Defined Benefit (DB) pension scheme funding: 2020 reflection and predictions for 2021
4 mins read
Employers and trustees should engage in contingency planning
The global economy took a significant hit in 2020 and the repercussions of this economic turmoil is likely to go on for some time. While this has affected the majority of organisations, small to medium-sized schemes are at increased risk of employer failure in 2021 and beyond. It’s essential that these schemes undertake contingency planning so that they can identify and address any significant threats. Well-governed schemes establish regular flows of information, simple triggers and pre-agreed actions to manage their vulnerability.
Common characteristics of smaller schemes that make them particularly vulnerable
There are some key features that are more common to small and medium-sized schemes than larger ones. They make outcomes for small to medium-sized schemes more volatile than those of larger schemes.
- More risky investment strategies, as measured by a lower allocation to bond investments that closely match schemes’ liabilities and higher concentration in growth assets (for example, UK equities).
- Higher probability of employer default, as measured by rates used for Pension Protection Fund levies.
- Higher proportion of schemes with low funding levels, as measured by the proportion of small schemes with a buy-out funding level below 50%.
Source: Pension Protection Fund Purple Book 2020
Employer covenant – uncertainty and the end of insolvency protection
What happened in 2020?
There have been fewer corporate insolvencies in 2020 than there were in 2019, due to the range of Covid-19 support measures offered by the UK Government.
Despite a lot of discussion on the matter, only around 10% of UK employers deferred payment of deficit reduction contributions.
What’s expected in 2021?
Insolvency protection and other support measures are due to end in 2021, which is likely to cause significantly more corporate insolvencies. Currently, some weak companies may be running like zombies until their inevitable demise in 2021.
Many economic forecasts are predicting widespread unemployment and employers fighting for survival – this may mean that pensions issues get pushed down the priority list. Contingency planning will enable organisations to give pensions issues due consideration, even in times of crisis.
Carrying out a detailed covenant review and putting an agreed process in place for receiving regular updates are vital. Contingency planning for challenging scenarios will help to identify any immediate actions and to react quickly to new events.
Most employers are viable and may simply want temporary flexibility to weather short-term difficulties (for example, through a temporary contribution suspension). Trustees need to question whether they’re receiving enough information to allow such flexibility. They need to take care that they’re not being moved to the back of the queue behind other creditors.
Risk settlement market (buy-ins, buy-outs and superfunds)
What happened in 2020?
2020 is expected to be the second busiest year for bulk annuity transactions, with £25bn to £30bn of new business written, down from £42bn in 2019. The absence of several multi-billion-pound transactions swamping the market in 2020 has enabled smaller schemes to gain insurers’ attention.
What is expected in 2021?
We expect the buy-in and buy-out market to be more active than it was in 2020, as schemes adjust their plans and expectations for buy-out funding following market shocks in 2020.
The first scheme transfers to superfunds will receive a lot of press coverage as they aim to break the link between schemes and employers at a cost below the buy-out premium. The potential saving in comparison to buy-out may lead some trustees and employers to review their long-term buy-out funding targets. The initial cases are likely to be complicated to govern, with high advisor fees that may prevent the smallest schemes from transacting with superfunds in 2021.
Both insurers and superfunds will offer their best pricing to schemes that are well prepared – preparation is similar for either objective. Key areas for preparation are: equalisation (for example, GMPs); data quality (for example, tracing members and collecting marital data); clear benefit specification (legally reviewed); realistic pricing and contribution expectations agreed with the employer (recent actuarial estimate), and a simple plan to execute the transaction.
We’ve never failed to get a buy-out quotation for a well-prepared scheme, including ones with less than £5m assets.
Trustees’ and employers’ plans need to include contingencies for a range of outcomes. This new year, we’ll be wishing for a swift end to Covid-19 and a smooth Brexit. However, it would be folly for trustees and employers to fail to plan for major disruption continuing deep into 2021.
To find out about the investment performance, scheme funding in 2020 and what is expected in 2021, download the full insight.
Head of Bulk Annuities, Capita
Colin is a senior actuary and Head of Bulk Annuities at Capita Pensions. He has extensive experience of taking trustees through the journey to buy-out and plays a leading role in preparing schemes for the bulk annuity market and the execution of bulk annuity transactions. Colin has more than 17 years of pensions advisory experience and more than 50 bulk annuity transactions to his name, so he has seen most of the different journeys that can be taken to reach buy-out.