Funding is reaching record levels and DB schemes are now in a position of strength. Current regulations compel schemes to target ultra low investment returns, but taking risk and therefore return out of DB pension investments may be going too far, representing a ‘missed opportunity’ to better invest £1.5 trillion of UK DB pension scheme assets.

Steve Hodder, partner at LCP, said: “For 20-plus years, regulatory focus has been on ‘slowing down’ DB schemes through reducing investment risk. This was right when schemes were generally poorly funded and running risky investment strategies.

“But the situation has now fundamentally changed, and I think the slow down mantra has become dangerously ingrained.

“DB schemes are now slowing to a standstill, which is a disproportionately costly way to manage ever diminishing downside risks.

“It is time to readjust our focus and adopt a mindset of ambition and opportunity. With member protection provided in a more efficient way, schemes can be “unlocked” to invest for moderate growth, potentially generating hundreds of billions of pounds to benefit UK savers and the economy.”

Growing appetite for turning up the heat

Dan Richards, client director at Zedra Governance, said he has had a number of conversations recently with consultants about alternatives to a DB endgame that focuses solely on low risk investments and an eventual buyout with an insurance company.

“The idea of turning up the risk is back on the table,” said Richards, “because something like 25% of themes think they are going to go to buyout in the next 12 to 18 months. That is absolutely impossible.”

He rejects the argument about covenants as some employers have covenants that are arguably stronger than some insurers.

“You could target a surplus, with slightly higher risk, and use that surplus to help pay for the DC contributions while you still have a trust arrangement in place.”

But high funding levels is not the only driver, said Richards: ““Since last September, hedging doesn’t quite work the same way if you cannot hold as much leveraged liability driven investment (LDI) instruments.”

Build it and they will have better pensions

Pension schemes have been a drain on companies for decades, but we’re now at a point where they stop being a drain to being something that potentially has quite a lot of value, said John Gething, a principal and actuary at Mercer

“There is a lot of interest because there’s so much money in plans,” said Gething.

“Many of these have got to the point of buyout and the CFOs and FDs who are overseeing the pension schemes see the value they will hand to an insurance company and wonder if there is a more efficient way to run the pension for the benefit of the members – and potential, the company, too.”

One way is to build a surplus. That often means you need to buy out before it can be released and the rules will dictate what can be done with the surplus.

“In order to get better outcomes quicker, the company agrees to some form of additional security – or potentially greater inflation protection for members – and in return, the company will look to use some of the excess return that comes from such a strategy perhaps for making DC contributions, addd Gething.

“We have a number of clients pursuing such a strategy, including half a dozen in the FTSE100.”

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