Autumn corporate report
This content is AI generated, click here to find out more about Transpose™.
For terms of use click here.
Corporate pensions: more options, new opportunities, what next?
Keeping on top of the changing pensions landscape is now a business essential, and failing to do so could represent a missed opportunity.
For the first time in history, with well funded DB schemes and more flexibility than ever, now is a time for DB schemes to support sponsors after decades of the reverse. Well designed and managed frameworks can provide sufficient protection for members whilst providing significant value to sponsors and a return on investment – whether that be getting rid of pension risk altogether to free up resources and management time or an intentional strategy to access value from the scheme over time.
Gordon Watchorn LCP partner and Head of Corporate Consulting
Scroll down to explore the full report, or jump to a key section:
Read our Autumn Corporate Report
Read nowThe world of workplace pensions is undergoing a quiet revolution
Legacy Defined Benefit schemes are turning from a millstone to an opportunity, with the majority of schemes currently in surplus or set to reach surplus soon. And the 2026 Pension Schemes Act sets out new powers for schemes to use those surpluses ‘in live running’ without needing to wind up the scheme to access those funds.
Alongside the traditional option of de-risking with an insurer – where pricing is attractive and competition intense – schemes have a range of new ‘endgame’ options including a run-on strategy with the potential to grow surplus, or consolidation into one of a growing number of DB superfunds.
At the same time, Government and regulators are increasingly focussed on making sure that pension scheme assets are working hard, and have warned against schemes – even those in clear surplus – simply drifting along with no clear strategy and direction.
But it is not only in DB where the pace of reform has been accelerating.
Assets in workplace DC schemes are set to overtake those in DB within the next five years or so, and there is a huge drive towards consolidation into a smaller number of larger schemes – so-called DC ‘megafunds’.
The Government is keen to see the assets of all schemes delivering more for members. It is implementing a new Value for Money framework which will result in all DC schemes receiving a ranking which will be publicly available to members and the media alike. There are also new duties for schemes to make provision for members not just up to retirement but to design good default journeys through retirement as well.
Innovation is happening at pace in the DC world, with new industry-wide ‘collective’ DC schemes set to offer companies new options and the potential to combine some of the best features of both DB and DC.
Companies standing behind workplace pensions, whether DB or DC, could be forgiven for thinking that they have enough on their plate running their business, and dealing with economic headwinds, without having to devote much attention to their pension arrangements. But the fast pace of regulatory reform and economic change means that keeping on top of the changing pensions landscape is now a business essential, and that failing to do so could represent a missed opportunity.
We hope that this short report gives you a flavour of the key issues you will need to consider depending on your own pension arrangements. Our experts stand ready to help you navigate how best to capitalise on the wide range of new opportunities that are on offer.
For many DB schemes, whether or not there is yet a meaningful surplus, conversations have already moved beyond whether a surplus exists to how it might ultimately be used.
Current legislation permits use of surplus to fund discretionary increases, improve the security of benefits, fund other employee benefits or give surplus back to employers if in members’ best interests, subject to the scheme’s rules and circumstances.
Until now, the clearest route for a sponsor to realise value from surplus in closed DB schemes has been through scheme wind-up, with a number of schemes already implementing or exploring this approach. While these approaches can deliver meaningful value, they have often constrained strategic flexibility.
However, as surpluses become more widespread and enduring, sponsors are increasingly considering how pension assets could contribute to broader business goals while maintaining appropriate protection for members. This shift in thinking is being reinforced by an evolving legislative and regulatory framework that is expected to provide much greater flexibility over how surplus can be used in the near future.
The long-awaited Pension Schemes Act 2026 has provided a clearer framework for schemes looking to run on and make use of DB surplus. The new flexibilities mark a significant shift and are expected to make it easier for surplus to be released where a scheme is funded above its low-dependency basis, although we expect different schemes will agree different thresholds above which surplus will be passed to the sponsor. In addition, the upcoming changes will no longer require a refund to the sponsor to be “in the members’ best interests”, resulting in a significant easement in the threshold to pass value back to the sponsor. TPR’s early guidance has encouraged trustees and sponsors to agree clear policies for surplus use as part of their wider endgame planning.
From April 2027, schemes will also be able to make lump sum surplus payments to eligible members. Where sponsors and trustees agree to share surplus, this will provide an option that members may value more, and one without the risks that additional DB liabilities bring.
For sponsors, this new regime therefore creates a real opportunity to move from discussing surplus in principle, to considering practical options for its long-term use. But the low-dependency threshold is not an automatic trigger for payments: trustees will rightly need to consider the strength of the employer covenant, investment risks and the level of protection retained for members.
Further regulations and formal TPR guidance are expected ahead of the new regime coming into force in April 2027, providing greater clarity on how these tests and safeguards will operate in practice. The sponsors best placed to benefit will be those that engage early with trustees and set out a clear long-term plan (see our checklist of actions overleaf).
Our 2026 DB pensions priorities survey shows just how quickly surplus is moving up the agenda. 69% of schemes are actively considering how best to put surplus to use, and importantly, schemes are rarely looking at just one home for that value. Of those considering surplus use, 71% expect to use it in at least two different ways.
Figure 1: What is your strategy for DB surplus over the coming years? (where schemes expect to use surplus)
Note our survey was issued before DWP released their draft surplus regulations, and TPR their accompanying statement.
Of the survey respondents, 91% were trustee-side. Almost half anticipate some value being returned to the sponsor, with a slightly lower proportion expecting surplus to improve DB members’ benefits.
Sponsors and trustees have an opportunity to develop a framework that balances member security, benefit improvements, future pension provision and value for the sponsor. For sponsors, the question is moving from “will we have a surplus?” to “what do we want the surplus to achieve?”, even if that surplus doesn’t exist yet.
The next chapter for DB schemes isn’t just about spending surplus. It’s about how you can generate more of it, with a clear plan to use it in a way valued by stakeholders and without introducing disproportionate risk.
Steve Hodder LCP Partner
What is needed for a successful surplus and run-on strategy?
To make the most of the new rules and maximise value, there are a number of areas that will need careful attention.
-
For schemes looking to run on, an intentional investment strategy will play an important role in generating additional value over time, with TPR explicitly saying that schemes should ensure their funding and investment strategy is aligned with their surplus policy.
-
A strong covenant will give trustees comfort in releasing value from the scheme. Contingent funding and other forms of
covenant support can also help create the capacity to deliver upside potential. Contingent assets may give trustees greater confidence to support additional expected investment growth whilst maintaining appropriate member security.
-
An effective member options and communications strategy can be a win-win, with members receiving additional flexibility and an enhanced experience, and the potential for reduced funding cost and risks. This may mean a review of existing terms and how they are communicated, or looking at potential new options such as pension increase exchange (PIE) or bridging pension.
-
A robust framework will be needed with clear responsibilities across the sponsor, trustees and advisers. This might include delegated authorities for timely action, conflict management processes and succession planning. Professional trusteeship can bring valuable expertise and wider experience, and investment delegation or consolidation may make sense depending on your scheme's circumstances and objectives.
-
Many schemes are likely to want a health check on their data and benefits as part of establishing a framework for surplus use and run-on. For trustees, this gives reassurance that any surplus is a true reflection of the position, and sponsors are also likely to value comfort that any money that comes out will not have to be returned at a later date if something new comes to light.
-
A surplus-sharing framework should also cover what happens if funding deteriorates. Sponsors and trustees should agree when distributions would pause, when the investment strategy would be reviewed, and when additional employer support or contributions might be needed. This can help avoid difficult negotiations later and facilitate swifter action.
-
Sponsors should also consider the accounting and tax implications of any potential strategy at an early stage, as these can materially affect the value of contribution offsets, benefit improvements or payments to the business. See page 11 for some comments on accounting treatment of surplus usage.
And of course, sponsors will have to weigh up many other considerations, including how any DB surplus strategy fits into wider business objectives, and how any sharing of surplus with DB members might fit with remuneration and benefits for current employees.
Checklist of actions to take:
- Check the legal position: Understand what the scheme rules say about entitlement to surplus and the powers available to use it.
- Set a clear surplus strategy: Understand your starting position and then agree what success looks like, including the various elements discussed above, plus the potential role of payments to the sponsor, increasing member benefits, paying for future benefit provision and reduced future funding costs. Consider the accounting and tax implications.
- Engage with the trustees early: Agreeing shared principles around security, investment strategy, funding buffers and use of expected future surplus is easier before a specific payment is being requested.
- Build in flexibility: Design the framework so that the balance between generating, protecting and distributing surplus can evolve as funding, covenant and market conditions change.
