De-risking pension schemes: what treasurers need to know

As companies take advantage of current opportunities for their DB schemes, treasurers have a key role helping to calmly navigate the waters, says Just’s Rob Mechem 
 

Defined benefit (DB) pension schemes, which pay retirement income based on salary and length of service, have been in the news – coming under the spotlight because of the dramatic increase in their funding levels. Scheme trustees and their corporate sponsors now need to think about the right next steps to ensure their DB scheme members are suitably protected, now and into the future.

Opportunity

In today’s world, it is ever more apparent there is a need for treasurers to balance a company’s financial risk with opportunity, and it is more typically part of their purview. For treasurers, this means thinking about the balance sheet, alongside the scheme sponsor, trustee, and scheme member needs.  

A DB scheme is a promise to pay its members an agreed amount for life; a promise that requires the scheme to be funded via contributions for as long as its members live. In the past, this has put some schemes in a tricky position. 

But now many schemes have seen a significant improvement in their funding position over the last couple of years, which has given trustees and sponsors more options for the future. Options include whether to de-risk the scheme fully, partially or maintain it ("run on”). To do any of these, sponsors need to understand the landscape and risks they are running – such as investment, longevity and inflation.

From a trustee's perspective, they have been the custodians of the scheme, responsible for ensuring it is run in an effective manner, with good risk management, strong governance, and members’ outcomes at the heart of everything they do.

For members, they've relied on these pension schemes for a substantial portion of their expected retirement income and want to know this will always be the case.

De-risking via an insurance policy

With the dramatic rise in scheme funding levels, more DB schemes are pursuing de-risking strategies known as bulk purchase annuities (BPA). A BPA is a special type of insurance policy for lots of individuals, offering financial security for DB scheme members and their pensions. It transfers the risks associated with a pension scheme over to an insurer. In 2023 alone, BPA deals amounted to circa £50bn, via 225 or so transactions.

With a buoyant market and attractive pricing, demand for these transactions continues at pace. Of course, with any opportunity, there are challenges. And for those considering a BPA, it is important to understand the journey and what is involved in this type of transaction. 

What do insurers consider?

Insurers see multiple possible transactions on a weekly basis and need to decide where to put their resources to maximise a successful transaction. To achieve the outcome you want, preparation is key. It is important to consider:

Data quality: from getting the right price for your scheme to a smooth transition experience, an insurer relies heavily on complete and accurate member data. While every scheme is unique, and some are more complex than others, data with any gaps will prolong the process and cost [you] more.

Benefit specification review: an insurer needs to be confident in the benefits they will need to insure. So, they want to see that the scheme’s lawyers (and administrators) have reviewed any benefit specification to ensure it correctly reflects the rules of the scheme.

Asset/payment understanding: if your scheme can afford to do a transaction, it needs to understand how it will pay. Does it have assets that are easily transferable or easily liquidated? Many schemes have purchased illiquid assets in the past and therefore need to consider the optimal way of approaching them.

Treasurers play key role

Other factors determine how likely an insurer is to quote and give you a good price for your scheme. These include: 

• The profile of the scheme: how many members it has, what type of members they are (pensioners versus deferred members; those who have not yet started to take their benefits)
• Whether all parties are engaged: this is where treasurers can really add value by being part of a strong working party, ensuring everyone understands their roles and robust governance is in place. Where this falls short, insurers have seen unnecessary delays and even cases not transacting due to indecision.
• Clear timetables and targets: insurers always look for transaction certainty and having a clear project plan with a well thought through timetable and an understanding of the level of pricing required are both strong indicators of this.
• Advisers: has the scheme selected advisers who have been involved in these processes before? This is important from a contractual perspective and to enable a successful transaction phase.

A BPA process tends to take a few months from initial conversations to a successful transaction and then a further six to 24 months to firm up the final data position. So, planning and preparation are critical to achieving a smooth process for all scheme stakeholders. 

Treasurers, therefore, have a key role to play in helping their scheme to calmly navigate these waters and avoid any pitfalls along the way.

About the author

Rob Mechem is director of DB Commercial at Just Defined Benefit Solutions