So, what next for defined benefit schemes? In 2022, several key trends emerged as the economic environment presented certain opportunities and employers contemplated what it means to operate an IORP II-compliant defined benefit scheme.
2022 market trends
- Defined benefit consolidation: In anticipation of IORP II, companies with multiple defined benefit schemes (such as those with separate staff and management schemes and those that acquired schemes through their M&A activity) moved to consolidate their schemes and, in doing so, consolidate their governance, compliance, funding and risk management efforts.
- Capitalising on strategic investment opportunities: Although schemes’ assets will be lower than in previous years, so too will their liabilities and many have reviewed their strategic investment allocations. Schemes have seen long-term interest rates rise significantly and are evaluating the opportunity to lock into current rates and de-risk their holdings.
- Annuity buy-ins: Competition and innovation in the annuity market, accompanied by the rising interest rate environment, has increased buy-in activity. This presents an opportunity to remove pension risk from the balance sheet and may appeal to those with the ultimate objective of full settlement in the medium-term.
- Full exit: The increased regulatory risk and costs associated with IORP II compliance are disproportionate for employers with smaller defined benefit arrangements. Full exit and wind-up continue to feature.
2023 and beyond
In 2022, trustees had to put in a lot of work and effort to comply with IORP II. This included documenting various policies and procedures and appointing Risk Management and Internal Audit Key Function Holders. 2023 and beyond will see these policies, procedures and functions “go live”, under the regulatory focus of the Pensions Authority.
As the full extent of what it means to operate in an IORP II world becomes clear, the operation of defined benefit pension schemes will continue to evolve.
The Pensions Authority has clearly articulated that “new legislation obliges us to oversee relevant schemes on a forward-looking risk-based supervisory basis, which will result in a much more challenging, judgement-based and intrusive oversight approach”. The extent to which this is a step change will be key.
What will this mean for employers who sponsor defined benefit pension schemes?
While the burden of compliance and the responsibility of responding to a more onerous regulatory regime will fall initially on pension scheme trustees, employers will want to ensure that the cumulative impact of this focus does not unreasonably increase the level of risk and cost. A key challenge for sponsors will be to navigate this regime change.
As proportionality doesn’t feature, we expect more employers to consider what’s next for their defined benefit pension scheme, with some key trends that emerged in 2022 continuing into 2023. A sensible starting point is:
- Financial assessment: How well-funded is the scheme? And based on expected future cash flow, when might the scheme become self-sufficient or be in a position to purchase annuities? What is the opportunity cost of the ongoing expenses to maintain the scheme?
- Scenario testing: With a good understanding of the financial position, how might certain actions change the expected future position? This could be, for example, additional funding; a change in strategic asset allocation; or carrying out a liability management exercise.
- Strategic decision-making: Based on the above, sponsoring employers can be more prescriptive in how the defined benefit scheme evolves and work to create and implement a clear action-orientated plan.
We are here to help you
Navigating the challenges and opportunities of the changing regulatory and economic backdrop can be difficult. We are ready to help you determine what’s next for your defined benefit pension scheme. Contact us today.
