Leah Evans, Partner, Aon
Over the course of 2024, the hot topic in endgame planning has been the debate between run-on or buyout. However, with the vast majority of schemes expected to move to buyout eventually, rather than a question of which endgame is better, the focus should simply be which option is the right fit for a specific scheme at any given time. If there is good reason to run-on for now, understanding how and when it might be appropriate to adjust strategy to buying out can bring the best of both worlds.
The preferred strategy for a given scheme will depend on the factors that make each scheme unique, such as size, benefit and membership profile, sponsor covenant and the risk appetite of stakeholders. Investing time to fully consider both options of run-on and buyout means it is often quite straightforward to identify the best fit for a scheme. For example, smaller schemes or schemes with concerns over sponsor covenant (current strength or longer-term predictability) tend to quickly identify buyout as their preferred endgame in the short-term.
In contrast, a decision to run the scheme on can be driven by different factors and stakeholders, for example:
· A desire from sponsors or trustees to build up and utilise surplus over time, e.g. to subsidise DC contributions, ongoing accrual or potentially additional member benefits
· Temporarily run-on while data projects are finalised or illiquid assets run off
· Other sponsor related considerations, including accounting or covenant
So, what are some of the key considerations and practical recommendations for agreeing a strategy?
1. Prepare to be flexible, and keep your strategy under review
While a decision to buyout in the near term is a one-off binary decision (i.e. you cannot go back to running on once you have bought out), the decision to run-on or target buyout in future is not.
Depending on the rationale for running on, this may be intended to be a time-limited strategy (e.g. linked to the development of the membership profile, or linked to practical factors such as data or asset readiness). In other cases, trustees or sponsors may choose to run-on for the foreseeable future until it is no longer economical to do so (e.g. once the scheme has fallen below a certain size) or circumstances change (e.g. sponsor covenant weakens or stakeholder views change).
Importantly, the factors driving these decisions can change over time and so trustees and sponsors need to ensure they can monitor the factors that led to this decision and are prepared to be flexible and adjust their plans in the short-term.
2. Understand impact on member security
Benefit security must be a key consideration in endgame planning. Moving to an insurer gives trustees a high degree of confidence that they have met their obligation to ensure members are paid the benefits they have been promised. Not only do schemes who move to buyout gain the benefit of relying on the chosen insurer's covenant, but they also benefit from the protections afforded by the wider UK insurance regime.
In a run-on scenario, trustees will need to ensure they are comfortable with the security provided for members. This might be achieved through a combination of sponsor covenant, additional layers of security (such as escrow funding, surety bonds or contingent assets) and through bespoke funding/risk mitigation agreements with the sponsor.
The right package of security will depend on the sponsor and relative size of scheme and can be determined through modelling which allows variation of parameters – with security of member outcomes as a key factor.
3. Readiness – just as important for run-on as it is for buyout!
Despite the potentially much longer time horizon in a run-on scenario, readiness is just as important for run-on as it is for buyout:
· Under a buyout scenario, trustees and sponsor need to be comfortable that they are insuring the right level of benefits to ultimately allow a scheme to be wound up
· Under a run-on scenario, trustees need to be confident that the underlying valuation reflects actual benefits promised if there is any distribution of surplus (to members and / or sponsor)
· In any case, trustees will want to ensure they can pivot quickly to, or accelerate a buyout strategy if applicable, e.g. if there is a weakening of sponsor covenant which means a run-on strategy becomes less viable
Consideration of a scheme's data quality, certainty of benefits due and its investment strategy are preparatory actions which are common across both buyout and run-on. This means this work can be started even while trustees and sponsors are still considering their endgame strategy.
What next?
As with everything in the industry, the outlook for pension scheme endgame planning is developing constantly. What is true today for particular schemes may not be true tomorrow, and so careful planning for every eventuality is a must.
In such a dynamic space, it is crucial that trustees and sponsors engage experienced advisers to make sure their chosen strategy is in the best interests of their members.
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