Case study: Changing the investment strategy to improve member benefits and better utilise surplus

Background:

We worked with a large UK hybrid (DB and DC) scheme which had a surplus on a prudent valuation basis.

The scheme rules state that the surplus is returned to the sponsor on windup. The Trustee has agreed to be buyout ready by a certain date and the sponsor is budgeting for return of the projected surplus, with the appropriate level of uncertainty/downside around this projection.

The investment strategy is heavily de-risked and 100% hedged on interest rates and inflation.

Trustee proposition:

The Trustee was concerned that the portfolio return was too low and the investment strategy was not working the scheme capital hard enough.

The Trustee proposed to increase expected return by 0.5% p.a. through diversified allocation to lower rated and less liquid credit (which the timeframe to buyout readiness allows). This approach ensures that there is no material increase in the downside uncertainty around the projected surplus and the additional return also improves the speed of recovery from any adverse market events.

This change in strategy allows the trustees to fund annual DC contributions for the sponsor in return for (the required) agreement from the sponsor for ongoing discretionary pension increases.

Benefits:

Members receive discretionary increases on an ongoing basis

The sponsor sees immediate increase in free cashflow while long term projections remain in place.

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