How has surplus been used so far?
Drawing on our experience of supporting 150+ schemes through the post-transaction phase, we looked at cases where surplus was ultimately distributed in our recent blog, A question of surplus.
Our analysis shows there is no one-size-fits-all approach. In around half of cases, the sponsor was the sole beneficiary of the surplus. Members were the sole beneficiary in 14% of cases, and 36% of the time the surplus was shared between both parties.
Where surplus is shared, it is most commonly (but not always) shared equally between members and the sponsor.
It should be noted these cases are for schemes that have wound up, and will have been influenced by the particular scheme rules in each case. Experience for ongoing surplus release under the forthcoming regime may therefore prove to be different.
Sponsors should already be starting to think about how any scheme surplus should be accessed and used once the new regime comes into force In many cases the starting point should be a full refund of the surplus to the sponsor.
Alex Whitley LCP Partner
Developments in endgame options
Endgame is now a strategic choice
Strong funding, competitive insurer pricing, and a maturing market for other endgame solutions give sponsors and trustees more ways to manage pension risk, release value, and secure members’ benefits.
The right option should therefore start with the desired outcome, rather than the solution or product that happens to be most readily available.
Bulk annuity pricing is currently at exceptional levels, supported by insurer capacity and strong competition for well-prepared schemes.
For many sponsors, insurance remains the clearest route to a clean break from pension risk. For trustees and members, it provides long-term benefit security with a regulated insurer.
But insurer selection is not just a price exercise. Execution, administration, member communications, and the post-transaction member experience matter too - and insurers are increasingly differentiating themselves in these areas.
Following a transaction, significant work remains, and sponsors should get involved to help manage this efficiently and effectively. The sponsor may also need to make important decisions, particularly in relation to indemnities.
A clear plan for managing any remaining surplus is equally important, and discussions should ideally begin well in advance of the transaction.
Figure 2: Combined buy-in pricing vs UK credit spreads
Run-on, superfunds and other options like a “sponsor swap” or capital-backed structures can offer a different balance of:
- Risk removal and corporate flexibility
- Upfront cost and future value
- Access to surplus and accounting outcomes
- Member security and governance
These routes are now credible strategic options — particularly where the sponsor wants to reduce pension risk without paying the full cost of immediate insurance, or where a well-funded scheme has the capacity to run on and generate further value.
The superfund market is gaining momentum. Clara has now announced eight transactions to date, totalling near £2bn, including transactions for solvent sponsors. TPT has recently become the second superfund to pass TPR’s assessment, offering a run-on model with potential for surplus sharing with members. Other new entrants, with providers working through TPR’s assessment process, could further increase competition, choice and innovation.
“Sponsor swap” transactions like the Aberdeen / Stagecoach deal (see case study) are an example of how innovative structures can support a clean corporate exit while targeting secure member outcomes. This will add to the range of credible endgame options.
Funding is not the only barrier to endgame. In a recent LCP survey, more than 70% of respondents identified barriers beyond fundinglevel – including poor data, complex benefits, GMP equalisation, unresolved legal issues, and illiquid assets.
These issues can delay a transaction, narrow the range of available options, and increase cost. Addressing them early is valuable whatever the eventual destination.
Being ready does not commit a scheme to a particular endgame – it gives sponsors and trustees the freedom to act when the right opportunity arises.
The endgame debate has moved well beyond a simple choice between ‘buy-out now’ or ‘wait’. Sponsors and trustees have more options — and more reason to be clear about the outcome they want for both the business and members.
Jonathan Griffith Partner and Head of Pensions Developments
Case study - Stagecoach Group Pension Scheme transferred to Aberdeen Group
Background: Stagecoach wanted to simplify its business while supporting the long-term security of its £1.2bn pension scheme and 22,000 members.
Outcome: LCP advised the Company through an extensive review of its endgame options and on the commercial aspects of an innovative agreement announced in December 2025.
Under the agreement, Aberdeen has replaced Stagecoach as sponsoring employer, taking responsibility for funding as well as the management of the Scheme’s assets. Rather than moving to insurance, the scheme will continue to run on, with robust safeguards to protect its financial security.
The arrangement included an initial uplift to all members’ benefits, better inflation protection and opportunities for further pension increases. It also provided Stagecoach with a swift and clean break from their DB scheme. This demonstrates how a tailored strategy can help align business objectives with better outcomes for pension scheme members, and how a scheme’s strong funding position can be used to create long-term value.
