Pensions supervision and annual compliance statements

The regulatory backdrop

IORP II has been implemented and the cost of operating a defined benefit scheme is materially higher than was historically the case. There is now the additional need for:

• professional trusteeship;

• internal audit and risk management key function holders;

• significant numbers of additional operational policies;

• annual compliance statements;

• own risk assessments; and

• critical administration and investment reviews.

The regulatory approach has also changed, with the Pensions Authority communicating “a move to a forward-looking and risk-based approach to supervision”. This approach is expected to be more invasive and more challenging, which brings with it a level of risk.

The Pensions Authority released an information note in December 2023 confirming the commencement of its supervisory review process in 2024. This process will focus on master trusts and large defined contribution and defined benefit schemes.
 

Steps to developing a suitable strategy

1. Assess the current financial position of your scheme, including the cost of a full buyout of the deferred and pensioner liabilities.

Given the dramatic change in interest rates, this starting position may have changed significantly since your last funding valuation.

Historically, annuities were viewed as prohibitively expensive. However, insurers are now diversifying investments to back the annuities beyond the traditional AAA-rated government bonds. The benefit of that investment approach is being passed to pension schemes through bulk annuity pricing terms. This means that annuities can offer a more efficient alternative to retaining the risk in the pension scheme.

It is likely that a shortfall will still exist, which prompts two questions:

• How will that shortfall be closed?

• What is the risk of that shortfall changing over time?

2. Consider the potential strategies available to to bridge any shortfall.

1. Adopt a “no change” strategy where existing pension funding arrangements continue into the future until such time as the gap is bridged.

2. Assess liability management approaches that would reduce the buyout cost, including transfer value options and pension increase exchange options.

3. Finance the shortfall upfront—equivalent to borrowing today to fill the deficit. The volatile pension funding obligation is replaced with relatively fixed repayments on borrowing. While debt creates an interest cost, it removes the volatility of pension funding and also removes the operational costs and regulatory risks inherent in running a pension scheme. In effect, a loan becomes cheaper to maintain and is lower-risk to service.

4. Adopt a phased approach by transferring the liabilities over time. For example, current market conditions could be ‘locked-in’ by purchasing annuities for the existing pensioners, thereby reducing the scale of the pension scheme.

Many employers are looking to explore a combination of these options.

3. Develop a plan to achieve the agreed objective

When the objective has been set, a clear set of steps can be agreed to achieve that objective. A range of critical factors will inform those steps. As part of this exercise it is important to:

• consider the accuracy and quality of the member data records;

• consider the termination clauses under the trust deed and rules; and

• engage with the insurers to ensure that they have the resources and capacity to execute a transaction.

There will also be considerations around the accounting impact of any transactions, whether to execute a single transaction, partial transaction or staggered transaction, and how that fits with the wider corporate and HR agenda.

Having a clear communications strategy across each of the stakeholders (trustees, executive committees, members, insurers) will be a critical workstream.

A successful transaction requires appropriate planning and a decision-making framework, including who is accountable and timings.

Managing defined benefit pension scheme risks in a proactive manner is now expected by the Pensions Authority. The current economic and regulatory backdrop presents an opportunity for employers to ultimately remove this from their responsibility and to secure these pensions with an insurer. Even for those employers who may be comfortable with the existing financing commitments to the pension scheme, having a framework for when such a transaction should be considered further and addressing the data, legal and insurer diligence noted above would be advisable.