UK defined benefit (DB) pension schemes are increasingly focused on their endgame planning, with the options for most being an insurance transaction or run-on.

The events since September 2022 have resulted in significantly improved funding positions for many UK DB pension schemes. As a result, many pension scheme trustees and their corporate sponsors are faced with an ‘endgame’ decision that would previously have seemed years away. An increasing number of schemes are looking to insure and buyout in the near term as a way to settle the liabilities of the scheme once and for all. At the same time, the Government has been progressing a series of changes to the pension regime that aim to make it more attractive for schemes to invest for a surplus over the long term. By doing so, they are creating a new and expanded opportunity set for pension scheme run-on strategies.

The question for trustees and sponsors now is whether you look to secure your scheme’s liabilities with an insurer or consolidator, or should you continue to run-on for the foreseeable future?

Choosing the best strategy can prove challenging but we are here to help.
 

Understanding your options

Insurance Transactions

With over 100 dedicated colleagues, we have the largest team of risk settlement specialists in the UK, meaning our expertise and breadth of experience is unrivalled in the market. As such, we have been entrusted to act as lead adviser on around 40% of all risk settlement deals since 2019, which include both bulk annuities and longevity swaps, across a range of scheme sizes from £1M to several £Bn. With a range of expertise at our fingertips, we can provide complete solutions to schemes, including member options exercises, investment advice and due diligence services.

Full Scheme Buy-in

Under a buy-in, the pension scheme buys an insurance policy to secure all future pensions and benefits due to be paid to members. The scheme pays a premium (typically up front) to an insurer, and in return the insurer takes on responsibility for meeting the insured benefits, along with the interest rate, inflation, longevity and demographic risks associated with those benefits. The insurer would generally make the payments to the scheme which, in turn, pays to the members. End result: the pension scheme holds the bulk annuity policy as an asset and retains the ultimate responsibility for interacting with members and making sure their pensions can be paid, while the insurer takes on the financial and demographic risks.

Buyout

Under a buyout, the pension scheme pays a premium (typically up front) in order to fully secure all future pensions and benefits due to be paid to members. In most scenarios, this will cover all members of a pension scheme. An insurer receives the payment and takes on responsibility for meeting those liabilities, along with the interest rate, inflation, longevity and demographic risks associated with the benefits. The insurer deals directly with the scheme members (who then become policyholders).

Longevity Risk

In DB pension schemes, longevity risk is the risk that members live for longer than what is currently expected. That results in pensions being paid for longer than expected, thus costing schemes more money. Once schemes are well funded and have managed investment risks, longevity risk is likely to be one of the most significant risks remaining for most schemes. Recent mortality trends have been volatile, and as a result future longevity expectations have proved increasingly difficult to predict. Trustees and sponsors of all scheme sizes have increased focus on managing longevity and mortality risk.

A longevity swap is an alternative way to remove longevity risk. There is no upfront payment required, and so your scheme can retain more assets either to provide additional asset returns in the future or to support an interest rate and inflation hedging strategy. Longevity swaps currently tend to be focused on pensioner members, and while they are available to schemes of all sizes, their complexity tends to mean they are more popular with larger schemes.

Superfund

A Superfund takes on DB pension schemes from their original sponsors, ending the sponsor’s responsibility for the pension scheme. A superfund is aimed at schemes with funding levels that are short of what is required for a full buyout with an insurance company. The cost of entering a Superfund is typically lower than an insurance buyout, so this can be particularly attractive where buyout is unaffordable and/or the employer has a weak covenant.

A Superfund operates as a pension scheme (with its own trustees, administrators and advisers) with pensions paid through its own assets held in reserve (via assets transferred from the existing scheme, plus a capital buffer to protect against adverse events). Transferring a DB pension scheme to a Superfund can improve the security of members’ benefits by replacing existing employer covenant with a capital buffer.

As Superfunds operates as a pension scheme, member benefits are covered by the Pension Regulator’s guidance and the Pension Protection Fund.

Further Information on our Risk Settlement services can be seen here.

Running On

Active Run-on

Active run-on is the strategy of operating a well-funded pension scheme with the explicit intent of building up surplus assets, then using that surplus to benefit the key stakeholders of the scheme: the members and sponsor. This type of strategy is not new but was highlighted in the recent Mansion House consultations as something the Government might want to further encourage in order to facilitate long-term pension scheme investment in productive finance.

Active run-on strategies can be deployed both for short periods (say, 3-5 years with the expectation to buyout with an insurer after that period has elapsed) or as the long-term endgame strategy for schemes. Active run-on is generally better fit for mid-to-large schemes (say £100M or more) with a strong or tending-to-strong sponsoring employer. These schemes can target material levels of surplus over time whilst maintaining exceptionally high levels of security for members. Surplus can then be used for the sponsor’s benefit and/or for the benefit of members via enhancements to benefits.

Further information on Aon’s Solution to Run-on (ASTRO) can be seen here.

Self-sufficient Run-on

Through self-sufficient run-on, schemes only hold low risk investments in order to manage down investment volatility to as low as reasonably possible. This aims to give a very low chance of further contributions being required from the sponsor but also reduces the level of surplus that is expected to build up.

This can sometimes be an interim strategy until the time when the cost of a full insurance buyout is favourable in comparison to the costs and risks associated with governing the scheme on an ongoing basis. Alternatively, the strategy might be adopted in order to avoid a scheme-specific concern with buying out, for example, in relation to a potential adverse impact on company accounts or member benefits.

Captive Buyout

A captive buyout is a hybrid endgame strategy that includes features of both insurance and running-on.

A key part of a captive buyout is the pension scheme insuring liabilities with a UK insurer. This provides the members and trustees of the scheme with the same high level of security as a buy-in or buyout. However, the insurer then reinsures some or all of the liabilities back to a captive reinsurance subsidiary owned by the sponsor. This leaves the sponsor with a portion of the ongoing assets, liabilities and risk attaching to managing pension liabilities, as well as the potential to benefit from any surplus/profit generated over time. In this way, it is similar from the employer’s perspective to an active run-on strategy.

For further information on low dependency run-on or captive buyout please get in touch [email protected]