According to a survey from Russell Investments, there has been a 33% increase in UK defined benefit (DB) pension schemes looking to run on/off, however, buyout remains the preferred long-term objective for those that have endgame targets.
As at 31 March 2024, the Pension Protection Fund (PPF) estimates that total DB assets were c.£1.2trn and over a third of schemes (by value) were in surplus on a buyout basis.
According to the Purple Book 2024, just over a third of DB pension scheme assets are above 100% funding on a buyout basis, corresponding to c.£413bn of assets.
However, despite funding levels improving significantly over the past couple of years, Russell Investments said that nearly a third of schemes have not yet decided on their endgame target.
For those that have an endgame target, it said buyout remains the preferred long-term option but there has been a 33% increase in schemes looking to run on/off.
Schemes are also getting closer to their endgame goals, according to the Russell Investments’ survey. Nearly a third (32%) of respondents said they expect to achieve their endgame target within 1-3 years, an increase from 25% who said so last year. Conversely, the number of respondents saying they were expecting to achieve their endgame target in 4-6 years and 7+ years, saw a slight decline.
PRT market
But Legal & General (L&G) believes the increase in funding level brings to life the potential immediate demand for pension risk transfers (PRT) from UK DB schemes.
It pointed out that in the first half of 2024, insurers completed £15.2bn of buy-ins and buyouts. L&G expects the total market volume at the end of the year to exceed £40bn, which would be one of the largest years on record.
L&G added that it expects the appetite for buy-ins and buyouts to remain elevated into 2025 and across the next decade.
It said: “Healthy DB funding levels are expected to persist resulting in a paradigm shift to an average c.£45bn per annum UK PRT market.”
L&G added that over the past two years, there has been a significant increase of £1bn+ buy-in and buyouts. In a record-breaking 2023, insurers completed 12 transactions of over £1bn. In 2024, L&G expects insurers to have completed a further 12 transactions of this size.
It added that the number of transactions completed each year is steadily increasing, primarily driven by schemes smaller than £100m, which make up the vast majority of transactions. L&G’s research shows that 226 transactions were completed market-wide in 2023.
However, L&G acknowledged that amid the rise in aggregate funding levels in recent years, many schemes are now not only fully funded but in surplus and seeking to maintain and even grow this surplus, which brings many potential attractions for schemes given the recent regulatory change surrounding surplus extraction.
It added that as trustees review their investment strategies with the objective of running on to pay pensions and grow a surplus, they will need to consider whether to return value to the sponsor, provide an uplift in benefits for members or to top-up a related DB or defined contribution (DC) scheme. It is therefore vital for them to take into account the assets, the liabilities and the sponsor covenant, it said.
L&G said: “UK DB pension schemes are in the healthiest, best funding position they have been for decades. Considering these improvements, much debate has centred around whether schemes should choose to buy out or run on.”
Buyout as the preferred endgame
“From speaking to pension schemes, our view is that most schemes will incorporate insurance into their long-term de-risking strategy and for many, moving to buyout will be a question of optimal timing.”
And while the chancellor’s Pensions Scheme Bill recommends a permanent legislative regime for superfunds, which will bring the potential for pooling of assets and greater economy of scale, Kunal Sood, managing director of DB solutions at Standard Life, expects that schemes in strong funding positions will continue to “value the high security that buyout affords members”.
He said: “With many schemes now in a funding surplus, buy-out remains the gold standard when it comes to securing members’ benefits, particularly in a volatile economic climate.”
Factors to consider
There are factors to consider when aligning with endgame, said Calum Cooper, partner and head of pensions policy innovation at Hymans Robertson.
He said: “In order for trustees and employers to define an endgame strategy for their circumstances, there are a number of competing considerations that must be worked through.”
Hymans Robertson’s Excellence in Endgames paper outlines key factors to consider when defining a core asset and surplus sharing strategy.
Cooper said: “For example, it’s really important to define your strategy for longevity risk as the next decade will be different. Real scenarios and interactive modelling can help bring this alive and save a lot of time and effort.”
He said there is “no perfect time” to start sharing surplus, and trustees and sponsors will need to balance the needs, wants and tolerances of stakeholders, adding: “The final decisions must ultimately be right for the members.”
Cooper explained that the longer schemes take to build reserves before distributing surplus, the higher the level of return and surplus share which can be targeted. “This opens the possibility for a wider range of asset classes – for example, illiquid assets may be a more attractive option. But it also changes who gets what.”
Cooper urged that external consideration must also not be forgotten.
“Changing legislation and guidance from the Department of Work and Pensions (DWP) and/or the Treasury may influence how you choose to share value. This is not straightforward territory. But with £100bns of surplus capital in DB schemes, the scale of the positive impact on members’ lives, sponsors’ businesses and the UK economy is such that the territory is worth travelling,” he said.
“The delicate balancing act of defining a productive and dynamic run-on investment strategy for the journey cannot be underestimated,” he urged.
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