Running on your DB pension Scheme - The (not so) new alternative to buyout 

  • Author
    Matt Smith
    Partner

Run-on is not a new concept for defined benefit (DB) pension schemes

Sponsors, trustees and their advisers have been working together for years to run-on DB pension schemes and pay members benefits. Improved funding positions have provided an opportunity for DB schemes to turn their attention to their longer-term strategy rather than focusing on achieving full funding on technical provisions.

A tailored approach to running-on is necessary to achieve the best outcome for stakeholders and DB pension schemes need to draw on their adviser’s experiences in actuarial, investment, benefit design, governance, covenant, risk management and risk transfer, to ensure they can make informed decisions.

Meeting your pension scheme objectives

When considering run-on, DB pension schemes should take flexible strategic decisions that can adapt to future changes. We have found that most DB pension schemes plan to ultimately insure remaining benefits through a buyout but running-on in the short to medium term, with specific objectives or in preparation for risk transfer, could lead to better outcomes for members and sponsors.

For open schemes, or those with aspirations to run-on for the long term, a holistic approach across covenant, investment, and funding advice can improve efficiency and ensure that objectives are met DB pension schemes need to establish the appropriate structure, keeping a focus on outcomes, and ensuring efficient implementation. Key elements will include collaboration between sponsors and trustees, risk management, effective governance, covenant assessment, and funding considerations.

What schemes can run on?

All schemes are essentially running on until they chose to proceed with a risk transfer opportunity. Size alone should not dictate the choice. Sponsor views, risk appetite, covenant availability, benefits and the scheme size all influence the decision. The benefits of run-on are not confined to members of larger schemes; solutions are available to support smaller schemes too. DB Master Trusts can offer  cost effective solutions with high governance standards.

Some examples where our clients have an active run-on strategy include:

  • Open schemes 

    who are running on to fund future accrual in a cost-effective way for sponsors and members.

  • Closed DB schemes with discretionary benefits 

    where they are funded and paid on a regular basis; risk transfer options are unattractive due to the need to crystalise the discretion.

  • Immature schemes

    where run on is being targeted in the medium term to avoid a comparatively prudent buyout pricing and improve value release for the sponsor and supplement member benefits. 

  • Surplus generation to support DC savings

     to fund DC contributions for the sponsor and/or make DC benefits more generous to improve DC member outcomes. 

How can we help?

Running on over any period may not be right for all DB pension schemes but, where it is the preferred option, having the right support structure in place will ensure that strategic plans can be implemented efficiently. This may not look like the status quo and could be very different in terms of governance, risk and collaboration. Our approach is to work with DB pension schemes to help deliver the best outcomes.

Some of the main elements of how we consult with DB Pension schemes are:

Effective run-on requires close collaboration between sponsors and trustees.  One where both parties are working together to reward managed risk delivering improved security, value for the sponsor and enhanced member outcomes.  Strategies that are easy to understand, monitor and implement have the greatest success.

An active decision to run-on may require a change in the risk management framework as different, new, types of risk may be present. Action should be taken to identify, record and considering appropriate mitigations; including possible pivot points, the point at which a strategy may need to change in the future.

Run-on does not necessarily need to mean higher costs. Effective governance is at the core of every well-run scheme. Ensuring the right governance framework may result in an evolution of the approach – the environment has changed; the scheme may have a different strategic objective; so the governance model should evolve to reflect this – for example, similar to how it has evolved with the increase in sole trusteeship.

Overall covenant availability is the corner stone to what options are available to manage risk during a period of run-on and how what might be necessary to get all parties comfortable.

Timeframe is a key determinant of investment strategy. Historically, deciding to run on lent itself to a low-risk approach, centred on reducing dependency on the sponsor and the risk of a deficit emerging. Alternative approaches are now emerging, focussing on surplus growth and value creation through a targeted approach to growth assets. Each approach has associated risks, different potential operating models and DB pension schemes should be fully aware of these prior to making any decisions.

Understanding how benefits will be paid in the future and how the cost of providing these benefits will change over time is essential to setting the funding strategy during run on; investment return is only one of many sources of surplus and the same approach to prudence may not be justified.

For some, structured products (such as captives, protected run-on solutions, special purpose vehicles), will form a valuable part of the toolkit. However, even where they do not, it is helpful for clients to understand the range of options available. 

Next steps?

Whether you are looking to buyout or run-on your DB pension scheme, Mercer are excellently placed to partner with you and bring to bear our strategic expertise across the full spectrum of the UK pension space to ensure you achieve your objectives.
Author
Matt Smith

- Partner

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