Capital Backed Funding Arrangements

The rise in interest rates globally in 2022–23 led to improved scheme funding for many defined-benefit pension schemes. Many schemes in the UK now find themselves closer to, or at, a fully funded position on a low-risk basis (annuity buyout or self-sufficiency). Finishing the journey while managing the risk of losses on that journey is highly desirable, but may be difficult to achieve in practice. However many schemes are not yet sufficiently funded to buy out liabilities in full with an insurer. Others may not wish to, and many who can afford to do so are not yet able to for investment reasons (such as holding illiquid assets) or operational reasons (such as the time needed to resolve member data issues). For schemes that instead look to adopt self-sufficient ongoing management with low dependency on the sponsoring employer, this may be difficult to maintain in practice. In short, there remains a risk that benefits will not be secured in full, which with hindsight could have been avoided. The addition of capital to pension scheme assets has long been deployed to enhance the security of member benefits e.g., capital from insurers in the case of a buyout or capital from sponsors in the form of contingent assets. More recently, providers have developed a diverse set of arrangements that draw on external capital to aid trustees and corporates to meet scheme funding ambitions. Capital Backed Funding Arrangements (“CBFA”) are in this context an additional tool in the trustee toolkit for delivering funding strategies. This paper focusses on the UK-defined benefit market but the dynamics are applicable to other jurisdictions, with CBFAs being developed for wider markets (e.g., Ireland). In this paper we: survey the current scheme funding landscape and consider the need in this environment for arrangements to support scheme funding journeys to deliver benefits in full summarise the key features of arrangements in the market that may support these objectives set out considerations for trustees and sponsoring companies when assessing these arrangements. The aim of this paper is educational – to increase awareness of the key issues and potential solutions. Professional advice will always be required prior to any transaction. We welcome feedback from readers on further material that would be beneficial to support consideration of these arrangements.