The ultimate goal of a defined benefit scheme is clear – to ensure that all members receive the benefits they have built up in the scheme. For most schemes, this will involve some form of insured solution at a point in the future where remaining benefits are secured and the scheme is then wound-up. For some that will come sooner; for others it is currently a very distant prospect.
The UK funding regime has historically “ignored” this ultimate end point – rather, we have the somewhat vague construct of technical provisions (ongoing funding basis). This is the liability target required in funding valuations which must be prudent, but need not remove all future risks. Typically, you might see this liability target sitting in the region of 60-80% of the cost of insuring scheme benefits. Therefore, even if a scheme is 100% funded on the technical provisions basis, it will not be able to insure the benefits without significant further investment returns or significant further contributions from the sponsor.
As most of us working in defined benefit pension schemes already know, a scheme’s technical provisions are only a stepping stone towards the ultimate goal. What happens once full funding on an ongoing basis is achieved?
Over recent years, to assist scheme trustees with forward planning, the Pensions Regulator has introduced the concept of the long-term funding target (LTFT). The LTFT is defined as “the level of funding the scheme will need to achieve in order to reduce its dependence on the employer”. To me, this translates as meaning the buyout level funding or a level of funding that can be managed towards buyout without material further contributions from the sponsor.
The LTFT is now a key part of valuation discussions for 2019 and beyond. This is particularly the case for rapidly maturing schemes where the journey time to end point is getting shorter and shorter. The LTFT need not (and in most cases will not) bring about a change to the ongoing funding target or any immediate changes to the investment strategy. What it should do is bring about discussions on journey planning (both in the short and long-term), managing and reducing risk over time and possibly setting triggers that will reduce risk as the funding level improves and/or as the scheme matures.
Yields are returning to very low levels resulting in higher and higher liability values. As such, the funding challenges for pension scheme trustees show no sign of getting any easier. However, I am confident that looking to the future and setting clearly defined long-term targets (and clearly planning for how they will be achieved) will serve trustees well over the years ahead.