As the range of endgame options available to UK defined benefit (DB) pension schemes continues to grow, trustees are facing an increasingly complex decision-making landscape.
Ortec Finance, which offers tools for risk and return management, recently delved into why DB endgame decisions are scheme-specific.
One of the most fundamental considerations is a scheme’s funding position. Acting as a snapshot of a scheme’s financial health at any given moment, the funding position can help narrow down viable options. However, it should not be assessed in isolation. An underfunded scheme may appear to be in poor shape at first glance, but if its membership profile is relatively immature, there may be no immediate pressure to act, it said.
Scheme maturity plays an equally important role. More mature schemes tend to be more attractive to insurers, owing to the lower-risk nature of their liabilities, which can translate into more competitive pricing in the bulk annuity market. Mature schemes are also likely to be cashflow negative, which means liquidity becomes a central concern when structuring the investment strategy.
Speaking of which, the investment strategy is perhaps the single most influential factor in determining which endgame route is viable. A buy-out, for instance, requires a highly liquid portfolio before insurers will take it on, and transitioning to that position takes time. Run-on or a captive insurance arrangement, by contrast, can accommodate a broader range of investment approaches and offer greater flexibility.
Scheme rules can also place restrictions on the options available, particularly around how surplus assets are distributed. Even where run-on remains a possibility under such rules, the ability to release surplus may be constrained. Meanwhile, the sponsor’s covenant, its financial capacity to support the scheme, provides a further indication of what is realistically achievable. Run-on, for example, requires a reasonable level of covenant to remain a credible option.
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