Managing active members as part of the DB pensions endgame journey

What’s changed?

It won’t come as a surprise that many defined benefit (DB) pension schemes have seen an unexpected significant improvement in their funding levels over the last 18 months as government bond yields have increased. The estimated cost to secure benefits with an insurer has reduced as a result of this, coupled with continued attractive insurer pricing and a slowdown in longevity improvements. As such, getting pension liabilities off the company books has become achievable sooner than previously anticipated. This was evidenced by 2023 being a record-breaking year in the risk transfer market^[1]. For those that still have members building up benefits, companies need to consider their options before these members become a barrier to fully securing a buy-in or buyout.

Why do active members matter?

If members are still building up DB benefits within the scheme, then these liabilities cannot typically be fully covered by an insurance policy due to the uncertainty surrounding them. And building-up of benefits in a DB scheme doesn’t just mean future pension accrual, but can also include other benefits, (which would be in place through choice, or a requirement within the Rules) such as:

• A retained salary link on closure to future accrual
• Benefits that are linked to a member remaining with the company, such as enhanced early retirement or redundancy terms
• Benefits which are linked to prospective service with the company, such as an ill health or death benefit

Members who retain such benefits are sometimes referred to as “active/deferred” or “employed-deferred” members.

For schemes of a sufficient size, it could be possible to secure a buy-in for the non-active liabilities now and secure the active liabilities at a later date, removing a significant portion of the risk in the near term. However,

• Risk remains within the scheme
• The remaining active liabilities need to be of a sufficient size to be able to secure a competitive further buy-in in the future
• Careful consideration needs to be given to the investment strategy, as following a buy-in a large proportion of the portfolio will be tied up in an illiquid asset

If the ultimate aim is to buyout the scheme, then we suggest a more proactive approach should be taken with active benefits. We set out below some of the options available, which WTW have helped companies work through and implement.

Active accrual

 
Over the last decade or so, many companies have opted to close their scheme to future accrual. However, 24% of schemes still have active members, according to The Pensions Regulator’s latest survey. Current circumstances have led many companies to revisit their active membership and what can be done on the journey to a full buy-in/buyout:

• Close the scheme to future accrual now - we are seeing a number of closure exercises being undertaken, particularly (but not exclusive to) those schemes with a small number of active members. However, there may be a reason why the scheme has remained open to future accrual of DB benefits, for example a concern regarding employee retention or the impact of union involvement, so it may be appropriate to consider alternatives.

• Delay closure for a couple of years - the process of securing a buy-in and then converting this into a buyout can typically take a couple of years. This is divided into two time periods – the period to secure the buy-in and the period between buy-in and buyout.
  If the company wishes to retain DB accrual in the short term, we’ve worked with companies to carry out an initial buy-in and transfer the vast majority of the risk to the insurance market, with a plan to implement the closure after a period of time, say two years, to coincide with a buyout. In this case, the initial buy-in either treats the actives as if they became deferreds at a recent date or makes an assumed allowance for future accrual and/or salary increases. Once the closure is enacted, there is then a true up, reflecting actual salary increases and membership movements over the period. This gives the company the benefit of securing the majority of the liabilities up front, with a small associated risk in respect of the future accrual element.
• Moving active members to a DB MasterTrust - the DB MasterTrust market has been evolving over recent years, with a number of vehicles now available. The Mansion House speech put further focus on DB scheme consolidation, with DWP publishing its consultation in February on its proposed consolidator for private sector DB pension schemes to be run by the Pension Protection Fund. Further DB benefit accrual could be provided by the company by moving the active liabilities across to a DB MasterTrust, with a buy-in/buyout enacted for the non-active liabilities.

With a range of options available, it’s important for companies to consider the specifics of their circumstances and seek advice on what’s right for them.

Employed-deferred members

Our 2022 survey of plan change projects where WTW was involved found that nearly 90% of schemes have employed-deferred members:

• 86% of schemes offered enhanced ancillary benefits on closure (with enhancements to death in service, early retirement terms and ill-health benefits being the most common)
• 13% of schemes retaining salary linkage (10% of which were included in the 86% above as well).

Consequently, most companies will need to consider how to approach these benefits in a buy-in/buyout transaction. The approach should consider cost, P&L impact, fairness to members (considering security for all members, rather than enhanced benefits to a subset), what benefits can be insured, and legal requirements (e.g. if a salary link is set out in the rules). For these benefits, the options available include:

• Consult – consult with members to remove these benefits now, or prior to buyout. Messaging and communications in previous consultations, as well as any requirements in the Trust Deed and Rules, will be a key consideration here.
• Assume members remain active and meet the cost – for example, if members have enhanced early retirement terms linked to continued employment, these could be crystallised now for remaining active members and insured with the buy-in provider, making them non-conditional post buyout
• Insure the value of the enhancements – for those benefits that can’t be insured, look at providing some equivalence of value. For example, insuring inflation plus a margin in place of a salary link or making some allowance for prospective service in an enhanced ill health or death benefit (in both examples, making some allowance for members leaving service and breaking the link), assuming the insurer is willing to facilitate this.
• Assume all members become deferreds – for example, if the enhancement requires consent (company, trustee or joint), then the consent could be withdrawn on buy-in/buyout. This will clearly require careful consideration as members may have expectations of consents remaining in place (perhaps based on past practice and/ or communications).

We have seen all these options implemented in practice and would be happy to assist in discussing which might be the most suitable route for you, based on your scheme specifics. Ideally this would be considered in advance of the buy-in project to ensure the preferred approach is insured upfront.

What should I be doing?

If you have a scheme which is open to DB accrual or has employed-deferred members, have you considered how these will be provided under your long-term plans for the scheme? It is important to consider the options available to your specific circumstances now so that, if your end game plan is to buy-in/buyout, you’re ready to transact when the time is right and take advantage of any market opportunities.

Footnote

1. “De-risking report 2024,” January 2024. Return to article undo