DB scheme sponsors need to be wary about the potential for scheme pension surpluses to end up trapped or unproductive, according to LCP.
According to LCP’s most recent corporate report, increased financing levels indicate that surpluses are either already present or far closer than they have ever been. This requires scheme sponsors to reevaluate their long-term strategy, taking into account new factors like how accessible the excess is, what that means for their end goal, and making choices like whether to de-risk or whether contributions are still required.
In order to reach a mutually agreeable end goal, LCP is pushing sponsors to collaborate closely with trustees. They should seek advice on the conditions under which the rules of their programme allow refunds of surplus, as well as make sure they have accurate projections of their financing status and an easy means to track it. They will be able to maximise their opportunities as a result.
Other concerns that sponsors need to keep in the forefront of their minds, according to the research, include investing in accordance with their long-term strategy, with increased gilt yields, capped inflation, and Covid-19 effects lowering liability targets.
Due to the extreme volatility of the gilt market, certain schemes will need to make challenging judgments on LDI. In the new environment after the gilts crisis, they will need to decide whether to tolerate less LDI hedging or fewer growth assets.
Although index-linked gilts are the most popular method for schemes to hedge inflation, for schemes with long time objectives, looking at investments that will reflect inflationary developments, such as ground rents and long-lease property, could mean stronger protection at a better price.
Furthermore, due to rising inflation and the cost-of-living crisis, there may be significant public and member pressure to approve bigger pension increases in particular circumstances.
LCP also says that sponsors must comprehend the potential effects on their first valuation under the new regime as the new funding code is anticipated for implementation the following year. Although there is still uncertainty, many people anticipate larger financing goals and quicker recovery times.
LCP partner Phil Cuddeford says: “Scheme surpluses are a nice problem to have but sponsors need to work out the direction of travel for their scheme with their trustees in order to negate any risks.
“There are so many issues for sponsors to keep on top of, whether it’s responding to the new world of less efficient LDI, higher for longer inflation and interest rates, the prospect of tougher new rules on pension scheme funding or exploring new options for end-game. For the sponsor who is on the ball with oversight of their pension scheme, this is also a time of great opportunity.”
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