Pension scheme sponsors have a ‘once in a lifetime opportunity’ to reap rewards for their members and shareholders – LCP

LCP are urging pension scheme sponsors to make sure their scheme is on the right course as it could reap rewards for members and shareholders in the years to come.

LCP’s latest report Seize the moment, highlights the variety of options now open to mature DB schemes approaching the end of their journey. There are multiple “endgame” options now available and new innovations are coming forwards all the time. A strategy which seemed right when set a couple of years ago could be missing out on important new opportunities.

As at the end of September, FTSE 100 balance sheet surplus levels stood at £70 bn, broadly equating to a 120% funding level. These historic levels have led to a boom in the bulk annuity market with LCP’s de-risking report suggesting that 2023 is on track to be the busiest on record. Sponsors have previously tended to opt for the de-risking route because they’ve tended to see the scheme as a millstone around their neck. In an era of high funding levels there is now more opportunity to do more for scheme members, whether that is supporting DC members or offering discretionary increases to DB members.

All of this is independent of any further reforms that might come off the back of the Chancellor’s ‘Mansion House’ agenda which may provide further space for seeing a pension scheme as an asset and not a burden.

When it comes to investment, more schemes are now holding a far larger proportion of illiquid assets following the LDI crisis as many schemes needed to reduce their holdings in liquid assets. LCP warn that this may hinder flexibility and schemes will need to make careful consideration around when and if they reduce their holdings. The report also urges sponsors to learn lessons from the LDI crisis.

The report also highlights that mortality is an important consideration for sponsors not just for the balance sheet but also when it comes to funding and de-risking discussions. Sponsors are likely to continue to see reduced liabilities coming through for funding and accounting due to mortality assumptions over the coming year. 2023 data so far shows 4-6% higher mortality than 2019, with early estimates suggesting that the CMI 2023 tables expected to be released in Q1-Q2 2024 could lead to a further 1-2% reduction in liabilities.

There are several big changes in the pension landscape that schemes also need to be on top of. These include:

• Contingent funding solutions can provide significant benefits for both sponsors and members. With improved funding positions, an ever increasing risk of overfunding and a new funding regime expected, contingent assets are being adapted to meet the needs of all pension scheme stakeholders.
• Mansion House reforms In the Chancellor’s Mansion House speech in July 2023, a whole raft of reforms were announced that are designed to ensure that money saved in UK pension schemes is used more productively. With c.£1.5 trillion sitting in workplace DB schemes, the DWP has also published a call for evidence on ‘options for DB schemes’. One of the principal ideas discussed in the consultation is one developed by LCP, designed to free up well-funded DB pension schemes to invest for long-term growth instead of continuing to move to more and more low-risk, low-return assets. Although the timings are tight we could see some key changes in the pensions space before the end of this parliament, and as always change means risks and opportunities for sponsors.
• Mortality is an important consideration for sponsors not just for the balance sheet but also when it comes to discussions around funding and de-risking. Sponsors are likely to continue to see reduced liabilities coming through for funding and accounting due to mortality assumptions over the coming year. 2023 data so far shows 4-6% higher mortality than 2019, with early estimates suggesting that the CMI 2023 tables expected to be released in Q1-Q2 2024 could lead to a further 1-2% reduction in liabilities.
• The new Funding Code the expectation is that all schemes will be required – by law – to target a low-risk investment and funding strategy by the time they reach a certain level of maturity, and trustees must follow the principle that deficits should be paid off as soon as the employer can “reasonably afford.” The Code is expected to come into force from April 2024.

Gordon Watchorn, author of the report and Partner at LCP, commented, “An intense focus on protecting against what could go wrong means there has been little consideration of the likelihood or consequences of what could happen and how things could improve for all when things go right. In this environment of unprecedented funding levels when there are now more options for sponsors, it’s time to be more innovative and bold and to keep the strategy under constant review.”

Steve Webb, Partner at LCP, added: “With so many other issues competing for the time and attention of business leaders, a relatively mature DB scheme can easily slip down the priority list. But our message is both urgent and optimistic. There is a once in a lifetime opportunity now and time devoted to making sure your scheme is on the right course could reap rich rewards in years to come.”