Capital backed funding arrangements (CBFA) can offer “tangible benefits” for defined benefit (DB) pension schemes to secure member benefits, the Institute and Faculty of Actuaries (IFoA) has said, clarifying that this is a “new area” that requires greater understanding.

A report from the IFA noted that whilst many DB pension schemes now find themselves on track or ahead of their funding targets, schemes may find that an insurance buyout is not feasible or desirable in the near term.

It also acknowledged that, employer’s focus on the opportunity cost and tax implications of trapped surplus is likely to increase, admitting that, for many employers, it may not appear to be an efficient use of capital to pay cash into the pension scheme to reach full funding on a buyout basis if this results in a heightened risk of trapped surplus emerging.

In addition to this, it suggested that the consequences of missed opportunities to secure benefits in full become more apparent, which could be a particular concern in the current economic environment, when companies are already facing increasing stress on several fronts.

However, it pointed out that a diverse set of arrangements has been developed by a number of providers, which draw on external capital to aid trustees and corporates to meet scheme funding ambitions, highlighting CBFAs as “an additional tool in the trustee kit” in this sense.

In contrast to a DB master trust, superfund, or pension buyout where there is a step-change in governance arrangements, the CBFAs considered in the IFoA's paper were primarily an investment decision, time-limited and within the remit of the existing trustee board.

Based on this, the IFA suggested that CBFA's can potentially improve member outcomes in a number of ways, including by reducing downside investment risk, and paying benefit cashflows with added security, while retaining some investment upside and flexibility.

However, the IFoaA stressed the need for trustees to seek impartial advice, warning that the CBFA market can be "bewildering" at first consideration, not least due to the number of new providers in recent years and the flexibility of those providers.

According to the IFoA, most material has been prepared for direct engagements between a provider and pension schemes and is not easily shared, which can result in options not being considered, and therefore in missed opportunities to achieve scheme objectives.

Given this, it suggested that a framework could help enable effective comparison, assessment and discussion of these arrangements, and give sufficient introduction to enable the trustees or companies to identify appropriate next steps, including the nature of expert advice needed.

Commenting on the findings, report author, Derek Steeden, commented: “Capital Backed Funding Arrangements can offer tangible benefits for DB pension schemes to secure member benefits in full: downside investment protection, covenant improvement, access to investment expertise, governance arrangements and potentially assistance to prepare for an insurance buyout or a low dependency strategy.

“Arrangements offer distinct benefits when compared with DIY approaches, superfunds, DB master trusts and conventional insurance risk transfer policies.

“However, there are new risks to consider and this remains a relatively new area with limited standardisation or information in the public domain. It is important to understand how an arrangement works both in the normal course of events, in periods of stress and if the arrangement is terminated.

“In this paper we set out a framework to enable an effective initial comparison, assessment and discussion of these arrangements, and to give sufficient introduction to enable the reader to identify appropriate next steps.”

Share Story: