Funding Strategy & Risk Management Solutions

Closure to future benefit accrual / Pensions investment strategy

Many companies have three key objectives with their pension schemes. They wish to reduce inherent risk and reduce cash funding requirements whilst maintaining member confidence in the funding of their plans.

Over the past decade, there has been a move from defined benefit to defined contribution for new hires to reduce costs. However most companies have not yet closed their defined benefit schemes to existing members. Many UK companies therefore retain material legacy pension liabilities that represent a significant operational and financial risk to the business. The cost of providing defined benefit pensions has increased in recent years, due to volatile investment markets, increases in life expectancy and legislative changes. The nature of these factors has led to increased costs that can be unpredictable and volatile.

Pension scheme trustees also need to consider the strength of the employer covenant when negotiating with the employer on its contributions. Currently many employer covenants are getting weaker as profits and cashflows decrease. This may lead to a higher funding target being adopted and requests by trustees for even higher cash contributions. However, if significant contributions are made and markets and companies then recover, this could lead to schemes having ‘trapped surpluses’ which cannot be returned to employers.

We work with you to understand and identify appropriate solutions to address your funding challenges. Addressing a pension deficit does not necessarily require the traditional approach of increased cash contributions in the short-term. With pensions high on corporate and government agendas, it is timely for companies to consider why they provide pensions and how they manage the funding and risk associated with them. Approaches used with our clients include:

Closure to future benefit accrual | Investment strategy | Tax profile of pension scheme investments | Pension Funding Partnership

Closure to future benefit accrual

Whilst past liabilities cannot be amended or reduced, future benefit provision can usually be changed.

Several companies have recently altered pension benefits being provided to current employees. This approach is likely to generate immediate cash savings. However, there are employee relations and reputational issues to be considered; and changes to future benefit provision do not address the legacy of past benefits.

Investment strategy

Traditionally, UK pension schemes have invested heavily in equities. In recent years there has been a gradual shift from equities to lower-risk investments such as bonds, but many schemes retain significant holdings in equities and other high risk assets that have seen large falls in value. By agreeing with trustees to invest in assets that are less volatile and move more in line with pension liabilities (“Liability Driven Investment”), companies can reduce significantly the risk they carry in their pension schemes.

Careful planning is required, however, to avoid ‘locking in’ investment losses.

Tax profile of pension scheme investments

Optimising the tax profile of your pension scheme investments can have a significant impact on investment returns. UK pension funds are generally assumed to be tax exempt. In reality, pension funds may be paying large amounts of tax in the form of withholding taxes, VAT and stamp taxes.

The structure of investments (including third party manager vehicles) can have a significant impact on the tax efficiency. Trustees should ensure that they have fully reviewed any structure before committing funds. Pension funds may also suffer withholding tax on direct investment into overseas equities that they could be in a position to recover.

Pension Funding Partnership

Deloitte has developed the Pension Funding Partnership, (“PFP”) a unique and innovative solution to assist in the funding of pension scheme deficits using company assets and to meet wider corporate and Trustee objectives.

In the context of deficit financing, the PFP involves setting up a partnership between the company and the pension scheme, backed by valuable company assets (including property, subsidiary share holdings, stock and receivables). The pension scheme then receives a fixed market rate of return from its partnership interest and a final payment depending on the scheme deficit at the end of the term.

The key advantages of the PFP are:

Significant reduction in cash contribution requirements;
Immediate reduction in scheme deficit;
Increased security for scheme trustees;
High quality, secure bond-like cashflows paid to the scheme over a long term;
Enhanced co-operation from scheme trustees (e.g. by improving funding in advance of mergers or to fund liability management exercises); and
Efficient use of cash via a reduction in “regret risk”, preventing the risk of a trapped surplus due to overfunding of the pension scheme.

Deloitte are the market leaders in implementing asset based funding structures. We have successfully completed the implementation of PFP structures for a substantial number of major corporate clients this year including John Lewis, Sainsbury, ITV, Marks & Spencer, and Whitbread to fund over £2bn of pension deficits.

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