Self-sufficiency end-game solution for a large engineering firm

The organisation

One of the defined benefit pension schemes of a large engineering client was relatively small in comparison to the size of their company, and it had been offered to its staff over many decades. Like many companies, the sponsor had a strong stable covenant and was confident that it could continue to afford to support the pension scheme over the medium and long term.

The scheme was:

• Well funded, having benefited from strong investment performance in the past. This allowed for a heavily de-risked investment strategy that sought to protect the healthy funding position
• Closed to new members, although it was still open to the accrual of new pension benefits.
• Predominantly made up of deferred ex-employees and active current workers who were still accruing their pensions

Why self-sufficiency?

When schemes target self-sufficiency as an end-game solution, the trustees and employer agree to support the defined benefit pensions of their employees (past and present) until they are all paid. In doing so, there lies a reasonable expectation that the scheme will not need to call on the sponsor again for additional funding.

This often results in a lower cost solution for the company in terms of contributions required, whilst the trustee board is able to oversee the payment of the pension promises made to their former employees in a paternalistic fashion.

The cost of transferring this type of scheme (with relatively young members) to an insurer through a buyout arrangement was significantly more expensive than continuing to run the scheme on a self-sufficient basis. If the scheme were to target buyout, the liabilities to be funded would have been at least c.20% higher, or in this case, c.£60m larger.

Given the strong sponsor support and high level of security that the company could provide to its members, the trustees agreed that the scheme target should be run on a self-sufficient basis.

Outcome

The capital injection that would have been required to transfer the scheme to an insurer could instead be put to more productive use if reinvested back into the business. Reinvestment would grow, strengthen and stabilise the company’s position, in turn further supporting the pension scheme.

Meanwhile, the scheme’s investment strategy could be derisked to the extent that there was little risk of a significant deficit recurring. A sufficient moderate return could be generated over the long term, which enabled assets to keep steady pace with the liabilities. The trustees would retain oversight of the staff that had been employed over the years, which reaffirmed the scheme’s target to deliver pension promises as they fell due.

The following graph demonstrates the stable funding position and investment strategy of a pension scheme managing to self-sufficiency.

Stable funding position

Source: SEI as at 30 September 2018.

Investment strategy

Source: SEI. For illustrative purposes only.

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