Operational strategy
Schemes and sponsors should develop their operational strategy alongside their endgame strategy to ensure they have the resources and expertise needed to deliver it effectively.
This includes deciding which responsibilities to retain in-house and which to outsource for example, to an Outsourced Chief Investment Officer (OCIO). As part of this, sponsors should assess current and future resourcing needs and develop a succession plan in case of change.
What should sponsors be doing now?
With endgame options continuing to evolve, sponsors do not need to make a definitive choice today. Instead, the priority should be to put in place a robust decision-making framework that preserves flexibility and allows the strategy to adapt as circumstances change.
Our LCP Elevate framework is designed to support this approach:
- Establish your starting point. Get a clear understanding of the scheme’s position and rules, alongside stakeholders’ objectives and priorities.
- Assess the options. Evaluate the full range of endgame options and potential outcomes against your objectives, taking account of longevity trends and insurance pricing.
- Agree a preferred endgame target and timeline. This could include running the scheme off over the long term or deferring your chosen endgame beyond the point at which it becomes affordable.
- Build a resilient, flexible strategy. Put in place a robust and efficient strategy that delivers on your objectives while retaining the flexibility to adapt as circumstances change.
- Monitor and reassess. Review the strategy as a whole, track progress against your objectives and regularly reassess.
Elevate: A flexible, active run-on strategy framework helping our clients turn DB pension schemes into real assets
Find out moreAdequacy moves to the forefront
Whilst automatic enrolment transformed workplace pensions by bringing millions more people into pension saving, the next key challenge is savings adequacy. Ensuring people save enough is perhaps the key challenge for the UK’s pension system. The Pensions Commission is considering what is needed to create a system that is adequate, fair and sustainable over the long term.
As current employees increasingly rely predominantly on DC pensions, employers should ask if their existing pension schemes are likely to deliver the retirement outcomes they want for their workforce, and that their employees will expect.
This could be particularly important for populations made up of mostly low or moderate earners where the benefits of an income in retirement are more likely to outweigh the additional flexibility of DC.
Time to benchmark DC provision
Against that backdrop, DC benchmarking should be moving up the corporate agenda, with sponsors also considering wider factors such as expected member outcomes and members’ experience at and beyond retirement.
Increasing contributions will remain one of the most direct ways to improve member outcomes. However, helping employees get comfort their contributions are building up enough pension for a comfortable retirement will also likely be a priority. CDC has the potential to bring significant
improvements here and could be an important consideration for many employers.
Employers may also want to future proof their arrangements to align with wider changes currently being considered by DC trustees on Guided Retirement, that will also include considering CDC and other decumulation strategies.
Guided retirement policy consultation
On 3 November, the Government issued its ”Guided retirement policy consultation”. This included new details of how trustees of DC schemes are expected to be required to default savers into Retirement CDC or other collective solutions.
This is likely to further accelerate interest from sponsors in refining their own Future of Pensions strategies, including forming views on the CDC and DC considerations we have set out in the following sections.
Collective Defined Contribution (CDC) schemes
A large recent structural change is the introduction of new UK Collective Defined Contribution (or CDC) schemes. These schemes aim to combine some of the attractive features of DB and DC schemes, with employers and employees paying fixed contributions (as with a traditional DC scheme) but members’ assets being invested collectively rather than in individual pots.
At retirement, schemes provide members with an income for life, akin to a DB pension – albeit not guaranteed. Target pensions and increases can be adjusted, including reductions where required by the scheme’s funding position. Improved investment strategies due to collectivisation mean expected member outcomes from CDC could be 25% better than today’s best drawdown strategies and even higher compared to annuities.
The experience of Royal Mail, which introduced the UK’s first CDC scheme in 2024, shows CDC can move from theory into practice. The market has now moved into the next phase and legislation allowing creation of unconnected multi-employer CDC schemes came into force in July 2026. We expect commercial schemes to become available from mid 2027.
The regime anticipates competing commercial multiemployer arrangements, creating the potential for employers to access CDC without establishing their own scheme. Other, likely larger, employers or industry groups may also want to leverage the new regime to establish their own schemes, perhaps aligning with related industry developments such as utilising DB surpluses to make future service contributions.
