Long-term funding: Are we on the right track?

Galvanised by the Pensions Regulator’s new defined benefit funding code of practice, trustees and sponsors must address the maturing status of their DB schemes. TPR expects trustees to determine a clear journey plan towards a lower-risk position as they close in on their goal. 

With a second consultation on the new code due later this year, there is an increasing spotlight on trustees in setting their long-term funding objectives and developing a plan to achieve this.

While the finer details of the code are still being developed, we believe the scheme-specific focus on getting to the endgame is a vital step forward in improving security for DB scheme members.

The veritable minefield of endgame options may present a challenge for trustees to navigate, particularly where they are also balancing uncertainty with the extent of support from the sponsoring employer

That said, trustees must consider the regulatory direction of travel in their decision-making, particularly relating to investment strategy.

The past few months have witnessed a favourable uptick in scheme funding welcome news after the significant swings in scheme deficits throughout 2020. However, looking forward, the headline topic for trustees’ agendas is where they go from here.

The veritable minefield of endgame options may present a challenge for trustees to navigate, particularly where they are also balancing uncertainty with the extent of support from the sponsoring employer.

However, some simple steps can help trustees design a framework that ensures consistency with regulatory expectations while enabling effective decisions today, that are aligned to the future.

Select a destination

Historically, the funding gap (or deficit) to an endgame destination has loomed so large to not merit much thought.

However, with positive progress in scheme funding over the last year, coupled with accelerating maturity profiles, trustees should rethink their goal and what is achievable.

Today, many trustees start by asking if the scheme could buy-out in 10 years’ time. Increasingly, the answer is maybe, and they should factor this into the investment strategy and journey plan today.

However, if this is not achievable, the next question should be how well funded could/should the scheme be in 10 years’ time on a prudent measure-self sufficiency. Asking such questions will assist trustees in future-proofing against the current regulatory direction.

Review the journey plan

With the destination in mind, trustees should rethink their journey plan. For example, are they targeting the right investment return today or taking too much risk to achieve that return target?

We are seeing schemes that, having followed a neat derisking framework, are typically anchored to full funding on technical provisions or a measure of self-sufficiency.

But the measure of the liabilities set by these schemes may contravene what the DB funding code expects. So it is important to figure out the impact of aligning.

There will be times where scenario testing alternative journey plans is vital to inform both the trustees and sponsoring employers what is possible today and in the future.

Crunching the numbers also ensures that the scheme is targeting an appropriate investment return today and avoids derisking too soon or indeed too quickly.

Being flexible is key to ensuring that trustees stay on the right track to reach their endgame destination. Indeed, it might even be time to change track and be more certain of arriving on time.

Don’t get blown off course

For most DB schemes, the journey to their endgame is not without risk. TPR expects schemes to reduce investment risk as they mature.

However, trustees must balance derisking against achieving the long-term funding target. Derisking too soon can bear a profound impact, extending the timeframe to the ultimate destination, and placing greater reliance on the sponsoring employer.

Derisking is not the blunt instrument it once was and need not mean sacrificing return. We have been helping trustees design solutions that meet their need for return while managing key risks in the liabilities and tackling increasing cash flow demands.

The three steps outlined here provide a robust framework to reach your endgame without getting blown off course. Importantly, we find this supports more effective governance with scope to adapt the journey along the way and navigate what is likely to be a volatile path ahead.

Ajeet Manjrekar is co-head of solutions at River and Mercantile