“End game” options – choices and challenges
27th May, 2021
The availability of consolidator “end game” options, both on and off balance sheet, is a great development for DB schemes as it increases the choices available in different circumstances, maximising the likelihood of members receiving their full benefit entitlement.
These consolidator vehicles should be considered alongside the other, more traditional, end game options of “big bang” buyout, buyout after multiple buy-ins, and long-term self-sufficiency (this could potentially also be backed by partial insurance; for example, in respect of longevity risk). However, while the additional choice is undoubtedly a good thing, it does create additional challenges for trustees and sponsors in deciding what strategy is best for their scheme, and how this should be pursued.
Risk, practicalities, advice and planning
The first challenge is understanding the various alternatives, not just at a high-level but specifically in terms of which risks they address and which risks they leave on the table, and how each solution fits in with the risks that are prevalent in a particular scheme. Unfortunately, none of the end game approaches are entirely risk-free, not even buyout, so what schemes do is gradually reduce overall risk and volatility by giving up some of the upside risk. How and when this is done will have an impact on the overall cost of providing scheme benefits, and may in some cases also impact the amount of benefit received by members.
Understanding the practical implications of the various strategies is also fundamentally important. For example, partial buy-ins can be very attractive and generally fit in well alongside wider asset de-risking However, they can result in a slower transition to full buyout; for example, if the liabilities left uninsured are unattractive or more costly to insure. Similarly, any arrangements with collateral requirements can delay additional de-risking, depending on the specific requirements and also the availability of matching assets to support these.
An additional challenge is connected with understanding what advisory support the trustees require, also the scope and limitations of such advice, particularly if significant modelling is required and specifically modelling of potential outcomes at the individual member level. Separate strands of advice, for example around sponsor covenant, are relevant to which options will be of interest, but will also introduce additional uncertainty around the strategy to be followed.
My view is that there should be clarity at outset on the detailed process – what needs to be done, by whom and at which point. Selecting the right partner to support the trustees choose a strategy for their scheme is a very important step – robustness and pragmatism are the key words, and these are normally developed from experience. Advisory costs will also be relevant, but it would be short-sighted for this to be the main consideration.
The last challenge, once a suitable strategy for a scheme has been identified, is to set up an implementation plan and follow it through. Very often options are explored and even formally assessed, but then not acted on because it is felt that “the time is not right”. In practice, it is never too early to agree an end game plan – some plans just need more steps than others! A degree of flexibility will be desirable in case circumstances change, and this aspect should be monitored alongside the implementation of the wider plan. Monitoring and reporting should be regular and visible to all stakeholders.
Good governance leads to good outcomes
Finally, I would stress the common theme running through the above, which is “governance”. Where this is missing, plans won’t be formulated, or are likely to fail. Conversely, a well governed scheme is almost certainly bound to achieve a good outcome for members, by whichever means available at that point.