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The Department for Work and Pensions (DWP) issued a White Paper earlier this year, explaining their proposals for increasing protections for defined benefit (DB) pension scheme members and making improvements to the system.
One area they have focussed on is a requirement for pension trustees to set a long-term funding objective for their scheme, and then to report against that objective. For pension schemes that are open to new members and future accrual, the objective may be to continue relying on employer support. However, for the majority of DB schemes which are closed either to new members or to all future accrual, the objective is more likely to be purchasing full benefits with an insurance company by a set time, or targeting an approach where reliance on the employer is minimised.
What might be a suitable objective for a charity’s pension scheme?
One of the key drivers for charities will be to reduce volatility and the likelihood of large increases in deficit contribution requirements. This is important to avoid larger proportions of the charity’s budget being spent on pension scheme deficits rather than charitable activities.
However, many charities have been operating for a significant period of time, and will envisage continuing their activities over a very long horizon. If so, a suitable objective may be to target a position where the pension scheme is sufficiently funded to support itself with a lower risk-investment strategy, reducing the likelihood of relying on contributions from the employer. This is commonly referred to as a “self-sufficiency” objective.
Reducing volatility on the journey to self-sufficiency
A typical approach for many pension schemes is “high risk now, low risk later”. For example, it is often assumed that higher risk assets such as equities are held for non-retired members, gradually switching to safer assets such as government bonds as members retire.
Given the desire to reduce volatility, for charities in a stable financial position a more sensible approach may be to take a consistent level of risk over a longer period of time. This could mean significantly less risk now, compensated for by slightly more risk over the long term.
This alternative would reduce the chance of significant additional contributions being needed in the short term, as the investment risk is spread over a longer period rather than being heavily concentrated during the next few years.