.
12 | 23 DB Endgame Options ǀ 6
Superfunds1
: Clara Pensions – bridging the gap to buyout
Clara Pensions (‘Clara’) is currently the only regulated DB Superfund in the UK. Clara offers an opportunity for trustees and
sponsors to ensure that scheme members are paid their full benefits at retirement, without having to meet the relatively
higher cost of securing scheme benefits with an insurer. Clara is then responsible for running the scheme and ensuring that
members’ benefits are paid as they fall due. Once the scheme is sufficiently mature and it is no longer practical to continue
running the scheme, the liabilities and assets are transferred to an insurer, at which point the cost of securing a buyout would
be much cheaper.
Clara would typically be considered as a viable endgame option for schemes that possess the following characteristics:
– 5–10 year time horizon to reaching buyout: The Pensions Regulator (tPR) would typically recommend schemes that are
within 5 years of reaching buyout to continue running on instead of transferring to a Superfund (tPR’s second ‘gateway
principle’).
– Relatively weak employer covenant: sponsoring employers with a weak covenant carry greater insolvency risk. In the
event of the sponsoring employer becoming insolvent, the scheme would be required to wind up. In the event that the
assets are still insufficient to secure a buyout following the addition of any capital following the completion of solvency
proceedings, the scheme would enter the PPF and members would not receive their full benefits. Additional capital is
posted as buffer assets to replace the sponsor covenant.
As Clara continues to grow and establish itself as a robust risk transfer vehicle, we expect to see a greater range in the types of
schemes looking to use this vehicle. For example, trustees and sponsors of smaller schemes with relatively strong covenants
might use Clara as a means of achieving the dual objective of benefiting from Clara’s scale and also alleviating pressure on the
corporate sponsor’s balance sheet. This ability to provide the benefit of economies of scale is also consistent with the UK
government’s desire to have greater consolidation within the UK DB pensions market (i.e. having a smaller number of more
efficiently run schemes).
We believe that this push towards greater consolidation of the pensions market will act as a tailwind for Superfunds such as
Clara. Furthermore, the previously mentioned supply-demand constraints within the bulk annuity market will also encourage
more schemes to consider alternative risk transfer options to buyout. That being said however, we also believe that there are
certain schemes that might still consider other endgame options outside of Superfunds or buyouts (at least in the immediate
term) and we will discuss these in the next section.
Superfund transactions completed to date
Sears Retail Pension Scheme Debenhams Pension Scheme
Size £590m £600m
Number of members 9,600 10,400
Additional capital injection £33m £34m
Type of transaction Weak Employer covenant case PPF+ assessment case
Member benefits
Member benefits met in full backed by
capital injection
Member benefits restored to
100% with back payments made
for period spent in the Pension
Protection Fund
1 When discussing Superfunds within this paper, we are mainly referring to the Clara-Pensions Superfund, which is currently the only Superfund to have passed
the Pension Regulator’s (tPR) assessment.
12 | 23 DB Endgame Options ǀ 7
Alternative capital-backed risk transfer options
Despite the significant improvement in scheme funding positions, there are still a number of schemes that find themselves
falling short of being able to achieve a full insurance buyout. Trustees of schemes that fall into this category might therefore
explore alternative risk transfer options such as Capital Backed Journey Plans (CBJPs).
CBJPs and Superfunds help schemes meet their long-term funding objectives (e.g. reaching buyout, or effectively running
on to maturity) by providing third party capital that is used to protect against any adverse funding experience (thereby
mitigating sponsor covenant risk). Although both risk transfer approaches are similar in that they utilise third party capital
to support scheme funding, there are a number of differences, such as governance terms, regulation and overall structure. The
table below outlines some of these differences:
CBJPS Superfunds*
Time-horizon
(before aiming for buyout)
10+ years 5-10 years
Regulation
None
(Although tPR** may consider oversight
if further deals are transacted)
tPR** Legislation
Link to sponsor retained Yes No
Trustee board retained Yes No
Typical sponsor covenant Likely to be Weak / tending to weak Weak / tending to weak
Provision of external capital
External capital provider injects capital at
outset to support additional investment risk.
Capital can be provided either directly or via
an alternative means, e.g. a surety bond
Clara provide a capital injection at outset
(has been in the range of 5-10% of
liabilities for deals written to date) to act
as a buffer in case of adverse funding
experience
Investment return target
(gross of fees)
Gilts + 5% to 7% p.a. (gross) Gilts + 1.5% to 2.5% p.a. (gross)
Investment risk***
No explicit risk target, but is considered over
the entire investment period
Less than 1% chance of funding level
being below 100% in 5 years
*We have used Clara, which is currently the only Superfund to have passed tPR assessment, to illustrate the characteristics of a Superfund in this paper
**The Pension’s Regulator
*** For Superfunds, this is the TPR requirement for the test of funding when agreeing the buffer amount
A key difference between CBJPs and Superfunds is the structure of the risk transfer vehicle. The decision to use a CBJP is
often viewed as an investment decision. Third party capital providers work directly with trustees and their advisers to set a
new, typically more aggressive, investment strategy that aligns with their goal of helping the scheme reach full funding on the
agreed long-term funding basis, whilst simultaneously generating a profit for the external capital provider. In the case of a
CBJP, the link to the sponsoring employer remains intact and the sponsor is not usually required to inject any further capital
into the scheme.
The trustees also retain their stewardship responsibilities over the scheme’s assets. We would note, we understand only one
capital backed journey plan transaction has been completed to date, in 2020 (‘First of its kind’ capital-backed journey plan
transaction completed by UK scheme – Pensions Age Magazine). With Superfunds, sponsoring employers are required to
provide additional capital alongside the capital provided by external investors. However, upon completion of the transaction,
the links between the scheme, the sponsoring employer and trustees are severed.
Trustees and sponsors will need to be aware of these differences when deciding which capital-backed risk transfer approach
is better for their scheme, making sure that they are well-informed of the various risks and operational considerations
associated with each of them. Of note is the less stringent regulation of CBJP providers – although CBJPs may come with a
12 | 23 DB Endgame Options ǀ 8
slightly lower operational burden and cost than a Superfund, trustees and sponsors might obtain greater comfort from the
stricter capital adequacy and broader regulatory requirements that Superfunds comply with under the tPR.
Does full funding mean you have reached the end?
We previously discussed how the large rise in yields has led to more schemes now being able to afford an insurance buyout.
We also noted the capacity constraints that have arisen within the bulk annuity market as a result of this greater demand. Due
to this occurrence, there are likely a number of schemes that are fully funded on a buyout basis, but are still finding it difficult
to obtain a buyout quote. Schemes that find themselves in this position might consider running on, by maintaining a suitable
level of risk, but generating a return that will build up a funding surplus within the scheme.
When preparing for a buyout transaction, trustees will typically transition their scheme’s investment strategy to a portfolio
comprising gilts and investment grade credit matching their specific circumstances. A primary purpose of this exercise is to
invest schemes’ assets in a portfolio that closely matches insurance pricing, thereby mitigating the risk of the insurance price
‘moving away’ from the scheme.
In the event that schemes choose not to target buyout and continue running on, they can remain invested in return-seeking
growth assets. This approach has the following potential benefits:
– Buyout cost saving: by choosing to run on, trustees and sponsors can avoid having to incur the various costs associated
with a buyout transaction, e.g. the sponsoring employer making up any shortfall between the scheme assets and buyout
price and trustees not having to incur the numerous advisory costs (legal, actuarial and investment advice). This of course
must be measured against the ongoing cost of running the scheme, as the trustees will be responsible for obtaining the
necessary administrative, actuarial, legal and investment support required to ensure that their schemes are run as
effectively as possible.
– Ability to generate surplus: retaining exposure to return-seeking growth assets enables schemes’ portfolios to potentially
deliver greater long-term returns and, in turn, generate surpluses.
– Greater scope to invest in ‘productive assets’: instead of solely investing in gilts and credit, schemes would be able to
continue allocating to more productive, long-terms assets such as infrastructure and farmland. Pension schemes have the
ability to help drive long-term impact by continuing to invest in assets such as infrastructure, which will play a key role in
the transition towards a greener society.
The second bullet point around surplus generation has been one that has been discussed quite heavily across the industry and
one that we believe will continue to attract a lot of attention going forward given the significant impact a surplus can have on
enhanced member benefits, sponsoring employers and the broader UK economy as a whole. How this surplus might evolve
under a number of different scenarios is showcased below.
Chart 2: Evolution of UK DB Pensions (Buyout) Surplus2
Source: VLK, Moody’s Analytics
2 Assumed an investment return of Gilts+1.5% p.a. Modelling is hypothetical and illustrative, based on a number of assumptions regarding financial markets and
relationships between them. A model is necessarily a simplified representation of the real world, with simplifying assumptions made in order to be usable
-
0.2
0.4
0.6
0.8
1.0
1.2
1.4
2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
£
trillion
90% confidence interval Median projection of Buyout surplus
12 | 23 DB Endgame Options ǀ 9
The chart above shows the distribution of potential outcomes, focusing specifically on the evolution of the buyout surplus.
