Making old DB pension schemes invest so heavily in low cash returning government bonds may not be the best use of limited resources. Well financed schemes have run the hard yards of derisking and cash contributions so, should the aim be to hand over to life insurance companies? The irony is that if you can afford to do it, you don’t need to yet and there are better ways forward for all stakeholders.
The derisking approach is based on a fear for the future of the sponsor of the scheme. The answer can be to address it directly with a surety style product from a financial institution. Banks and insurers are surprised they are not asked about such products. Capacity and pricing are all attractive. Once in place it means the scheme always has a fall back cash source. Downside addressed, the scheme can use long term actuarial and investment strategies which just factor in more time. That is time in which the high levels of actuarial prudence “trues up”.
Illiquidity is no problem and 'mark to market' culture less of a driver if you know the cash is not yet needed. What about more commitment to infrastructure investment? That fits back to the original idea of DB schemes helping to fund real economy growth and employment.
The graphic shows what is happening now with the 'derisk and sell off' plan contrasted with the 'flat line' approach. Given half a chance, most asset managers would go for the flat line strategy.
All that is really required is for a new collaboration. The Pensions Regulator introduced the framework for just that five years ago in the form of the Integrated Risk Management exercise. This allows actuaries, asset managers and bankers to cross cultural divides and work together.
So what happens if the scheme is overfunded? Excellent news. Plan for it now. For the trustees and sponsor there can be a 'Reactivation Moment' for the scheme on a DC basis in a new tier. This means that there is scope to improve benefits for members old and new.
For corporates, surpluses can be used to meet current DC contributions – an earnings boost. Improvements all round can be a positive feature for HR to put to new employees. And it’s good for Environmental, Social and Governance commitments and Section 172 Statements on its approach to employees.
There is no need to make the controversial step of winding up the scheme or taking cash out. Far better to make the scheme an explicit part of an employment approach.
Pension funding can switch from dull backwater to a positive statement by the business about its ethos.
Read William McGraph's previous article on Defined Benefit pension schemes: Has filling black holes created a magic money tree?