Ian Wright: Stakeholders should have another look at CBJPs and may find them a useful addition to the toolkit as part of a long-term journey plan.
Since the early 2000s, the industry has absorbed increasing legislative and regulatory obligations for defined benefit (DB) pension scheme funding. Managing these (largely historic) liabilities has been a real challenge for both sponsors and trustees, and at times awkward.
The attraction of final settlement of historic pension scheme liabilities is obvious, but not always immediately realistic. While the cheaper consolidator option is attractive for some, there is ultimately a limit on what the market can absorb.
We are now moving into a world where schemes must have a formal journey plan to some form of end state, whether settlement or long-term run-off. Many DB schemes and sponsors had more or less formal plans, and are relatively well-funded, but now they have to write it down in a form the Pensions Regulator (TPR) recognises.
Awkwardly, many sponsors and schemes had a plan – and support structures to get them ‘home' – which now may not fit within TPR's new covenant guidance (December 2024). A quid pro quo deal to trade a funding and investment strategy for parental support, for example, is unlikely to meet TPR's look through criteria – that the guarantor is really fully backing a scheme with no strings attached. Given that these were hardly negotiated, this could be painful.
While buyout or consolidator transfer will ultimately remain attractive, run-off may be increasingly attractive given recent government indications around surplus refunds.
A clear opportunity for CBJPs
There is a clear opportunity for a commercial product to help bridge the gap, such as capital-backed journey plans (CBJP).
CBJPs are an investment product; they are not in and of themselves a settlement solution. A third party provides a capital buffer to support a pre-determined investment journey to a particular agreed endpoint over an agreed period (which could be between 5 and 15 years), effectively underwriting some investment risk, and allowing schemes to adopt an investment strategy that on their own may not be feasible. From the provider's perspective, the attraction is that some, or all, of the excess returns above the agreed target will at some point accrue back to the provider.
These structures are a bridge because what they're doing is putting some capital underneath the scheme to enable it to do something more aggressive than it otherwise would be able to do, so that it can go faster or more certainly towards an endpoint.
While capital backed journey plans have been around for a number of years, they have yet to become an established part of the pensions landscape. Indeed, only one transaction appears to be in the public domain.
There are several reasons for this, but changes to the regulatory landscape, and potential relaxation of surplus refund rules, appear to change the dynamic. Where sponsors and trustees are uncertain as to the eventual endgame, particularly in the light of uncertainty around surplus refunds and possible additional liabilities arising from recent court judgments, a ‘wait and see' approach to journey planning may be more attractive.
CBJPs probably aren't attractive for schemes with an employer in, or bordering on, genuine distress.
Supplementing covenant support
The essence of the CBJP is to supplement covenant support either to allow implementation of a plan with greater certainty, or to take a slightly greater degree of risk – and so move more quickly to a target – than would otherwise have been feasible, but in either case there remains some need for ongoing sponsor support. And early exit from a CBJP may be challenging and potentially costly.
However, for sponsors and schemes that have no immediate concerns about sponsor support and no desire for imminent settlement, a CBJP may be an attractive part of what is now a mandatory journey plan.
And even if the eventual target is settlement, data and administration reconciliation may take some years fully to resolve. Even if a scheme is funded on a buyout basis, it may not be possible to transact until those issues are largely resolved, so a CBJP can be built into that journey.
Trustees, and sponsors, will still need to be comfortable with the apparent asymmetric risk/reward balance between them and the provider.
Trustees will have to balance their investment duties with their overarching duty to deliver the promised benefits. A trustee's primary obligation is to ensure that the promised benefits are delivered, not generally unilaterally to seek to build up surplus by taking unnecessary risk. Any upside forgone appears strictly illusory as it was not expected to occur in the ordinary course of events. So, a CBJP, delivering intended investment return with greater certainty or achieve a funding target faster than would otherwise be feasible, won't conflict with these duties.
Sponsors may see attractions in supporting a CBJP to accelerate a journey over and above what they might otherwise have to contribute, particularly where an existing guarantee structure needs revisiting and/or as part of a wider discussion about use of possible surplus in due course. And where sponsors need to offer transaction mitigation (where corporate activity appears to weaken the sponsor supporting a scheme), a cash injection to support a CBJP and potentially allow surplus access in due course may be sensible.
The world has changed and continues to evolve in this area. Stakeholders should have another look at CBJPs and may find them a useful addition to the toolkit as part of a long-term journey plan.
Ian Wright is technical director at Arc Pensions Law