There is also growing interest in CDC as a retirement income solution for existing DC savers. Retirement CDC would allow an individual to transfer their DC pot at retirement into a collective arrangement designed to provide an income.
Taken together, these developments have the potential to create a new commercial CDC market alongside traditional DC. For today’s DC providers, that creates a natural reason to consider how collective solutions could sit alongside existing offerings.
CDC is moving from concept to reality, with the first schemes now operating and more employers exploring whether it could play a role in their retirement offering.
We believe three key questions should be on corporate agendas
We have also developed a framework to help sponsors refine their future pensions strategies.
- Adequacy: Are our current contribution rates and wider DC or other provision likely to produce the retirement outcomes we want for our employees, and that they expect?
- Future design: How might CDC arrangements improve the situation for our current employees and what are our views on them?
- Preferred model: Which of the emerging commercial CDC or other models might be best suited to meet employees’ future needs?
These questions are examined further in our future of pensions report.
While there can be challenges for those used to the flexibility and individualism of DC, I believe that for many savers these are vastly outweighed by the higher expected retirement outcomes and ease of retirement planning of CDC.
Helen Draper LCP partner
Figure 3: A comparison of DC and CDC solutions for future savers
DC reform moves to centre stage
Whilst the industry gets to grips with CDC schemes, DC schemes have become the main form of workplace pension saving for millions of employees across the UK these arrangements are increasingly where the long-term focus lies.
The policy agenda is shifting accordingly, with substantial reforms designed to improve value, increase scale, broaden investment opportunities and provide members with more support as they move into retirement.
For sponsors, these developments matter even where day-to-day responsibility for DC provision has been outsourced to a master trust or pension provider.
A new value-for-money framework will require schemes to assess and publish performance across investment returns, costs and charges, and quality of service. The aim is to identify arrangements delivering good outcomes and encourage others to improve, consolidate or transfer members elsewhere. The bar for good DC provision is rising and the message from government is clear: low cost will not necessarily mean good value.
The framework will be introduced in stages, with final rules and regulations expected in 2027. The first full assessments are expected in 2028, based initially on data collected from July to December 2027. Initially, the requirements will apply to master trusts, single-employer trusts with at least 50,000 members and open, firm-designed multiemployer contract-based arrangements, before extending more widely.
The question for employers is changing from ‘is our DC scheme competitive today?’ to ‘is it built for the pension market of tomorrow?’
Stephen Budge LCP partner
Under the new Guided Retirement framework introduced by the Pension Schemes Act 2026, DC schemes will need to provide members with one or more default pension solutions designed to provide a sustainable retirement income, while retaining member choice.
A strong DC proposition will increasingly need to support members not only while they are saving, but also as they move into retirement. Providers will have flexibility over the solutions they offer, which may include combinations of drawdown, annuity purchase and, in time, Retirement CDC. Current plans would see the duties applying to master trusts and GPPs from the second half of 2029, with other DC schemes following in 2030.
The drive towards consolidation is gathering pace. From 2030, master trusts and group personal pensions used for automatic enrolment will generally need at least £25bn in a single main scale default arrangement, unless they qualify for an exemption, new entrant route or transition pathway – under which they are expected to need at least £10bn by 2030 and a credible plan to reach £25bn by 2035. The intention is to create the scale needed to improve governance, efficiency and investment opportunities.
At the same time, small deferred pots are being addressed through automatic consolidation. Eligible pots of £1,000 or less could be transferred to authorised consolidators where no contributions have been received for at least 12 months. This should make it easier for members to keep track of their savings and reduce unnecessary costs.
The new system is expected to begin operating in 2030, with much of the detailed framework still to come.
Taken together, these measures are expected to accelerate consolidation and increase the importance of scale, capability and long-term investment in DC provision.
Larger schemes should be better able to invest in a wider range of assets, including infrastructure and growth businesses. These assets have the potential to improve diversification and long-term member outcomes, while also supporting investment in the UK economy.
The Government has not imposed a mandatory allocation to UK investment. However, the Pension Schemes Act 2026 includes a reserve power that could be used to introduce asset-allocation requirements if voluntary progress is judged insufficient. This sits alongside the voluntary Mansion House Accord, under which participating providers have committed to an ambition of investing at least 10% of their main DC default funds in private markets by 2030, including at least 5% in UK private markets.