We’ve assumed that, on average, schemes will adopt relatively conservative investment strategies (i.e. not take on an
excessive amount of investment risk), given the overall improvement in funding positions. In the (median) base case, which is
shown by the solid yellow line, we believe there is an opportunity to generate a surplus of around £0.5 trillion over the next 10
years, and in an extremely optimistic scenario (shown by the top of the blue bar on the right) up to £1.2 trillion over 10 years.
The key takeaway here is that there is great potential to generate a large amount of surplus within the UK DB pensions
market, even after allowing for a continuation in the significant buyout activity of £50 billion per year. This opportunity is
overwhelmingly anchored by larger schemes (£500m+).
This dilemma of looking to continue generating surplus whilst effectively managing the risk of a deterioration in schemes’
funding positions is one that many participants in the industry now increasingly find themselves trying to address. In light of
this, there are a number of interesting run-on solutions that aim to allow schemes to keep some investment risk on the table
whilst managing funding risk through the use of different guarantee mechanisms to protect the Scheme from funding level
shocks or covenant default.
Solutions such as these come with some extra complexity but will likely be well-suited to large schemes with more
sophisticated governance frameworks and strong sponsor covenants.
Potential benefits of generating a surplus
Top-up inflation
proofing
for DB members
Improved life
insurance
and medical benefits
Inflation protection
DB Members
Increased cashflow
from lower DB
contributions
Increased cashflow
from lower DC
contributions
Overall increase in
shareholder value
Sponsor
Additional
contributions
for DC members to
address intra-
generational issues
Ability to target
certain member
groups
DC
Worse-off members
looked after
Impact investing
Support Mansion
House reforms
DC
12 | 23 DB Endgame Options ǀ 10
Facilitating other forms of running-on:
Asset-led discounting and dynamic discount rates
Asset-led discounting is an alternative approach to deriving a pension scheme’s discount rate, which is typically set as the
yield on fixed interest gilts at the valuation date plus some margin that is set in accordance with the level of investment risk
(i.e. the riskier the investment strategy, the greater the margin and vice versa). Under the asset-led discount rate approach,
the discount rate is usually set as the best-estimate long-term expected return of the investment strategy backing the
scheme’s liabilities, with a ‘haircut’ for prudence.
The aim of this discounting approach is to reduce the funding level volatility by valuing the liabilities using a discount rate that
reflects the long-term expected returns of the assets. This in turn allows schemes to continue investing in a broader range of
assets whilst managing the risk of a severe divergence in the value of the assets and the liabilities over the long-term.
When considering adopting an asset-led discounting approach, trustees should keep in mind the following potential
benefits and drawbacks:
– More stable liability value between actuarial
valuations.
– Less constraints on the assets (and returns) that can
be generated.
– Investments made on fundamental ‘investment-
worthiness’ of assets rather than investing in
assets that solely aim to match the movement
in liabilities.
– Potential to generate greater scheme surplus over
the long-term.
– Introduces an extra layer of complexity – for
example, calculating and agreeing on the discount
rate, transfer values, etc.
– Not widely used in the pensions market and
actuarial models are often calibrated to gilts
(though there are a number of precedents).
– Likely to result in ‘riskier’ investment strategies.
– If expected returns are not realised, the scheme
can incur large deficits.
– Any shortfall ultimately needs to be covered by
the sponsoring employer, who must be able to
tolerate the potential for large contributions in
‘bad’ scenarios.
This concept of asset-led discounting would be well suited for schemes which choose to run on.
Benefits Drawbacks
12 | 23 DB Endgame Options ǀ 11
Conclusion
The industry finds itself in unique situation which very few would have predicted at the height of the COVID pandemic in
2020. We estimate the surplus as at February 2024 (on a proxy buyout basis) to be in the region of £210bn. Even allowing for
a blockbuster decade of buyout activity at £50bn p.a., aggregate surpluses could reach half a trillion pounds across the
industry over the next 10 years.
Research paper authors
Arif Saad
Executive Director
Fiduciary Management
Panashe Bera
Vice President
Investment Strategy
Follow Arif on LinkedIn Follow Panashe on LinkedIn
The endgame decision is therefore hugely important and has wide-ranging implications for different
stakeholders across the pensions market. This decision will affect the way in which pension assets are
invested over the long-term, which will have significant implications for broader society as a whole
given the sheer size of the UK pensions market. As such, it is extremely important that trustees,
sponsors and advisers alike think deeply about where their schemes are going and how they are going
to get there.
12 | 23 DB Endgame Options ǀ 12
Appendix
Endgame options explained
BUYOUT SUPERFUNDS CBJPS RUN-ON
How does it
work?
Pension scheme
liabilities are fully
insured by insurance
company. Scheme
pays insurer single
lump sum premium
at outset in exchange
for transferring
liabilities to insurer.
Similar to a buyout, schemes
transfer liabilities to the
Superfund, but would typically
pay a lower premium, together
with a capital buffer as cover
for sponsor covenant
replacement. The current single
UK Superfund, Clara, operates
a “bridge to buyout” model,
where Clara runs the schemes
for 5 – 10 years before
transferring liabilities to an
insurer.
An injection of capital
is provided by an
external third party to
support greater
investment risk, which
is required to close the
buyout deficit and
thereby accelerate the
journey to buyout.
Schemes continue to take
investment risk. Schemes
may also choose to use
various run-on solutions
that allow them to
generate surplus over the
long term whilst
managing funding risk
through the use of
guarantee mechanisms.
Type of schemes
that typically
consider this
Well-funded
schemes with a
sponsor who is
looking to transfer
the scheme’s
liabilities off of it’s
balance sheet.
Relatively well-funded schemes
with weak sponsor covenants
Schemes looking to
expedite their journeys
to buyout and with
sufficient capacity to
accommodate greater
(capital-backed)
investment risk.
Usually larger schemes
with relatively strong
sponsor covenants and an
appetite to retain
investment risk in order
to generate surplus.
Schemes typically won’t
be looking to buyout in
the near-term.
Size of schemes
that typically
consider this
Any size Potentially any size Potentially any size
Typically larger schemes
(£300m+)
Typical required
(buyout) funding
level
100% c.80%+ 80% - 90% 95%+
Link to sponsor
retained?
No No Yes Yes
Link to trustees
retained?
No No Yes Yes
Disclaimer
This document is issued by Van Lanschot Kempen Investment Management (UK) Ltd. (“VLK Investment Management (UK)’’) for information
purposes only. The information contained in this document is of a general nature. No part of this document may be reproduced or copied
without prior written consent from VLK Investment Management (UK). This document is subject to revision at any time and VLK Investment
Management (UK) is not obliged to inform you of any changes made to this document. VLK Investment Management (UK) is registered in
England & Wales with registration number 02833264. Registered office at 20 Gracechurch Street, London EC3V 0BG. Tel: 0203 636 9400.
VLK Investment Management (UK) is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 166063).
VLK Investment Management (UK) does not accept any responsibility or liability caused by any action or omission taken in reliance upon
information herein.
This document should not be considered as the giving of investment advice by of VLK Investment Management (UK) or any of its members,
directors, officers, agents, employees or advisers. In particular, this document does not constitute an offer, solicitation or invitation to enter
into a transaction, including with respect to the purchase or sale of any security interest or other in any jurisdiction. Neither this document
nor anything contained in this document shall form the basis of any contract or commitment whatsoever. This document is not intended to
provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. No responsibility can be accepted for
errors of fact obtained from third parties, and this data may change with market conditions.
Past performance is not indicative of future results. The value of investments and the income from them may go down as well as up and are
not guaranteed. The value of investments and the income from them may go down as well as up and investors may not get back the amounts
originally invested. All investments involve risks including the risk of possible loss of principal.
Modelling is hypothetical and illustrative, based on a number of assumptions regarding financial markets and relationships between them. A
model is necessarily a simplified representation of the real world, with simplifying assumptions made in order to be usable.
The usefulness of the models in this analysis or others should therefore be considered in the context of the limitations of any model,
particularly with respect to key aspects including but not limited to: i) the amount of weight that should be given to recent levels of market
volatility compared to long term historic averages, ii) should future volatility levels be determined by the markets, through observation of
derivative prices, iii) past performance should not be a guide, and iv) should the expectation of default risk and recovery rates for debt
instruments be based on past data.
Output from any model will vary based on the approach taken around these key assumptions and others. Any modelling assumptions may
prove to be incorrect and actual results will differ from the results of the model. The results between different models will also differ,
potentially substantially, from that shown in our analysis. As such, recommendations, decisions and advice based on modelling by their nature
contain associated (model) risks. We do not make any claims to accuracy and we acknowledge that there are a wide range of alternative
underlying assumptions that may be just as valid as those we use. Any modelling assumptions (and the resulting analyses and forecasts) may
require modification as additional information becomes available and as economic and market developments warrant. Nothing contained
herein may be relied upon as a guarantee, promise, assurance or a representation as to the future.
I N V E S T M E N T M A N A G E M E N T
20 Gracechurch Street
London
EC3V 0BG
United Kingdom
T +44 770 138 8323
vanlanschotkempen.com/investment-management

