A true turning point in the road for pensions journey planning – the growth of alternatives to traditional insurer buyout.

A true turning point in the road for journey planning – the growth of alternatives to traditional insurer buyout.

Journey planning towards a full risk transfer continues to be a point of focus in the pensions world. Many defined benefit (DB) schemes continue to have strong funding levels, and professionals across the pensions space have seen a surge in demand for buy-out services. 

We are also seeing the steady growth of alternatives to the traditional insurer buy-out model, offering potential cost-efficiencies and new routes for schemes that are not yet at the 100% funding level. Insurers will continue to provide great outcomes and options for many schemes - and we strongly support insurer work – but at the same time, new alternatives provide additional opportunities in the market. Those opportunities may be of growing interest when combined with the new surplus proposals from government and could potentially give rise to an enhanced return of capital back to scheme employers.

In this short article, we will explore and compare three strategies that schemes can consider in their journey plans: capital backed journey plans, superfunds and the traditional insurer buy-out. 

Capital backed journey plans (“CBJPs”)

A CBJP offers trustees access to additional capital without the need to draw on the scheme’s sponsor. Hymans Robertson has referred to such schemes as “a bit like fiduciary investment management, but with additional capital underwriting investment returns and with layers of controls and protections”. Some familiar products in this space include the Aspinall vehicle and the Pensions Safeguarding solution. 

From our work on capital backed projects for schemes we have found the terms set out to be balanced in their approach, with good account taken of key drivers for trustees.

The service is offered by capital providers, who target a certain return on the scheme’s assets. The scheme’s assets are then invested with the provider’s own capital, and they are intended to grow together to reach the endgame target (e.g. the necessary funding for a buy-out). This can potentially be faster than the freestanding strategy that trustees may adopt, due to both the initial capital injection and the provider’s investment strategy. 

If a greater return is achieved, there will be an agreement in place on how this is apportioned. However, if the provider’s promised return is not achieved, it is the capital that makes up the difference (the extent to which and when it does so will depend upon the terms of the contract). 

Potential advantages:

• this is an option where schemes have not yet reached the requisite funding level for a buy-out, and it can help schemes get there faster; 
• schemes can benefit from the capital provider’s investment management; 
• the capital is used to buffer against poor returns; and
• there may be a prospect of enhanced return of surplus to the scheme employers.

Potential disadvantages:

• the pension liability is not fully bought out at this stage; and
• advisory costs may be greater than for some insurances projects, but we expect to see these costs come down as more projects are entered into. 

Superfunds

These are sometimes referred to as “commercial consolidators”. There have been a number of interested parties in this space, with Clara being the first superfund to receive the Pension Regulator’s approval. These superfunds consolidate DB schemes at a lower cost than insurance buyouts and use a ringfenced capital buffer as protection in lieu of an employer’s covenant. This can be paid into the scheme should it fall below a certain funding level, with the intention that members receive their benefits with a higher degree of certainty than would otherwise be the case. 

There have now been a number of successful “Clara” transactions, for both solvent and insolvent employers. Again, from our own work on Clara, we consider that the terms generally include a good degree of balance, and many of the relevant terms will have been reviewed by the Pensions Regulator as part of their clearance process on earlier deals.

Potential advantages:

• it can be a great solution where the employer covenant is weakening or where schemes are not yet ready for an insurance buy-out;
• the employer has no further liability for the benefits that are transferred; and
• these transfers are intended to meet members’ benefits at a lower cost to the scheme than full insurance buy-outs.

Potential disadvantages:

• there can be high advisory costs for implementation (but again we expect these to fall); and
• members’ benefits are not guaranteed in full until any buy out for that section is achieved (though the Pension Protection Fund exists as a safety net). 

Traditional insurer buy-out

Despite the new options appearing on the market, a traditional insurer buy-out remains the appropriate option for many schemes. This offers a well-known approach where the default risk is remote, meaning members can be guaranteed their full benefits. 

Potential advantages:

• it is a tried and tested approach;
• there are plenty of options as the market is well established;
• pension liabilities that are transferred are fully settled, allowing the sponsor to remove this liability from its balance sheet; and
• members’ benefits are secured – the risk of default is remote.

Potential disadvantages:

• this option is only suitable for schemes that can meet the 100% funding level for insurers;
• it may not be the best option for member outcomes in all schemes; and
• other options might give rise to the potential for enhanced return of surplus to scheme employers.

Concluding remarks

As funding levels remain strong across the DB space, we encourage trustees and sponsors to continue assessing their long-term goals for schemes. Demand continues to increase in the market, and we are seeing exciting new entrants and innovative solutions to securing members’ benefits. We expect this will only continue as more schemes choose the alternative options discussed above.

If you would like any advice or assistance with your scheme’s journey planning, we are very well placed to help. Please contact Clive Pugh or your usual Burges Salmon Pensions and Lifetime Savings team contact.