In blog 6 in the series, we look at some specific case studies to highlight how alternative endgame arrangements can deliver meaningful financial benefits for both sponsors and members.

Pension scheme

Run-on

The pension scheme in both case studies is 105% funded on a low-dependency basis of gilts+0.5% p.a., with a liability value of £3bn.

Captive Insurance

The pension scheme in both case studies is 105% funded on a low-dependency basis of gilts+0.5% p.a., with a liability value of £3bn.

Timeframe

Run-on

10 years

Captive Insurance

10 years

Investment strategy

Run-on

Captive Insurance

The expected return of the strategies with the same label above is of similar level. For example, both high-risk strategies are expected to deliver gilts+1.5% p.a.

Surplus extraction framework

Run-on

  • At the end of each year
  • When the funding level reaches 110% on the low-dependency basis, excess surplus above this threshold may be extracted; and
  • If the funding level falls below 100% on the low-dependency basis, then a lump sum deficit contribution will be made to bring the funding level back to 100%.

Captive Insurance

  • At the end of each year
  • 100% of surplus is distributed back to the sponsor in the form of dividend payments when the Solvency Capital Ratio (SCR) is over 135% at the year-end; and
  • The sponsor needs to provide sufficient capital to the captive insurer to bring the SCR back to 125% when it falls below.

Regulatory framework

Run-on

Pension Scheme - UK

Captive Insurance

Life Insurance - Bermuda SCR

Additional capital

Run-on

n/a

Captive Insurance

We assume an extra £1bn of capital is held in surety bonds from inception to ensure the captive insurer’s solvency level is in line with its operating solvency target. This £1bn is modelled in our stochastic ALM tool (GLASS) as a separate balance sheet item. It is not invested and is used solely in the solvency calculation.

Other assumptions

  • Deficit‑reduction contributions/capital injections, and surplus/net profits are discounted at 8% p.a., reflecting the assumed cost of capital for a hypothetical sponsoring company.
  • Tax and expenses are ignored.
  • Additionally, in the captive insurance case study, fronting insurer fees and captive set‑up costs are also ignored.  

Our stochastic ALM tool, GLASS, can incorporate tax, investment and other expense in the analysis. We simply excluded these in factors in both case studies because they can vary materially from one scheme to another.

Given the sensitivity of outcomes to these assumptions—as well as differences in scheme design and stakeholder risk appetite—the results can vary significantly. This highlights the importance of performing a scheme‑specific stochastic ALM analysis to assess the value of endgame options for each indicial case.

Net NPV

Run-on

Captive Insurance

The charts above show the cumulative Net Present Value (NPV) of net return (surplus extracted minus capital injected) under each investment strategy over the next 10 years, a key metric for sponsors weighing the endgame options for their DB schemes. The results show that the higher the level of risk, the greater the return, and is skewed to the upside, which is a logical conclusion.

The captive insurance option appears more attractive compared to the run-on option because:

  1. Fronting insurer fees and set up costs of captive insurer is excluded. Users can either deduct these costs from the NPV or embed them in the stochastic projection to assess the expected return, reflecting their unique circumstances.
  2. The insurance regulatory framework is generally more stringent than that for pension schemes. As a result, the median expected capital required to restore the solvency level back to the target is higher across all three investment strategies. The range of the expected capital requirement is also wider. Please see charts below for more information.

Contributions

Run-on

Captive Insurance

Cumulative net present value of contributions required to restore the funding or solvency level back to the minimum threshold.

Conclusion

The case studies above highlight how alternative endgame arrangements can deliver meaningful financial benefits for both sponsors and members. However, the outcomes can be very sensitive to the underlying assumptions and scheme‑specific factors that feed into the analysis. These include, but are not limited to:

  • Scheme asset and liability size
  • Current funding level
  • Time horizon for running- on or implementing a captive solution
  • Investment strategy
  • Sponsor and trustee risk tolerance
  • Surplus‑extraction framework (e.g., extraction/injection thresholds, frequency, and whether surplus is shared with members)
  • Costs and expenses
  • …  

Given this complexity, careful assessment of ongoing investment risks is essential when evaluating endgame options. An approach that works well for one scheme or sponsor may be less appropriate for another. Therefore, trustees and sponsors must evaluate these options in the context of their own scheme’s circumstances. 

Interested to know more?

This article is the sixth in our series on rethinking the endgame for UK defined benefit pension schemes,

Download the whitepaper for a full comparison of endgame options where we evaluate the options using GLASS.

Or access the full series, here

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