For some time now there has been growing interest in the future of defined benefit (DB) schemes – from government, regulators, insurers, investment managers, consultants, and other interested parties.
Current private sector DB landscape
Before we consider where the DB sector is heading, it’s important to understand the current private sector DB landscape. At present there are around 5,300 funded DB trust-based private sector schemes, with signs of a slow but steady decline in terms of scheme numbers. They cater for about 10 million members (down from 14 million in 2006) and their assets amount to around £1.4 trillion.
Of the roughly 5,300 private sector DB schemes, 505 schemes (around 10%) remain open to new members and around half remain open to future accrual, representing £321 billion in total assets and 2.06 million members in open DB schemes.
The overall funding position of private sector DB schemes has improved significantly in recent years. The aggregate surplus (total assets less total s.179 liabilities) of the schemes is estimated at £437.0 billion at the end of June 2023. The position has improved significantly from December 2021, when a deficit of £129.3 billion was recorded.
As noted in the Work and Pensions Committee’s Saving for Later Life report released last year, DB schemes remain of critical importance in the provision of pensions in the UK. According to the report, people with access to a DB pension are more likely to be on track for an adequate income in retirement. But the reality is that DB schemes are unlikely to return as the predominant pension offering in the private sector.
Buy-in/buy-out volumes set to increase
There can be no doubt that the ‘endgame’ market is evolving, and it’s likely that the number of schemes considering their options will continue to grow. With the continuing improvements in funding positions, the number of DB schemes in surplus is expected to rise in the coming years, allowing schemes greater opportunity for buy-in or buy-out.
Indeed, buy-in and buy-out volumes are expected to reach a record high in 2023. Estimates from a number of consultancy firms predict that buy-in and buy-out volumes will this year break the £44 billion record set back in 2019. According to one estimate, the DB de-risking market is on track to hit record volumes of £45–£60 billion in 2023, with as many as 15 £1 billion+ transactions expected.
The number of DB schemes that will be in a position over the next 10 years to enter an endgame scenario is anticipated to grow as funding levels improve, whether that be through an insurance solution (buy-in/buy-out), or investment or administration mergers or consolidations.
Impact of increased buy-in/buy-out activity
In terms of insurance solutions, following on from the funding improvements seen in 2022, pricing will likely continue to be attractive for schemes that are properly prepared. However, schemes will have to work much harder than in the past to secure active insurer participation given the capacity constraints in the buy-in/buy-out market resulting from increased demand. With more DB schemes approaching the insurance market than ever before, insurers are finding it difficult to quote on all transactions, prioritising those that give them the best chance of securing a deal. Those schemes that have laid the groundwork will be best equipped to gain insurer engagement. More complex and smaller transactions may well be de-prioritised.
“The number of DB schemes in surplus is expected to rise in the coming years, allowing schemes greater opportunity for buy-in or buy-out"
We may be on the verge of a lack of insurer capacity becoming an issue. However, this is not due to a lack of capital or appetite, but to limited human resources. The way the market currently operates means that, if a significant number of smaller (sub-£100 million) schemes start looking at buy-in/buy-out solutions at the same time, many schemes will not be able to secure deals. And it will likely be the smaller schemes, whose members would arguably most benefit from an insurance solution, that will unfortunately tend to miss out.
Insurers are aware that this increase in demand is likely to continue for some time and many are strengthening their front- and back-office staffing to be able to increase capacity.
These capacity constraints are real, but they are not permanent. It is likely that actions will continue to be taken by various participants in the industry (including some of those already mentioned) that will eventually overcome the current capacity constraints.
Alternatives to buy-in/buy-out
There are of course alternatives to buy-in/buy-out. And with many DB schemes now exceeding their funding targets, this is prompting many sponsors and trustees to review their DB endgame plans.
The alternatives to insurance solutions include schemes continuing to run on (although arguably not indefinitely), or perhaps consolidating in different vehicles – for example, DB Master Trusts which can give trustees greater control over the journey to endgame where the scheme is not in a position to achieve a full insurance buy-out and help set a clear path to a low-risk target, ultimately reducing the sponsor’s contribution burden. DB Master Trusts can help sponsors to move to a low-risk target over time, which then gives them the option of either running the scheme off within the DB Master Trust, or bridging to a full insurance buy-out when this becomes achievable.
There is also the developing Superfund market that might provide a different but potentially desirable home for some schemes. Although currently untested, Superfunds could potentially provide an affordable option for employers, creating an incentive and an achievable goal for them to make a one-off payment to reach self-sufficiency funding levels, without having to pay for the more expensive insured buy-out option. The government recently confirmed that it is looking to finalise the Superfunds legislation “as soon as parliamentary time allows” and establish a permanent regulatory regime to authorise and supervise them.
Potential changes to the DB landscape
As announced by the Chancellor in his Mansion House speech in July, the government is exploring various ways to incentivise private sector DB schemes to invest more in productive assets. These include:
- Exploring alternative ways in which DB surpluses can potentially be used – for example, to encourage trustees to take on greater investment risks or perhaps allowing employer-sponsors to use DB surpluses to provide additional contributions (over and above statutory minimum contributions for auto-enrolment) for defined contribution members.
- Considering whether a public consolidator should be established to operate alongside commercial consolidators such as DB Master Trusts and Superfunds.
- Exploring whether the role of the Pension Protection Fund could be expanded to take on the role of a public consolidator.
As consolidation in the industry continues over the next few years, the government is hopeful that more private sector DB schemes will achieve greater scale and be able to invest in a wider range of asset classes (at lower cost), with potentially more being invested in UK growth assets.
“The government is exploring various ways to incentivise private sector DB schemes to invest more in productive assets”
But to achieve this objective, a change in regulatory focus is needed, particularly for open DB schemes and closed schemes with long time horizons. With many DB schemes in a position of strength and funding reaching record levels, the current regulatory focus on ‘slowing down’ DB schemes through reducing investment risk could represent a missed opportunity to better invest the £1.4 trillion of private sector DB pension scheme assets.
There is an argument that DB schemes (particularly those which are not targeting endgame in the next 12-18 months) should be encouraged to readjust their focus and adopt a mindset of ambition and opportunity. By allowing certain DB schemes to turn up the risk dial, they can be ‘unlocked’ to invest for moderate growth, potentially generating billions of pounds to benefit savers, schemes and the UK economy.