The DB Endgame - To Buyout or To Run-on?

 As DB pension schemes mature and approach their endgame, trustees and sponsors face a strategic choice - whether to pursue a full insurance buyout or continue running the scheme on retaining sponsor support.  This decision carries significant implications for member security, sponsor capital deployment, surplus distribution, and long-term governance responsibilities.

With funding levels improving across many schemes and providing greater opportunity for insurance transactions, now is a critical moment to reassess the trade-offs between transferring liabilities to an insurer versus retaining them in pursuit of greater value capture. The analysis presented here is designed to illustrate those trade-offs.

A Look into Buyout

We begin by looking at the financial soundness and value-for-money implications of fully insuring a DB pension scheme - comprising both deferreds and pensioners.  We assume the insurance premium to buyout is £360 million and prudently estimated liabilities are £300m. Under this arrangement, the insurer assumes responsibility for paying all future member benefits, discharging the scheme’s liabilities in full.

From a trustee and sponsor perspective, assessing the value of this transaction means ensuring that members’ benefits are secured to a high standard, while also ensuring that the cost of the transaction is justifiable relative to the risks being removed.

At the heart of this transaction is the £60 million in “surplus” - all of which would be expected to accrue to the insurer if the transaction goes ahead.  The surplus acts as a buffer to support both the insurer's future investment performance and its ability to manage long-term risks such as longevity and inflation changes. We assume the insurer expects to achieve a modest investment return of 0.5% per annum above the risk-free rate investing conservatively to match liabilities with a long-term investment horizon and well-diversified asset base. We estimate the expected value of economic benefit to the insurer from taking on these liabilities to be around £98 million*.

We then apply our proprietary Surplus Management Framework to estimate the economic value of the insurer’s contingent support - placing a value on the support implied given that the insurer receives £360m to invest conservatively in respect of £300m worth of expected liabilities over a 20-year term.  

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