Capital Backed Journey Plans - helping pensions schemes run for the line?

Help finishing the race

Often on a run, I’ll completely switch off, but sometimes it can be good head space to think about a certain topic. Capital Backed Journey Plans were one of those topics.

In simplest terms, a pension scheme trustee or sponsor can contract with a Capital Provider to fix a journey plan - such as becoming fully funded on a self-sufficiency basis in 10 years’ time. As part of this contract, the Capital Provider gives an upfront cash injection to the scheme.

In running terms, if I was running a long-distance race and someone offered to run with me to the end, I’d certainly take them up on that. If someone offered to pick me up and move me closer to the finish line, I’d definitely be tempted! A Capital Backed Journey Plan effectively does both of these things for a pension scheme - guaranteeing a final outcome and also injecting some cash to push you closer to the end. What’s in it for the Capital Provider? In practice, the Capital Provider will still run the same race as you, making sure you get to the end, but they will run the race more quickly to maximise their outcome. The contract will implicitly (or maybe explicitly) agree with a target level of investment return for the scheme, the Capital Provider will make a profit if they can work the assets harder and generate an even higher return than required - taking greater investment risk and investing in a higher returning portfolio as a result.

If I think about my running friends, there are some I’d be sure could pace me well to the end, and others who always go off too fast and either a) blow up before the finish, or b) smash out a personal best (“PB”). The Capital Provider will be aiming to get a PB, and you certainly don’t want the strategy to blow up. If they do blow up, you need to be comfortable that the initial cash injection is sufficient to keep the scheme on track to achieve a sensible target.  In entering into this contract, a drawback is that the scheme is giving up its potential to achieve its own PB as it will be fixing the journey plan - the scheme will finish the race as agreed in the contract, and it won’t be benefitting from going any faster.

When establishing a contract, trustees must be comfortable that commercially, all aspects of the deal stack up and the risks being taken are sufficiently compensated. From a fiduciary perspective, trustees also need to be comfortable with taking this extra investment risk on behalf of members.

More creativity in end-game options

Innovation is a good thing and more offerings coming to market to help schemes achieve their end game is helpful in that it provides options - with some options being better suited to certain schemes than others.

For some schemes, innovations that help bridge the gap from their current position to buyout (assuming this being the end-game target) have become somewhat redundant as market movements in the past year or two have naturally bridged this gap for them.  Buyout may therefore be a much more realistic target in the next 5 years without any extra help, or innovation. 

Capital Backed Journey Plans to date is an untrodden path, however, they could be particularly useful for schemes with a relatively weaker sponsor, where there is uncertainty in the time period for which the sponsor will be able to continue to support the scheme or where the extra capital can enhance the current position and hopefully get the scheme to the desired endpoint sooner than perhaps otherwise. At the end of a long race, it’s difficult to finish alone, and a Capital Provider can be on hand to give that extra support when you need it. This support could potentially extend to the scheme running a surplus should the scheme decide, and be in a position, to head in that direction.

Running a race that’s right for you

There aren’t currently many Capital Providers around, and a very limited number have written business. Given the infancy of the market, the Providers are likely to be keen to engage. Whilst this is in an unregulated market, the Pensions Regulator is likely to also be keen to understand the framework that gets established - with them pointing at the DB superfund guidance as a useful reference point for schemes considering this route.

Due diligence is a really important step to understanding all the details, including any potential risks. Capital Providers in the market also each do something a little bit different, therefore spending time to consider the different approaches available and the merits of each is worthwhile if thinking about going down this route. Capital Providers may also want to “run” for a minimum amount of time (e.g. because their strategy involves illiquid assets which need to be held for a certain term), trustees should understand any such lock-in periods and any associated detail in the contract.

Who wins in the race?

When I first started running, my husband used to (jokingly) tell me off for making friends running around Parkrun. If I had time to chat, I wasn’t working hard enough. But the ultimate goal for parties of the same race can be different - who is winning?

Ultimately trustees need to consider what journey plan is most appropriate for their circumstances, collaborating with the sponsor in arriving at this decision. Capital Backed Journey Plans offer welcome innovation when considering the end game for DB pension schemes, which in some cases could lead to more certainty and better outcomes for members and sponsors. However, this is a new area with little standardisation - trustees would need to do a lot of hard work upfront with advisers to consider whether they are comfortable introducing more investment risk, understanding if risks taken will be sufficiently compensated and having confidence that their chosen Capital Provider can deliver. 

There is no way to finish a race without some effort and risk, whilst Capital Backed Journey Plans may provide a guarantee you will finish the race, this is subject to the strength of that guarantee, which rests on the detail in the contract. Trustees should be aware of any areas or events that could leave them exposed. Depending on what end goal is agreed with the Capital Provider, there may also be further work to do once reaching that point (an extra lap around the park!)

The winning here is delivering the best outcomes to members without taking unnecessary risks.