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DB plan sponsors could see surplus assets over next decade

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UK defined benefit (DB) pension plan sponsors could have access to GBP1.2 trillion in surplus assets over the next decade, industry research reveals.

The “extremely optimistic “projections from investment manager Van Lanschot Kempen assume a continuation of improvement in funding levels following increases in gilt yields against which liabilities are discounted following the September 2022 mini Budget.

Even under more conservative assumptions, the firm believe there is an opportunity to generate a surplus of around GBP0.5 trillion over the next 10 years.

Arif Saad, Head of Client Advice, UK at Van Lanschot Kempen, says given the large amounts potentially available, trustees and sponsoring employers should think again about buying out with insurance companies, and instead run their DB schemes on.

Saad notes that since the buyout market, which was already suffering capacity constraints, will be overwhelmed with interest from plans unexpectedly in the black following the gilt crisis, alternative endgames in which the sponsor retains control of any surplus makes sense. 

“Schemes that encounter difficulties securing benefits with an insurer due to capacity constraints might consider running on by maintaining a suitable level of risk, but generating a return that will build up a funding surplus within the scheme,” Saad says.

By retaining control of the scheme, trustees will be able to invest in what Saad calls “productive assets” including infrastructure and private debt, which are riskier than gilts but offer the potential for longer-term outperformance.

Saad says this has the dual function of driving returns and providing capital for the UK’s net zero emissions target by supporting green infrastructure.

“Pension schemes have the ability to help drive long-term impact by continuing to invest in assets such as infrastructure, which will play a key role in the transition towards a greener society,” Saad says.

At the same time the Department for Work and Pensions (DWP) has issued a consultation on relaxing legislation around access to DB pension scheme surpluses, making it easier for employers to use excess funds elsewhere across their business 

Saad says: “The development of legislation that focuses on expanding the way scheme surpluses can be accessed will be enticing to both trustees and sponsors alike, who may be interested in the prospect of enhancing member benefits, be that defined contribution or DB, or extracting surplus after decades of deficit contributions.”

Van Lanschot Kempen says the opportunity to capitalise on surplus is “largely anchored” by schemes with GBP500 million in assets. 

However, Saad highlights the move of the Debenhams and Sears pension funds into Superfund Clara – which is the first of such regulated entities in the UK – as “proof of a concept to an idea that has been in development for years, and one that could help many schemes in difficult positions ensure that they deliver full member benefits by acting as a bridge to buyout”.

He adds: “As Clara continues to grow and establish itself as a robust risk transfer vehicle, we expect to see a greater range in the types of schemes looking to use this vehicle. For example, trustees and sponsors of smaller schemes with relatively strong covenants might use Clara as a means of achieving the dual objective of benefiting from Clara’s scale and alleviating pressure on the corporate sponsor’s balance sheet.”

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