With all the vigour (and, for some, forced jollity) of a post-wedding conga line, we are now heading for the door marked Brexit.
So, what strategic issues will affect UK defined benefit pensions and what, if anything, can be done to recognise them?
Most schemes will know where they stand at present. And for most, this will be significantly short of a full buy-out position and, probably, short on a scheme-specific funding position (or technical provisions basis). Brexit won’t change any of this in the short term. Life should just carry on as now.
From a strategic viewpoint, as always, we need to look at the triumvirate of scheme support; investments, funding and covenant.
Investments are what they are. Most schemes will have already had discussions with their advisers about the strategic impact on existing investments of Brexit. Some may also have talked about changes in overall strategy. However, I would suggest that this debate cannot really take place until the next two areas have been fully explored.
Funding, the comparison of assets with the value of liabilities and the consequences for contributions, is largely covered by legislation.
Whilst this legislation does derive almost wholly from the EU (via the IORP directive), it is enacted by UK law and does not seem likely to change, at least in the short term. However, what could change is the interpretation of how the law should be implemented.
Under the EU, there is a clear direction of travel towards insurance level security for occupational pension schemes. The so-called “Solvency II for Pensions”.
Whilst the last attempt to introduce this (via IORP II) was successfully dispatched to the long grass, it clearly hasn’t left the EU agenda. This would seem to suggest that any interpretation of words like “appropriate” and “prudent” when taken up to the EU level would tend to fall towards the conservative end of the spectrum.
Post-Brexit there could be a chance that this direction of travel might subtly change. Evidence of this could come from the response to the recent green paper on pensions, giving some indication how these loose words might be interpreted when there is no EU process in place to review.
Examples could be a change of focus from a “gilts plus” benchmark for funding to a more interpretative “expected return” approach. Whilst we would not expect any announcement on this we might see less push back on reported positions and a wider spread of scheme specific results emerge. If this is correct we would recommend a strategic approach of keeping options open to take advantage (if appropriate) of any resultant flexibilities.
Finally, and possibly most importantly, schemes should consider how Brexit impacts the scheme sponsor and the overall scheme covenant. Each scheme will be different and each sponsor different – so no general rule applies.
Some specific points come to mind. Is the sponsor - or any covenant support, both implicit and explicit - based in the EU. If so, how confident are trustees that this support remains focused on the UK?
Is the actual business likely to be impacted by Brexit and any new trade rules? How will this impinge on the ability to make contributions to the scheme if needed? Has the sponsor become a more likely takeover target and what might this mean for the scheme? What powers does the scheme have in such circumstances and should they make the sponsor aware?
There are just some of the questions to ask and forewarned is forearmed. Whilst the two-year divorce proceedings may seem a long time, they will soon pass. Every scheme with a sensible Integrated Risk Management Plan should be considering these questions and more.