More Related Content

Similar to Kempen ' UK DB Endgame Paper Apr 24 final3.pdf

ACS2011PaperAndrewHoultram
ACS2011PaperAndrewHoultramACS2011PaperAndrewHoultram
ACS2011PaperAndrewHoultram
Andrew Houltram
 
The Renaissance of Stable Value: Capital Preservation in Defined Contribution
The Renaissance of Stable Value: Capital Preservation in Defined ContributionThe Renaissance of Stable Value: Capital Preservation in Defined Contribution
The Renaissance of Stable Value: Capital Preservation in Defined Contribution
Callan
 

Similar to Kempen ' UK DB Endgame Paper Apr 24 final3.pdf (20)

tpr ldi response to the work and pensions commitee
tpr ldi response to the work and pensions commiteetpr ldi response to the work and pensions commitee
tpr ldi response to the work and pensions commitee
 
Defined Benefits in a Defined Contribution Plan
Defined Benefits in a Defined Contribution PlanDefined Benefits in a Defined Contribution Plan
Defined Benefits in a Defined Contribution Plan
 
The Evolving DB Endgame Agenda (2).pdf
The Evolving DB Endgame Agenda (2).pdfThe Evolving DB Endgame Agenda (2).pdf
The Evolving DB Endgame Agenda (2).pdf
 
Outline March 2014
Outline March 2014Outline March 2014
Outline March 2014
 
Whole life insurance 0699 2016
Whole life insurance 0699 2016Whole life insurance 0699 2016
Whole life insurance 0699 2016
 
Scheme Strategy Wp 2008 10
Scheme Strategy Wp 2008 10Scheme Strategy Wp 2008 10
Scheme Strategy Wp 2008 10
 
Regulatory Environment: PwC Top Issues
Regulatory Environment: PwC Top Issues  Regulatory Environment: PwC Top Issues
Regulatory Environment: PwC Top Issues
 
The eternal actuarial struggle
The eternal actuarial struggleThe eternal actuarial struggle
The eternal actuarial struggle
 
BP action group letter to the Work and Pensions committee
BP action group letter to the Work and Pensions committeeBP action group letter to the Work and Pensions committee
BP action group letter to the Work and Pensions committee
 
ACSDA Volumen_3Risk
ACSDA Volumen_3RiskACSDA Volumen_3Risk
ACSDA Volumen_3Risk
 
Pension Finance
Pension FinancePension Finance
Pension Finance
 
ACS2011PaperAndrewHoultram
ACS2011PaperAndrewHoultramACS2011PaperAndrewHoultram
ACS2011PaperAndrewHoultram
 
Is there as silver lining for prpp?
Is there as silver lining for prpp?Is there as silver lining for prpp?
Is there as silver lining for prpp?
 
Bancassurance from A Regulatory Perspective, Lloyds Africa Markets
Bancassurance from A Regulatory Perspective, Lloyds Africa MarketsBancassurance from A Regulatory Perspective, Lloyds Africa Markets
Bancassurance from A Regulatory Perspective, Lloyds Africa Markets
 
AgeWage response to the DWP call for evidence on options for DB schemes.pdf
AgeWage response to the DWP call for evidence on options for DB schemes.pdfAgeWage response to the DWP call for evidence on options for DB schemes.pdf
AgeWage response to the DWP call for evidence on options for DB schemes.pdf
 
Redington and Societe Generale CIB - Equity Hedging for UK Pension Funds - Ma...
Redington and Societe Generale CIB - Equity Hedging for UK Pension Funds - Ma...Redington and Societe Generale CIB - Equity Hedging for UK Pension Funds - Ma...
Redington and Societe Generale CIB - Equity Hedging for UK Pension Funds - Ma...
 
Citi prime services report on liquid alternatives
Citi prime services report on liquid alternativesCiti prime services report on liquid alternatives
Citi prime services report on liquid alternatives
 
Discretion is the better part of value (2).pdf
Discretion is the better part of value (2).pdfDiscretion is the better part of value (2).pdf
Discretion is the better part of value (2).pdf
 
The Renaissance of Stable Value: Capital Preservation in Defined Contribution
The Renaissance of Stable Value: Capital Preservation in Defined ContributionThe Renaissance of Stable Value: Capital Preservation in Defined Contribution
The Renaissance of Stable Value: Capital Preservation in Defined Contribution
 
Wiliam McGrath's commentary on the actuarial standards governing the buy-out/...
Wiliam McGrath's commentary on the actuarial standards governing the buy-out/...Wiliam McGrath's commentary on the actuarial standards governing the buy-out/...
Wiliam McGrath's commentary on the actuarial standards governing the buy-out/...
 

More from Henry Tapper

More from Henry Tapper (20)

Pension dashboards forum 1 May 2024 (1).pdf
Pension dashboards forum 1 May 2024 (1).pdfPension dashboards forum 1 May 2024 (1).pdf
Pension dashboards forum 1 May 2024 (1).pdf
 
20240419-SMC-submission-Annual-Superannuation-Performance-Test-–-design-optio...
20240419-SMC-submission-Annual-Superannuation-Performance-Test-–-design-optio...20240419-SMC-submission-Annual-Superannuation-Performance-Test-–-design-optio...
20240419-SMC-submission-Annual-Superannuation-Performance-Test-–-design-optio...
 
Log your LOA pain with Pension Lab's brilliant campaign
Log your LOA pain with Pension Lab's brilliant campaignLog your LOA pain with Pension Lab's brilliant campaign
Log your LOA pain with Pension Lab's brilliant campaign
 
fca-bsps-decision-letter-redacted (1).pdf
fca-bsps-decision-letter-redacted (1).pdffca-bsps-decision-letter-redacted (1).pdf
fca-bsps-decision-letter-redacted (1).pdf
 
letter-from-the-chair-to-the-fca-relating-to-british-steel-pensions-scheme-15...
letter-from-the-chair-to-the-fca-relating-to-british-steel-pensions-scheme-15...letter-from-the-chair-to-the-fca-relating-to-british-steel-pensions-scheme-15...
letter-from-the-chair-to-the-fca-relating-to-british-steel-pensions-scheme-15...
 
House of Commons ; CDC schemes overview document
House of Commons ; CDC schemes overview documentHouse of Commons ; CDC schemes overview document
House of Commons ; CDC schemes overview document
 
magnetic-pensions-a-new-blueprint-for-the-dc-landscape.pdf
magnetic-pensions-a-new-blueprint-for-the-dc-landscape.pdfmagnetic-pensions-a-new-blueprint-for-the-dc-landscape.pdf
magnetic-pensions-a-new-blueprint-for-the-dc-landscape.pdf
 
2024-04-09 - Pension Playpen roundtable - slides.pptx
2024-04-09 - Pension Playpen roundtable - slides.pptx2024-04-09 - Pension Playpen roundtable - slides.pptx
2024-04-09 - Pension Playpen roundtable - slides.pptx
 
Aon-UK-DC-Pension-Tracker-Q1-2024. slideshare
Aon-UK-DC-Pension-Tracker-Q1-2024. slideshareAon-UK-DC-Pension-Tracker-Q1-2024. slideshare
Aon-UK-DC-Pension-Tracker-Q1-2024. slideshare
 
Con Keating's coffee morning presentation.pptx
Con Keating's coffee morning  presentation.pptxCon Keating's coffee morning  presentation.pptx
Con Keating's coffee morning presentation.pptx
 
Budget 1974.care of Peter Cameron Brown .
Budget 1974.care of Peter Cameron Brown .Budget 1974.care of Peter Cameron Brown .
Budget 1974.care of Peter Cameron Brown .
 
JD ED Strategy Policy and Analysis. TPrpdf
JD ED Strategy Policy and Analysis. TPrpdfJD ED Strategy Policy and Analysis. TPrpdf
JD ED Strategy Policy and Analysis. TPrpdf
 
2024-3-29 - PR Newswire - Federal Judge Says BP Must Reform its Pension Plan.pdf
2024-3-29 - PR Newswire - Federal Judge Says BP Must Reform its Pension Plan.pdf2024-3-29 - PR Newswire - Federal Judge Says BP Must Reform its Pension Plan.pdf
2024-3-29 - PR Newswire - Federal Judge Says BP Must Reform its Pension Plan.pdf
 
Press release from the BP Pensioner Group on the WPC DB report
Press release from the BP Pensioner Group on the WPC DB reportPress release from the BP Pensioner Group on the WPC DB report
Press release from the BP Pensioner Group on the WPC DB report
 
Work and Pensions report into UK corporate DB funding
Work and Pensions report into UK corporate DB fundingWork and Pensions report into UK corporate DB funding
Work and Pensions report into UK corporate DB funding
 
The Pension Regulator's "desputed numbers"
The Pension Regulator's "desputed numbers"The Pension Regulator's "desputed numbers"
The Pension Regulator's "desputed numbers"
 
Advice Guidance Boundary Review Evidence Final Feb 24.pdf
Advice Guidance Boundary Review Evidence Final Feb 24.pdfAdvice Guidance Boundary Review Evidence Final Feb 24.pdf
Advice Guidance Boundary Review Evidence Final Feb 24.pdf
 
2024.02-The-radical-option-in-UK-pensions-New-Financial.pdf
2024.02-The-radical-option-in-UK-pensions-New-Financial.pdf2024.02-The-radical-option-in-UK-pensions-New-Financial.pdf
2024.02-The-radical-option-in-UK-pensions-New-Financial.pdf
 
letter to the EF and Premiership about pension liabilities
letter to the EF and Premiership about pension liabilitiesletter to the EF and Premiership about pension liabilities
letter to the EF and Premiership about pension liabilities
 
Financing-Growth - take a step to the right.
Financing-Growth - take a step to the right.Financing-Growth - take a step to the right.
Financing-Growth - take a step to the right.
 

