DB pension planning: begin with the end in mind

Estimated reading time: 5 minutes

I’ve been talking for a while about the importance of long-term strategic planning: thinking about where your defined benefit pension scheme is heading and working backwards from there.

“Begin with the end in mind” you may have heard me say at some point. The Pensions Regulator is now encouraging exactly the same kind of thinking – a move away from seeing the triennial actuarial valuation as a snapshot funding review and moving towards schemes having a genuine long-term plan that endures from valuation to valuation. In other words, long-term solutions for long-term problems. Sounds simple like that doesn’t it?

But what does it mean in practice? What’s the best way to develop and manage your own long-term DB pension strategy?

Well at the heart of every strategy is a long-term goal. I play chess and the long-term goal in chess is clear – capture the opponent’s king before yours is captured. Every element of a chess player’s strategy can then be tested against this goal – does this move make it more likely that I’ll win? If the answer’s yes then it’s a good move. If the answer’s no then you should look for a better move. But how many pension schemes have even articulated what their long-term goal is, let alone test their decisions against it?

To help with this we’ve developed a simple defined benefit pension scheme framework that decision-makers can work through. Answering five simple questions will result in having a robust strategic plan for your scheme. You can then test your decisions against this framework – you’ll know what a “good move” looks like. We call this the DB Navigator® approach:

The first question begins with deciding on the objective. You might be thinking it’s obvious; the goal of a DB pension scheme is to pay all the pensions. But is it? Most schemes will want to insure their pensions through an insurance buyout and so for these schemes the goal will be to pay an insurance premium, with pensions being paid in full before that point.  

What about the timeframe?

In chess there’s a time limit. The clock is ticking and if you run out of time before your opponent does then you lose – even if you’re about to win. There’s a time limit for your DB pension scheme too. It’s a bit more subtle, but you really want to be getting your pension scheme well-funded and well de-risked before it becomes too mature. You may also have time constraints imposed by the employer covenant too. The right timeframe for your DB scheme will be unique to your circumstances.

Once you have a clear goal and a clear timeframe you can test your investment and funding strategy against that plan. Will you get there in time? Do you need to speed up, or can you afford to slow down and take a steadier, less-risky approach? Without a clear target in mind, how do you really know that your strategy is the right one? Many schemes have simply set their investment strategies by reference to the return assumed in the actuarial valuation – sometimes without even realising that the return in the actuarial valuation has been set by reference to their current investment strategy.

Types of scenarios

And of course, no long-term plan will pan out exactly as you hope. When I play chess my opponents have a habit of moving their pieces about as I’m trying to attack them – and I keep needing to react to my opponent’s attacks. No amount of upfront planning is going to deal with all the eventualities, but it’s still really useful to think ahead. In simple terms there are only two “types” of scenarios that can come through, either “I get ahead” or “I get behind”. I plan for these possibilities when I play chess – if I’m ahead I usually plan to simplify things to consolidate my advantage, and if I’m behind I usually try and complicate matters, hoping for my opponent to make a mistake. 

The same is true of your DB pension strategy – “stuff will happen” and you’ll need to react to that, but there are really only two “types” of scenarios – either you’ll be ahead of the plan or you’ll be behind it. You shouldn’t set actions in stone, but you can have a discussion upfront about how you’ll likely react if you’re ahead, or if you’re behind. For example, if you’re ahead you might agree that you’ll probably prioritise investment de-risking over and above reducing contributions (or vice versa). On the other hand, you may decide that if you’re behind then you’ll probably look to re-risk your DB pension strategy before you increase contributions. What’s right for you will depend on your unique circumstances, and those may change over time, but the key point is that by planning ahead and having these discussions upfront, before you find yourself there, then you should be able to act much more quickly when the time comes.