Small schemes face big decisions amid growing cost pressures

But shifting regulation, a turbulent macroeconomic environment and a red-hot insurance market have only added to the need for strong governance, management and clear decision-making by trustees and sponsoring employers.

A significant proportion of the DB universe

Small schemes account for more than a third (36 per cent) of all DB schemes, a proportion that has remained broadly unchanged over the past decade. 

It means there are more than 1,800 schemes in the market, albeit a number that has dropped by around 500 over the past decade.

The perennial problem smaller schemes face is clear – attracting and engaging insurer attention when transactions for larger schemes may be considered as the best use of insurers’ limited resources.

Given they account for such a significant proportion of the DB universe, how these schemes are run is an important aspect of the industry.

With a congested insurance market, small schemes continue to have two clear areas of focus. First, how these schemes can reach endgame, and second, how schemes can optimise their day-to-day running if insurance is a less viable short-term option.

Defying the odds to attract insurers

The latest Pension Protection Fund Purple Book shows that small schemes are the most well-funded on a full buyout measure compared with larger schemes. 

Their aggregate funding measure of 84.6 per cent – no larger scheme bracket exceeds 80 per cent – demonstrates that many are in a strong position for approaching the insurance market.

Yet, with around 200 derisking transactions each year, there is a significant pool of schemes for insurers to pick from, which will continue for many years to come.

Therefore, the perennial problem smaller schemes face is clear – attracting and engaging insurer attention when transactions for larger schemes may be considered as the best use of insurers’ limited resources.

Moreover, Broadstone data demonstrates that strong funding levels are now prevalent within the small scheme market, particularly after rising gilt yields drove healthier funding positions across the board.

No longer are small schemes just fighting against the bigger schemes for insurer attention, but now they must battle it out among each other in what is a hugely competitive market. It means small schemes must work harder to gain traction. 

Preparation is key. A well-governed scheme with high-quality data and suitable investments stands a far stronger chance of success as insurers look for “easy wins” in a sellers’ market.

Unless, and until, insurers scale up their resources, this environment is likely to persist, so small schemes must decide how and when to approach the derisking market. If now is not the right time, employers and trustees will want to ensure high-quality and cost-effective management of their scheme on an ongoing basis.

Growing cost pressures

The desire to reach endgame quickly is understandably strong for small schemes, given operations are an immensely challenging task and the disproportionately high management time and cost involved with running them. 

It is vital that trustees are taking steps to make their administration and governance as effective as possible.

The incoming funding code is one example of increased complexity, reporting and cost, particularly for small schemes, and is likely to exacerbate the challenge of ongoing scheme management. 

Schemes must therefore ensure that they are receiving excellent advice and services that are personalised to their individual circumstances. Attention to detail around, for example, selecting administrators that are able to provide a cost-effective service without skimping on quality is essential.

This will allow schemes to maintain their wait for market opportunities as and when they arise while maintaining the security of their members’ benefits.

Big decisions

Evidently, small schemes face a challenging environment, and lack the scale to absorb further complexity and new regulation as comfortably as their larger peers. 

Big decisions are required by trustees and employers on the relative merits of taking the scheme to the insurance market or ongoing management for what could be another five to 10 years.

Insurance offers a route to security for their members as well as, winding down the burdensome operations of the scheme. But to stand a chance they need a detailed and tailored strategy to ensure they engage with insurers ahead of other easier or larger schemes.

Trustees need to consider these decisions now while market conditions are favourable.

Andy Thomson is actuarial director at Broadstone