Recently uploaded

一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
atedyxc
 
NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...
NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...
NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...
Amil baba
 
Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...
Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...
Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...
pillahdonald
 
一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书
一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书
一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书
atedyxc
 
一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书
一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书
一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书
atedyxc
 
Zepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptxZepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptx
aryan963438
 
GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...
GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...
GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...
indexPub
 
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
atedyxc
 
Bahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttxBahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttx
AbdulNasirNichari
 
Rapport annuel de Encevo Group pour l'année 2023
Rapport annuel de Encevo Group pour l'année 2023Rapport annuel de Encevo Group pour l'année 2023
Rapport annuel de Encevo Group pour l'année 2023
Paperjam_redaction
 

Recently uploaded (20)

project ratio analysis of bcom studies .
project ratio analysis of bcom studies .project ratio analysis of bcom studies .
project ratio analysis of bcom studies .
 
Canvas Business Model Infographics by Slidesgo.pptx
Canvas Business Model Infographics by Slidesgo.pptxCanvas Business Model Infographics by Slidesgo.pptx
Canvas Business Model Infographics by Slidesgo.pptx
 
How do I sell my Pi Network currency in 2024?
How do I sell my Pi Network currency in 2024?How do I sell my Pi Network currency in 2024?
How do I sell my Pi Network currency in 2024?
 
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
 
NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...
NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...
NO1 Best kala jadu karne wale ka contact number kala jadu karne wale baba kal...
 
Indirect tax .pptx Supply under GST, Charges of GST
Indirect tax .pptx  Supply under GST, Charges of GSTIndirect tax .pptx  Supply under GST, Charges of GST
Indirect tax .pptx Supply under GST, Charges of GST
 
Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...
Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...
Top^Clinic Soweto ^%[+27838792658_termination in florida_Safe*Abortion Pills ...
 
一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书
一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书
一比一原版(UIUC毕业证书)UIUC毕业证香槟分校毕业证成绩单学位证书
 
how do I cash out pi network coin in 2024.
how do I cash out pi network coin in 2024.how do I cash out pi network coin in 2024.
how do I cash out pi network coin in 2024.
 
Top 5 Asset Baked Tokens (ABT) to Invest in the Year 2024.pdf
Top 5 Asset Baked Tokens (ABT) to Invest in the Year 2024.pdfTop 5 Asset Baked Tokens (ABT) to Invest in the Year 2024.pdf
Top 5 Asset Baked Tokens (ABT) to Invest in the Year 2024.pdf
 
is pi Network coin available for sale in 2024
is pi Network coin available for sale in 2024is pi Network coin available for sale in 2024
is pi Network coin available for sale in 2024
 
New Stratus Corporate Presentation May 2024
New Stratus Corporate Presentation May 2024New Stratus Corporate Presentation May 2024
New Stratus Corporate Presentation May 2024
 
How can I withdraw my pi coins to real money in India.
How can I withdraw my pi coins to real money in India.How can I withdraw my pi coins to real money in India.
How can I withdraw my pi coins to real money in India.
 
一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书
一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书
一比一原版(KPU毕业证书)昆特兰理工大学毕业证成绩单学位证书
 
Zepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptxZepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptx
 
GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...
GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...
GLOBAL RESEARCH TREND AND FUTURISTIC RESEARCH DIRECTION VISUALIZATION OF WORK...
 
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
 
Monthly Market Risk Update: May 2024 [SlideShare]
Monthly Market Risk Update: May 2024 [SlideShare]Monthly Market Risk Update: May 2024 [SlideShare]
Monthly Market Risk Update: May 2024 [SlideShare]
 
Bahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttxBahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttx
 
Rapport annuel de Encevo Group pour l'année 2023
Rapport annuel de Encevo Group pour l'année 2023Rapport annuel de Encevo Group pour l'année 2023
Rapport annuel de Encevo Group pour l'année 2023
 

Kempen ' UK DB Endgame Paper Apr 24 final3.pdf

  • 1. INVESTMENT MANAGEMENT Strategies for Winning the Endgame April 2024 Capital at risk
  • 2. INVESTMENT MANAGEMENT Contents Executive summary 2 Introduction 4 Insurance Buyout 5 Superfunds 6 Alternative capital-backed risk transfer options 7 Does full funding mean you have reached the end? 8 Facilitating other forms of running-on 10 Conclusion 11 Executive summary In recent years, the pensions landscape has changed drastically. Particularly relevant has been the rise in gilt yields that was experienced over the past two years, which has significantly accelerated the time to reach buyout for many schemes. However, does being 100% funded on a buyout basis automatically mean that a scheme should complete a buyout of scheme liabilities? This paper aims to broaden the thinking around the pensions endgame, acknowledging that buyout is the Gold Standard, but simultaneously raising the question “is it the be-all and end-all?” For decades, defined benefit (DB) pension scheme trustees and sponsors have strived to reach the Holy Grail of endgames – Buyout. The security that comes with transferring scheme liabilities to well-capitalised, strictly regulated insurance companies has resulted in this particular ‘endgame option’ being recognised as the ‘Gold Standard’ across the pensions industry.
  • 3. 12 | 23 DB Endgame Options ǀ 3 Key considerations for trustees and sponsors – Despite the sizeable improvement in scheme funding positions across the UK DB pensions market, we expect many schemes will encounter difficulties securing benefits with an insurer due to capacity constraints across the market. – Beyond this, we believe that a number critical developments will prompt trustees and sponsors to consider alternative endgame options. For example, the completion of the first two DB Superfund transactions has given proof of a concept to an idea that has been in development for years, and one that could help many schemes in difficult positions ensure that they deliver full member benefits by acting as a bridge to buyout. – Furthermore, the development of legislation that focuses on expanding the way scheme surpluses can be used will be enticing to both trustees and sponsors alike, who may be interested in the prospect of enhancing member benefits, be that defined contribution or defined benefit members or extracting surplus after decades of deficit contributions. – In December 2023 the Financial Reporting Council (FRC) published version 2.0 of Technical Actuarial Standard 300: Pensions (TAS 300), stating that “practitioners providing advice to trustees and employers, must consider credible alternatives to the potential transaction for the long term provision of members’ benefits.” This paper discusses these considerations in greater detail, and highlights some of the potential benefits (and risks) that come with alternative endgame strategies such as Superfunds, Capital Backed Journey Plans (CBJPs) and scheme run-on.
  • 4. 12 | 23 DB Endgame Options ǀ 4 Introduction Over the past two years, the UK defined benefit pensions market has undergone significant structural changes – from the major changes in the design of the Liability Driven Investment (LDI) market, driven by the 2022 UK Gilts crisis, to various pensions policies outlined in the Chancellor of the Exchequer’s Statements and the 2023 Mansion House speech. Amidst all of this, there has also been significant volatility across financial markets, with the most important (for the UK pensions market) being the sharp rise in gilt yields over the period. This rise in yields has drastically improved the funding positions of many DB pension schemes. According to data from the Pension Protection Fund’s (PPF) 2023 Purple Book, (The Purple Book 2023 – ppf.co.uk) the aggregate buyout funding level of the UK pensions market was roughly 112% as at 31 March 2023, equating to a surplus of c.£150 billion. Chart 1: PPF aggregate buyout funding position estimate Source: PPF Purple Book (2023 Edition) This improvement in scheme funding positions has led to trustees, sponsors and advisers engaging in earlier conversations on potential endgame options for their schemes, with the landscape now including a number of options that aim to capture different segments of the pensions market. This paper explores these different options and aims to highlight some of the key considerations trustees and sponsors should keep in mind when thinking about the right endgame for their schemes. (3,000) (2,500) (2,000) (1,500) (1,000) (500) 0 500 1,000 1,500 2,000 £bn Total Assets Total Liabilities (Buyout Basis) Surplus / (Deficit)
  • 5. 12 | 23 DB Endgame Options ǀ 5 Insurance buyout – the industry’s ‘gold standard’ endgame option Endgame planning is a key part of a DB pension scheme’s journey, with trustees seeking the assistance of their advisers and support of their sponsoring employers to determine the most effective means of securing the long-term benefits of their schemes’ members. For over a decade, transferring a scheme’s liabilities to an insurance provider (i.e. an insurance buyout) has been viewed as the ‘gold standard’ approach for securing members’ benefits. This is largely due to the strict capital adequacy requirements that insurers are required to adhere to, requirements that aim to provide purchasers of insurance policies with a greater sense of security and maintain the stability of the market. However, the significant rise in gilt yields over recent years has resulted in a large fall in the value of DB pension scheme liabilities, which, on average, has resulted in a drastic shrinking of schemes’ (buyout) funding deficits. With significantly lower deficits, many schemes find themselves much closer to buyout. However, two crucial questions then arise: 1) Does the current insurance market possess sufficient capacity to handle this sudden spike in demand for bulk annuity policies? 2) With surpluses, and ongoing covenants, are insurers always the better option than running-on outside of the insurance regime in all cases? According to a 2024 report published Hymans Robertson (Risk Transfer – Buy In, Buy Out, Longevity Swaps – Hymans Robertson) insurers have been bolstering their businesses through new hires and greater technological innovation to cater to this increased demand. However, we believe the sheer number of schemes looking to secure a buyout is likely to put a strain on the bulk annuity market for the next five years. Furthermore, there has been some concern voiced by the UK’s Prudential Regulation Authority (PRA) around the increased use of funded reinsurance and some of the potential risks this poses to the market. When annuity providers insure liability risk, they often repackage this risk to a range of reinsurers. The PRA have identified a structural shift in the global life insurance sector, with insurers increasingly making use of cross-border funded reinsurance arrangements. Newer counterparties are more focussed on returns, with investment in private markets and limited appetite for insurance risks. Additionally, trustees and sponsors may also choose to not to buyout immediately to allow their schemes to mature and continue to build up surpluses, thereby making the prospect of buyout more affordable. We believe this together with the previously mentioned constraints will trigger trustees to consider alternative endgame options. Vehicles such as Superfunds offer trustees a cost-effective route to secure member benefits.
  • 6. 12 | 23 DB Endgame Options ǀ 6 Superfunds1 : Clara Pensions – bridging the gap to buyout Clara Pensions (‘Clara’) is currently the only regulated DB Superfund in the UK. Clara offers an opportunity for trustees and sponsors to ensure that scheme members are paid their full benefits at retirement, without having to meet the relatively higher cost of securing scheme benefits with an insurer. Clara is then responsible for running the scheme and ensuring that members’ benefits are paid as they fall due. Once the scheme is sufficiently mature and it is no longer practical to continue running the scheme, the liabilities and assets are transferred to an insurer, at which point the cost of securing a buyout would be much cheaper. Clara would typically be considered as a viable endgame option for schemes that possess the following characteristics: – 5–10 year time horizon to reaching buyout: The Pensions Regulator (tPR) would typically recommend schemes that are within 5 years of reaching buyout to continue running on instead of transferring to a Superfund (tPR’s second ‘gateway principle’). – Relatively weak employer covenant: sponsoring employers with a weak covenant carry greater insolvency risk. In the event of the sponsoring employer becoming insolvent, the scheme would be required to wind up. In the event that the assets are still insufficient to secure a buyout following the addition of any capital following the completion of solvency proceedings, the scheme would enter the PPF and members would not receive their full benefits. Additional capital is posted as buffer assets to replace the sponsor covenant. As Clara continues to grow and establish itself as a robust risk transfer vehicle, we expect to see a greater range in the types of schemes looking to use this vehicle. For example, trustees and sponsors of smaller schemes with relatively strong covenants might use Clara as a means of achieving the dual objective of benefiting from Clara’s scale and also alleviating pressure on the corporate sponsor’s balance sheet. This ability to provide the benefit of economies of scale is also consistent with the UK government’s desire to have greater consolidation within the UK DB pensions market (i.e. having a smaller number of more efficiently run schemes). We believe that this push towards greater consolidation of the pensions market will act as a tailwind for Superfunds such as Clara. Furthermore, the previously mentioned supply-demand constraints within the bulk annuity market will also encourage more schemes to consider alternative risk transfer options to buyout. That being said however, we also believe that there are certain schemes that might still consider other endgame options outside of Superfunds or buyouts (at least in the immediate term) and we will discuss these in the next section. Superfund transactions completed to date Sears Retail Pension Scheme Debenhams Pension Scheme Size £590m £600m Number of members 9,600 10,400 Additional capital injection £33m £34m Type of transaction Weak Employer covenant case PPF+ assessment case Member benefits Member benefits met in full backed by capital injection Member benefits restored to 100% with back payments made for period spent in the Pension Protection Fund 1 When discussing Superfunds within this paper, we are mainly referring to the Clara-Pensions Superfund, which is currently the only Superfund to have passed the Pension Regulator’s (tPR) assessment.