What should sponsors be doing now – our three key considerations
- Understand your provider’s direction of travel - Consider how your scheme and provider will feature in the drive for consolidation. Ask your provider for its three-to-five-year roadmap.
- Review the retirement proposition - Ask how your provider plans to develop its retirement offering, and whether the proposed member experience and support will meet the needs of your workforce.
- Understand how the default strategy is evolving - Ask how private markets and other productive assets are being considered within the default, and how the case for investing is assessed from a member-outcomes perspective.
Preparing for year-end accounting
LCP’s Accounting for Pensions report 2026 – the 33rd edition – estimated that FTSE 100 companies had an aggregate UK DB accounting surplus of £39bn at the 2025 year-end, with more than 80% of those companies reporting an accounting surplus.
Accounting treatment for different endgames
As endgame options continue to be a key point of discussion, their accounting implications are becoming increasingly significant for sponsors. Improved funding levels and the prospect of surplus mean that buy-out, run-on and other options are on the table for many schemes. However, the chosen endgame can produce very different outcomes for the balance sheet and profit and loss (P&L) account, so where sponsors are sensitive to their financial statements, it is increasingly important to understand the accounting consequences before committing to a strategy.
For example, where a pension scheme is transferred to a third party like an insurer, a superfund or another sponsor, the amount required to complete the transaction can often exceed the accounting value of the liabilities. A key accounting question is whether the difference between these two figures is booked to P&L, or elsewhere through other comprehensive income (OCI). A superfund transaction would usually be accounted for through a P&L settlement charge, whereas an insurance transaction (a buy-in) can often be accounted for through OCI (depending on certain details).
Similarly, surplus used for the benefit of members can lead to a potential P&L charge, but the extent and timing of this is often not straightforward and may depend on the small print of what’s been agreed or announced. A return of surplus to the sponsor is treated as a negative cash contribution rather than a P&L credit.
Early consideration of accounting can identify potential balance sheet or P&L consequences, inform the comparison between runon and different types of risk transfer and give finance teams time to engage with auditors and other stakeholders ahead of a transaction or agreement with the trustees.
Pension schemes as a source of capital
The persistency of pension surpluses creates another important yearend question: what does the surplus actually mean to the business and its stakeholders?
For some companies the amounts involved are significant. For over 40% of FTSE 100 companies with a UK DB scheme, scheme assets are equivalent to at least 10% of the company’s market capitalisation; for eight companies they represent at least 50%. At this scale, pension scheme performance represents an important risk, but also an opportunity for the wider business.
But an accounting surplus is not necessarily valued by investors pound-for-pound. In our view, rating agencies and other market participants may attach little or no credit to an accounting surplus if it is unclear how the company can ultimately benefit from it. The Financial Reporting Council has also noted that UK pension surplus disclosures may become of heightened interest to users if regulatory changes make surplus easier for employers to access.
Over time, we expect that investors will look beyond the headline surplus figure to understand how resilient it is, the timescales and terms for accessing it, and the risks that remain. That makes market messaging increasingly important. Sponsors should consider whether their year-end disclosures clearly explain the scale of the pension opportunity, the company’s rights and strategy in relation to surplus, and how the scheme fits into the wider corporate capital strategy.
Figure 4: UK DB pension scheme assets as a proportion of market capitalisation at 31 December 2025
Other topical year-end issues
Strategic questions may be attracting greater attention, but the traditional year-end assumptions remain important.
-
High-quality corporate bond yields have gradually moved upwards over the course of 2026. The yield on corporate bonds at 30 September 2026 was up 90bps compared to 31 December 2025. All else equal, this could lead to a c.10-15% fall in accounting liabilities. The corresponding fall in assets will depend on how hedged the assets are to the accounting position.
-
Major bond issues from Alphabet (£5bn in February) and Amazon (£4bn in September) are also lifting discount rates. Together, they now account for more than half the UK’s longer-dated AA corporate bond market, excluding universities and similar quasi-government organisations. These high-yielding bonds might increase discount rates by around 20 basis points, depending on the model and cash flow profile. Auditors’ approaches to including these bonds currently vary, so this will need consideration before year-end.
