The funding position of FTSE 350 defined benefit (DB) pension schemes on an accounting basis reached a record high in May, after the aggregate surplus increased from £51bn to £69bn, analysis from Mercer has revealed.

Mercer’s FTSE 350 analysis showed that the “vast majority” of schemes are now holding material surpluses on an accounting basis, with many schemes also becoming well-funded against their long-term funding targets or even against the cost of buyout.

Mercer Principal, John Gething, noted that the recent funding improvements have also led to a lot of interest from companies and trustees in exploring a range of end game options, with some considering "alternative, potentially more efficient options" to buyout.

In particular, Gething noted that some trustees and companies are considering if and how, to run-off their schemes for the benefit of the members and the company.

Indeed, a recent industry poll suggested that nearly a fifth (19 per cent) of DB pension schemes believe that run-off is most likely to be their endgame strategy.

In addition to run-off, however, Gething suggested that, depending on the scheme’s circumstances, companies may want to consider if they can access future excess returns in the pension plan if they are not needed to pay members’ benefits, explaining that there may be opportunities for trustees to maintain (or even increase) member security, whilst potentially providing greater inflation protection for members.

“For some schemes, these may be achievable objectives but the way to do it will vary from case to case and be subject to scheme specifics and legal advice – for the simplest cases, it could be as straightforward as a framework agreement between the company and trustees,” he added.

A missed opportunity?

Analysis of the FTSE100 DB pension surplus by LCP has revealed similar improvements, as the aggregate pension surplus increased from £59bn at the beginning of 2022 to around £67bn at the year-end, corresponding to an increase in average funding level from around 110 per cent to 120 per cent.

Commenting on the improvements, LCP partner and report author, Jonathan Griffith, suggested that, amid improved funding positions and market innovation, pension schemes are no longer seen as a "millstone weighing down corporate growth".

"DB pensions in the UK now stand at a crossroads – they could be consigned to the history books as the rapid increase in insurance de-risking takes hold, or could be seen as an opportunity for growth and improved outcomes delivering enhanced value for all stakeholders and wider UK plc," he stated.

However, LCP’s analysis also looked at the impact of prudence within UK pension schemes, showing that while the high level of prudence within UK pensions will have largely protected scheme sponsors against possible new significant cash calls, it can have unintended repercussions for corporate balance sheets.

In particular, LCP argued that the “huge shift” in market conditions over 2022 will have meant schemes taking a prudent approach will have missed out on a "golden opportunity" to generate value for sponsors, for members, and for wider stakeholders, arguing that schemes taking more risk will have benefited from "significant improvements" in funding levels on all measures.

“Prudent pension strategies largely worked as intended throughout the LDI crisis and limited risks of future cash calls on pension scheme sponsors,” LCP partner and head of corporate consulting, Gordon Watchorn, stated.

“Whilst this has increased the security of DB pensions over recent years, we are now at a point whereby schemes are looking to explore and implement different options to make the most of opportunities.”

More broadly, LCP’s analysis also found that pension schemes have accelerated the move out of equities, with the amount of FTSE100 assets invested in equities falling by £50bn in 2022.

This corresponds to the proportion of scheme assets in equities dropping by a third over the year and being less than 10 per cent of total DB pension assets for the first time.

In addition to this, it found that around three-in-four FTSE100 CEOs aren’t receiving pension contributions in line with their employees, despite ongoing campaigning from the Investment Association for executive pensions to be more in step with the rest of the workforce.

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