  • 7. 12 | 23 DB Endgame Options ǀ 7 Alternative capital-backed risk transfer options Despite the significant improvement in scheme funding positions, there are still a number of schemes that find themselves falling short of being able to achieve a full insurance buyout. Trustees of schemes that fall into this category might therefore explore alternative risk transfer options such as Capital Backed Journey Plans (CBJPs). CBJPs and Superfunds help schemes meet their long-term funding objectives (e.g. reaching buyout, or effectively running on to maturity) by providing third party capital that is used to protect against any adverse funding experience (thereby mitigating sponsor covenant risk). Although both risk transfer approaches are similar in that they utilise third party capital to support scheme funding, there are a number of differences, such as governance terms, regulation and overall structure. The table below outlines some of these differences: CBJPS Superfunds* Time-horizon (before aiming for buyout) 10+ years 5-10 years Regulation None (Although tPR** may consider oversight if further deals are transacted) tPR** Legislation Link to sponsor retained Yes No Trustee board retained Yes No Typical sponsor covenant Likely to be Weak / tending to weak Weak / tending to weak Provision of external capital External capital provider injects capital at outset to support additional investment risk. Capital can be provided either directly or via an alternative means, e.g. a surety bond Clara provide a capital injection at outset (has been in the range of 5-10% of liabilities for deals written to date) to act as a buffer in case of adverse funding experience Investment return target (gross of fees) Gilts + 5% to 7% p.a. (gross) Gilts + 1.5% to 2.5% p.a. (gross) Investment risk*** No explicit risk target, but is considered over the entire investment period Less than 1% chance of funding level being below 100% in 5 years *We have used Clara, which is currently the only Superfund to have passed tPR assessment, to illustrate the characteristics of a Superfund in this paper **The Pension’s Regulator *** For Superfunds, this is the TPR requirement for the test of funding when agreeing the buffer amount A key difference between CBJPs and Superfunds is the structure of the risk transfer vehicle. The decision to use a CBJP is often viewed as an investment decision. Third party capital providers work directly with trustees and their advisers to set a new, typically more aggressive, investment strategy that aligns with their goal of helping the scheme reach full funding on the agreed long-term funding basis, whilst simultaneously generating a profit for the external capital provider. In the case of a CBJP, the link to the sponsoring employer remains intact and the sponsor is not usually required to inject any further capital into the scheme. The trustees also retain their stewardship responsibilities over the scheme’s assets. We would note, we understand only one capital backed journey plan transaction has been completed to date, in 2020 (‘First of its kind’ capital-backed journey plan transaction completed by UK scheme – Pensions Age Magazine). With Superfunds, sponsoring employers are required to provide additional capital alongside the capital provided by external investors. However, upon completion of the transaction, the links between the scheme, the sponsoring employer and trustees are severed. Trustees and sponsors will need to be aware of these differences when deciding which capital-backed risk transfer approach is better for their scheme, making sure that they are well-informed of the various risks and operational considerations associated with each of them. Of note is the less stringent regulation of CBJP providers – although CBJPs may come with a
  • 8. 12 | 23 DB Endgame Options ǀ 8 slightly lower operational burden and cost than a Superfund, trustees and sponsors might obtain greater comfort from the stricter capital adequacy and broader regulatory requirements that Superfunds comply with under the tPR. Does full funding mean you have reached the end? We previously discussed how the large rise in yields has led to more schemes now being able to afford an insurance buyout. We also noted the capacity constraints that have arisen within the bulk annuity market as a result of this greater demand. Due to this occurrence, there are likely a number of schemes that are fully funded on a buyout basis, but are still finding it difficult to obtain a buyout quote. Schemes that find themselves in this position might consider running on, by maintaining a suitable level of risk, but generating a return that will build up a funding surplus within the scheme. When preparing for a buyout transaction, trustees will typically transition their scheme’s investment strategy to a portfolio comprising gilts and investment grade credit matching their specific circumstances. A primary purpose of this exercise is to invest schemes’ assets in a portfolio that closely matches insurance pricing, thereby mitigating the risk of the insurance price ‘moving away’ from the scheme. In the event that schemes choose not to target buyout and continue running on, they can remain invested in return-seeking growth assets. This approach has the following potential benefits: – Buyout cost saving: by choosing to run on, trustees and sponsors can avoid having to incur the various costs associated with a buyout transaction, e.g. the sponsoring employer making up any shortfall between the scheme assets and buyout price and trustees not having to incur the numerous advisory costs (legal, actuarial and investment advice). This of course must be measured against the ongoing cost of running the scheme, as the trustees will be responsible for obtaining the necessary administrative, actuarial, legal and investment support required to ensure that their schemes are run as effectively as possible. – Ability to generate surplus: retaining exposure to return-seeking growth assets enables schemes’ portfolios to potentially deliver greater long-term returns and, in turn, generate surpluses. – Greater scope to invest in ‘productive assets’: instead of solely investing in gilts and credit, schemes would be able to continue allocating to more productive, long-terms assets such as infrastructure and farmland. Pension schemes have the ability to help drive long-term impact by continuing to invest in assets such as infrastructure, which will play a key role in the transition towards a greener society. The second bullet point around surplus generation has been one that has been discussed quite heavily across the industry and one that we believe will continue to attract a lot of attention going forward given the significant impact a surplus can have on enhanced member benefits, sponsoring employers and the broader UK economy as a whole. How this surplus might evolve under a number of different scenarios is showcased below. Chart 2: Evolution of UK DB Pensions (Buyout) Surplus2 Source: VLK, Moody’s Analytics 2 Assumed an investment return of Gilts+1.5% p.a. Modelling is hypothetical and illustrative, based on a number of assumptions regarding financial markets and relationships between them. A model is necessarily a simplified representation of the real world, with simplifying assumptions made in order to be usable - 0.2 0.4 0.6 0.8 1.0 1.2 1.4 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 £ trillion 90% confidence interval Median projection of Buyout surplus
  • 9. 12 | 23 DB Endgame Options ǀ 9 The chart above shows the distribution of potential outcomes, focusing specifically on the evolution of the buyout surplus. We’ve assumed that, on average, schemes will adopt relatively conservative investment strategies (i.e. not take on an excessive amount of investment risk), given the overall improvement in funding positions. In the (median) base case, which is shown by the solid yellow line, we believe there is an opportunity to generate a surplus of around £0.5 trillion over the next 10 years, and in an extremely optimistic scenario (shown by the top of the blue bar on the right) up to £1.2 trillion over 10 years. The key takeaway here is that there is great potential to generate a large amount of surplus within the UK DB pensions market, even after allowing for a continuation in the significant buyout activity of £50 billion per year. This opportunity is overwhelmingly anchored by larger schemes (£500m+). This dilemma of looking to continue generating surplus whilst effectively managing the risk of a deterioration in schemes’ funding positions is one that many participants in the industry now increasingly find themselves trying to address. In light of this, there are a number of interesting run-on solutions that aim to allow schemes to keep some investment risk on the table whilst managing funding risk through the use of different guarantee mechanisms to protect the Scheme from funding level shocks or covenant default. Solutions such as these come with some extra complexity but will likely be well-suited to large schemes with more sophisticated governance frameworks and strong sponsor covenants. Potential benefits of generating a surplus Top-up inflation proofing for DB members Improved life insurance and medical benefits Inflation protection DB Members Increased cashflow from lower DB contributions Increased cashflow from lower DC contributions Overall increase in shareholder value Sponsor Additional contributions for DC members to address intra- generational issues Ability to target certain member groups DC Worse-off members looked after Impact investing Support Mansion House reforms DC
  • 10. 12 | 23 DB Endgame Options ǀ 10 Facilitating other forms of running-on: Asset-led discounting and dynamic discount rates Asset-led discounting is an alternative approach to deriving a pension scheme’s discount rate, which is typically set as the yield on fixed interest gilts at the valuation date plus some margin that is set in accordance with the level of investment risk (i.e. the riskier the investment strategy, the greater the margin and vice versa). Under the asset-led discount rate approach, the discount rate is usually set as the best-estimate long-term expected return of the investment strategy backing the scheme’s liabilities, with a ‘haircut’ for prudence. The aim of this discounting approach is to reduce the funding level volatility by valuing the liabilities using a discount rate that reflects the long-term expected returns of the assets. This in turn allows schemes to continue investing in a broader range of assets whilst managing the risk of a severe divergence in the value of the assets and the liabilities over the long-term. When considering adopting an asset-led discounting approach, trustees should keep in mind the following potential benefits and drawbacks: – More stable liability value between actuarial valuations. – Less constraints on the assets (and returns) that can be generated. – Investments made on fundamental ‘investment- worthiness’ of assets rather than investing in assets that solely aim to match the movement in liabilities. – Potential to generate greater scheme surplus over the long-term. – Introduces an extra layer of complexity – for example, calculating and agreeing on the discount rate, transfer values, etc. – Not widely used in the pensions market and actuarial models are often calibrated to gilts (though there are a number of precedents). – Likely to result in ‘riskier’ investment strategies. – If expected returns are not realised, the scheme can incur large deficits. – Any shortfall ultimately needs to be covered by the sponsoring employer, who must be able to tolerate the potential for large contributions in ‘bad’ scenarios. This concept of asset-led discounting would be well suited for schemes which choose to run on. Benefits Drawbacks
  • 11. 12 | 23 DB Endgame Options ǀ 11 Conclusion The industry finds itself in unique situation which very few would have predicted at the height of the COVID pandemic in 2020. We estimate the surplus as at February 2024 (on a proxy buyout basis) to be in the region of £210bn. Even allowing for a blockbuster decade of buyout activity at £50bn p.a., aggregate surpluses could reach half a trillion pounds across the industry over the next 10 years. Research paper authors Arif Saad Executive Director Fiduciary Management Panashe Bera Vice President Investment Strategy Follow Arif on LinkedIn Follow Panashe on LinkedIn The endgame decision is therefore hugely important and has wide-ranging implications for different stakeholders across the pensions market. This decision will affect the way in which pension assets are invested over the long-term, which will have significant implications for broader society as a whole given the sheer size of the UK pensions market. As such, it is extremely important that trustees, sponsors and advisers alike think deeply about where their schemes are going and how they are going to get there.
  • 12. 12 | 23 DB Endgame Options ǀ 12 Appendix Endgame options explained BUYOUT SUPERFUNDS CBJPS RUN-ON How does it work? Pension scheme liabilities are fully insured by insurance company. Scheme pays insurer single lump sum premium at outset in exchange for transferring liabilities to insurer. Similar to a buyout, schemes transfer liabilities to the Superfund, but would typically pay a lower premium, together with a capital buffer as cover for sponsor covenant replacement. The current single UK Superfund, Clara, operates a “bridge to buyout” model, where Clara runs the schemes for 5 – 10 years before transferring liabilities to an insurer. An injection of capital is provided by an external third party to support greater investment risk, which is required to close the buyout deficit and thereby accelerate the journey to buyout. Schemes continue to take investment risk. Schemes may also choose to use various run-on solutions that allow them to generate surplus over the long term whilst managing funding risk through the use of guarantee mechanisms. Type of schemes that typically consider this Well-funded schemes with a sponsor who is looking to transfer the scheme’s liabilities off of it’s balance sheet. Relatively well-funded schemes with weak sponsor covenants Schemes looking to expedite their journeys to buyout and with sufficient capacity to accommodate greater (capital-backed) investment risk. Usually larger schemes with relatively strong sponsor covenants and an appetite to retain investment risk in order to generate surplus. Schemes typically won’t be looking to buyout in the near-term. Size of schemes that typically consider this Any size Potentially any size Potentially any size Typically larger schemes (£300m+) Typical required (buyout) funding level 100% c.80%+ 80% - 90% 95%+ Link to sponsor retained? No No Yes Yes Link to trustees retained? No No Yes Yes
  • 13. Disclaimer This document is issued by Van Lanschot Kempen Investment Management (UK) Ltd. (“VLK Investment Management (UK)’’) for information purposes only. The information contained in this document is of a general nature. No part of this document may be reproduced or copied without prior written consent from VLK Investment Management (UK). This document is subject to revision at any time and VLK Investment Management (UK) is not obliged to inform you of any changes made to this document. VLK Investment Management (UK) is registered in England & Wales with registration number 02833264. Registered office at 20 Gracechurch Street, London EC3V 0BG. Tel: 0203 636 9400. VLK Investment Management (UK) is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 166063). VLK Investment Management (UK) does not accept any responsibility or liability caused by any action or omission taken in reliance upon information herein. This document should not be considered as the giving of investment advice by of VLK Investment Management (UK) or any of its members, directors, officers, agents, employees or advisers. In particular, this document does not constitute an offer, solicitation or invitation to enter into a transaction, including with respect to the purchase or sale of any security interest or other in any jurisdiction. Neither this document nor anything contained in this document shall form the basis of any contract or commitment whatsoever. This document is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. Past performance is not indicative of future results. The value of investments and the income from them may go down as well as up and are not guaranteed. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Modelling is hypothetical and illustrative, based on a number of assumptions regarding financial markets and relationships between them. A model is necessarily a simplified representation of the real world, with simplifying assumptions made in order to be usable. The usefulness of the models in this analysis or others should therefore be considered in the context of the limitations of any model, particularly with respect to key aspects including but not limited to: i) the amount of weight that should be given to recent levels of market volatility compared to long term historic averages, ii) should future volatility levels be determined by the markets, through observation of derivative prices, iii) past performance should not be a guide, and iv) should the expectation of default risk and recovery rates for debt instruments be based on past data. Output from any model will vary based on the approach taken around these key assumptions and others. Any modelling assumptions may prove to be incorrect and actual results will differ from the results of the model. The results between different models will also differ, potentially substantially, from that shown in our analysis. As such, recommendations, decisions and advice based on modelling by their nature contain associated (model) risks. We do not make any claims to accuracy and we acknowledge that there are a wide range of alternative underlying assumptions that may be just as valid as those we use. Any modelling assumptions (and the resulting analyses and forecasts) may require modification as additional information becomes available and as economic and market developments warrant. Nothing contained herein may be relied upon as a guarantee, promise, assurance or a representation as to the future. I N V E S T M E N T M A N A G E M E N T 20 Gracechurch Street London EC3V 0BG United Kingdom T +44 770 138 8323 vanlanschotkempen.com/investment-management