-
Our 2026 longevity report looks at whether record-low death rates, rising life expectancy trends and pensioner mortality being back in line with prepandemic levels signal the start of a new era for mortality. With the potential for medical developments, anti-obesity drugs and earlier cancer detection, there are some positive signs for life expectancies. Schemes and sponsors should revisit longevity assumptions, particularly where surplus or endgame decisions are sensitive to them. For example, for schemes looking to run on, longevity (both assumed and actual) can affect both the reported surplus and assessments of how much value may ultimately be available.
A period of relative stability in pensions accounting is welcome. Attention is increasingly turning instead to how evolving endgame and surplus strategies interact with the balance sheet and P&L, making it important to understand the accounting implications upfront. Under US GAAP the ‘surprise risk’ is even greater.
Phil Cuddeford, LCP partner
Aligning investment strategy to your overall pension strategy: options for targeting either run-on or settlement
A DB scheme’s endgame objective and its investment strategy come as an inseparable pair. Agreeing your ultimate destination and setting the right path to get there is fundamental to both corporate and member outcomes.
By far the area that has the biggest financial impact on sponsors, is the scheme’s underlying investment strategy. Adding just half-a-percent to investment return can often double the size of the surplus available to sponsors.
David Wrigley LCP partner
Investment strategies for running on
If you are aiming to run on and access surplus, setting an optimal investment strategy will be crucial to maximising value.
Trustees may also be more supportive if this can extend to benefitting members, whether that is a financial share or control over a positive member experience.
Perhaps counter-intuitively, targeting higher investment returns can be a long-term risk reduction tool by increasing surplus buffers in schemes. These increasing buffers can then support further growth allocation in a virtuous cycle.
Investment strategies ahead of settling liabilities
If sponsors wish to remove the pension scheme from the balance sheet, new and interesting options are available on the market, with superfunds and sponsor swaps joining established insurance settlement options. If targeting settlement, you will likely need your scheme’s investments to transition seamlessly into a portfolio that de-risks and aligns with the endgame objective.
Further, even if a full member insurance transaction isn’t desirable for you today, a pensioner-only buy-in can be a powerful strategic tool, locking in current attractive pricing, reducing longevity and inflation risk, and potentially improving expected returns compared with investments in corporate bonds and LDI.
Six top tips for DB investors in current market conditions:
- Reconsider investments in long-dated corporate bonds – the chart below shows how the additional return available compared to investing in government bonds is well outside its typical range over the past 20 years, meaning other investments are likely to offer better risk-return characteristics.
- Instead consider investing in shorter-dated bonds, which would limit any impact of a market repricing, and provide ample dry powder to invest in opportunities as they arise.
- Look at “bond-like” investments outside the bond market for higher returns. Long-dated property leases can offer broadly double the level of outperformance compared to corporate bonds for a similar credit risk.
- Build protection into your portfolio. Equities have had a good ride, and now may be a good time to put in place some downside protection. Options that look attractive in the current market include selling some of the upside to pay for downside protection and using specialist tail-risk hedging strategies.
- Beware of the concentration risks within global indices and passive investing. US tech companies make up a very significant proportion of global equity markets, but are increasingly the biggest suppliers of corporate bonds too.
- Manage how you access investments and the costs of implementation.
Figure 5: Credit spreads over past 20 years
Implement the right strategy at the right cost
Regardless of the chosen endgame, managing the costs of your investment arrangements should be high on your agenda. It is self-defeating to choose a great strategy if its benefits are eaten away by high investment costs.
For many schemes, investment arrangements were established when schemes were in a fundamentally different position with different priorities. Many schemes are overdue a review of which approach works best for them.
Three of the most popular governance models are:
Advisory
Trustees retain strategic control with varying levels of strategic and operationalsupport from their adviser. This can offer best-in-class investment solutions but can require trustee bandwidth and careful coordination.
A Core Manager arrangement
Helps to streamline your strategy, using a principal provider, often the Scheme’s LDI manager, to deliver (most or all of) the investment strategy implementation, but still preserves independent advice and trustee control.
OCIO and Fiduciary Management arrangements
Take this further and combine the advisory and core manager roles. This can save trustee time, but care is needed around potential conflicts and the level of fees paid.
Sponsors and trustees should look beyond the convenience of delegation and seek third-party advice if investment decisions do not align with the scheme’s ultimate objectives. These considerations are particularly important where illiquid assets could delay an insurance transaction or limit future options.
Ultimately the optimal investment governance model can balance cost, control and flexibility and help your scheme implement the right strategy as it progresses towards its endgame objective.
