United Kingdom: The Shifting Landscape of DB Pension Scheme Endgames

For many years, the story was straightforward: most DB pension schemes were in deficit, weighing heavily on employer balance sheets. The natural goal was buy-out; i.e., securing members' benefits through annuity purchase and winding up the scheme.

That picture has changed dramatically in recent years. A combination of market factors, including higher interest rates, have transformed scheme funding levels and most DB schemes are now in surplus.

This shift, alongside recent regulatory developments, means buy-out is no longer the only viable endgame. Employers and trustees now have a range of options, including running the scheme on indefinitely or exploring alternative forms of pension risk transfer.

Run-On

Under a run‑on strategy, the scheme remains in place and continues paying pensions indefinitely. This approach is particularly attractive for larger schemes with healthy funding levels and strong employer covenants, as they typically benefit from robust governance and scalable administration.

The scheme stays on the employer balance sheet, but with reduced volatility. Run-on will require a funding and investment strategy designed to achieve “low dependency” on the employer by the time the scheme reaches significant maturity. Schemes will generally target returns above low dependency to support benefit security and generate surplus.

What Happens to Surplus?

How surplus can be used depends on the scheme's trust deed and rules and legislation. Options include:

• Sharing it with members by increasing their benefits;
• Using it to fund contributions for DC members; and
• Refunding it to the employer (subject to tax).

The Pension Schemes Bill currently progressing through Parliament will give trustees greater flexibility to return surplus from ongoing schemes to employers, subject to their fiduciary duties. The government has also announced plans to allow ongoing schemes to make surplus payments directly to members.

RUN-ON WITH RISK TRANSFER

Schemes continuing on the employer's balance sheet, whether indefinitely or as a "bridge" to a full risk transfer transaction, have several risk transfer options.

Longevity Swaps

A longevity swap involves a counterparty (typically a bank or insurer) taking on longevity risk.  In exchange for a known premium, the counterparty agrees to cover benefit payments where members live longer than expected.

Capital-Backed Journey Plans

Under a capital-backed journey plan, a third party provides external capital to underwrite funding risks. The provider absorbs adverse experience within agreed parameters, receiving fees and a potential profit share in return.

Buy-ins

A buy-in is an insurance policy that matches some or all of the scheme's liabilities. It is often executed in phases. The insurer assumes investment, inflation, and longevity risk for the insured benefits while the scheme continues to run on. This approach maximises member security, though pricing reflects insurers' strict capital requirements.

FULL RISK TRANSFER – BUY OUT

Buy-out remains the traditional route to full risk transfer. On buy-out, the insurer converts an existing buy-in into individual policies for each member. Once complete, the scheme can wind up, and the trustees and the employer are discharged from their obligations.

Buy-outs typically occur one to two years after a buy-in, once the scheme has greater certainty over benefits and data quality. For the employer, settlement accounting applies after completion, with any remaining surplus distributed according to the scheme rules and legislation.

FULL RISK TRANSFER – ALTERNATIVES TO BUY-OUT

Alternatives to insurance transactions now exist for employers seeking full risk transfer and improved member security.

Superfund Transfers

A superfund transfer moves the scheme into a regulated consolidator—an occupational pension scheme in its own right. A ring-fenced capital buffer replaces the employer covenant. Benefit security is generally lower than insurance, but higher than a weak employer covenant, and pricing typically sits below buy-out levels.

These transactions must satisfy the Pensions Regulator's "gateway" tests, including demonstrating that buy-out is not currently affordable. The Pension Schemes Bill includes provisions for a statutory authorisation and supervision regime for superfunds.

Emerging Innovations

The risk transfer market continues to evolve. For example, we are aware of a recent "sponsor-swap" transaction in which an external asset manager replaced the sponsoring employer of a large DB pension scheme, illustrating the creative solutions now emerging in this space.