‘DB or not DB’ – That really is the question!

Three years ago, Steve Deverell-Smith co-authored a blog that looked at the options available to scheme sponsors at that time to manage spiralling pension costs. In this update, Steve takes a fresh look at the issues, reflecting on how much has changed over a relatively short period of time.

At the start of 2021, government bond yields were hovering below 1%. According to The Purple Book 2020, around one million members were still building up some form of new Defined Benefit (DB) accrual. And the average cost of providing future benefits was between 30% and 50% of salaries, depending on benefit design.

Fast forward to the present day and the number of members still building up benefits has fallen by some 30% to around 0.7 million, according to The Purple Book 2023. Yet, at the time of writing, yields are closer to the 4.5% mark and the comparable cost of DB accruals is less than half of what it was in 2021.

For those DB schemes still open to accruals this is great news from every angle. Benefits are just as valuable, yet considerably more affordable, than they were just a few years ago, and there is less pressure on the corporate purse strings to contemplate diluting or even curtailing future service benefits. However, this does prompt a new string of questions.

As ever in the complex world of UK pensions, there is no simple conclusion that can be drawn to suit all circumstances – the decisions made in the past will influence your next steps and influence the choices you will need to make in the future.

Open to future benefit accruals, but still living in the past?

For those schemes that are still open to new entrants and/or accruals, there’s a fair chance that unless you have recently concluded a late 2022 or 2023 valuation, sponsors (and potentially members) are paying more than they need to.

For those schemes in the T19 tranche of valuations (with effective dates running up to September 2024), discussions will no doubt provide the opportunity to renegotiate ongoing future service contributions, providing respite for many sponsors (and potentially members). If you haven’t considered this, you probably should, and sooner rather than later.

For schemes looking to ride the crest of a wave through to buy-out, the considerations are different.

Open to future benefit accruals, but contemplating transferring risk to an insurer?

With buy-out funding levels continuing to look attractive through a corporate de-risking lens, many sponsors and trustees will no doubt be considering whether the time is right to get those pension liabilities off the company books.

Before they can take advantage of current market dynamics, however, they need to revisit any ongoing accruals they may have. Active members and their associated liabilities cannot typically be covered by an insurance policy due to the inherent uncertainties surrounding them. There are options that avoid pressing the nuclear button straight away, but what is right for sponsors and members in this situation will vary.

Contemplating transferring risk to an insurer, but legacy ‘employed deferred’ benefits remain?

Many schemes closed to future accruals several years ago. However, for myriad legacy and legal reasons, they may still have ‘employed deferred’ members who typically have more generous benefits than their ‘true deferred’ counterparts. This will either involve an ongoing link to company salary or an entitlement to more generous terms while they remain in active company employment. Unfortunately, these benefits can quite often be uninsurable.

If your scheme fits either of the above boxes, chances are you will need to act before an insurer can take your pension obligations away from you.

Previously closed to accruals but made a commitment to revisit the decision if circumstances changed for the better?

For those sponsors that have recently and successfully acted to curtail all forms of accrual in their schemes, has that decision stood the test of time?

Under the pressure of consultation conditions, many sponsors will have committed to revisit the decision if financial conditions improved – and, for many, improved they certainly have.

While I’m not advocating a slurry of DB schemes to re-open their doors (wouldn’t that be nice though?), I do think there’s a good argument to revisit any prior commitments made on this front, given the corporate responsibility towards ‘good faith’ if nothing else. If I were a member, I would certainly be raising that challenge.

Is running-on the scheme a viable option?

Finally, you can’t read a pension briefing nowadays without someone mentioning the new kid on the block: ‘run-on’.

In practice, the principle of purposefully running-on a scheme to generate surplus assets does sound like a great option provided the basics are done well.

Yet to really make run-on work in the current environment you need the correct governance and scale:

  • Scale to ensure costs aren’t a stumbling block
  • Scale to access the right investments
  • Scale to make it viable to access surplus via subsidising Defined Contribution (DC) contributions in the same hybrid trust.

While none of the above is unsurmountable, it does strike me that if run-on is on your radar, then it may be simpler all round to consider the merits of repurposing DB surplus assets to make DB pensions more widely available. It may not quite be better pensions for all, but one small step feels like a better outcome to me than none – and I suspect it’ll be much easier to get your trustees’ agreement on sharing scheme surpluses in this way.

Looking to the future

Looking forward to the next three years, who knows what the future may hold? Not least considering where the current raft of DWP consultations on greater flexibilities will lead us – and when. It is, however, fair to say that it won’t be a quiet three years, and there’ll be plenty of interesting conversations and new solutions to embrace along the way.

In the end, people need a reliable income in retirement, and I hope we’re entering an era in which it will be easier to provide people with pensions, whether the scheme is DB, DC or even CDC.

Any questions or comments about this article?

Get in touch with the author, Steve Deverell-Smith.

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