In our 2021/2022 Annual Report and Accounts, published today, we've given an update on how we're looking to evolve our funding strategy. Our Chair, Kate Jones and CEO, Oliver Morley co-authored this blog post to share our thinking about what the future holds.
Our funding strategy is critical to us fulfilling our ultimate mission – to pay our members their compensation both now and in the future. As the fund of last resort, we want to provide a high level of confidence to our members on the security of their benefits.
In doing so we want to get the balance right between providing that confidence and not asking for more than we think we need from our levy payers.
Our current strategy dates back to 2010. Back then, we were in our relative infancy as an organisation, and the environment we faced was very different. It has for the past decade guided our approach to investment and setting levies, and helped us build up our financial strength.
Our funding strategy review has made good progress
Today in our annual report we've announced record funding levels, and for the past year or more we have been conducting a review of our long-term funding strategy. The review has been considering afresh the risks we face and how our approach needs to adapt in the future.
While long planned, the timing of the review is particularly apt as it has been a dramatic few years for both us and the schemes we protect. The risks we face have reduced and our own funding position has significantly improved, driven in large part by exceptional investment performance.
We’ve made good progress on our review, which is now in its final stages. Ahead of publishing the outcome this autumn, we wanted to share at this stage some of the key emerging conclusions with stakeholders.
Towards a new funding objective
Under our current strategy, our funding objective is defined as being financially self-sufficient by our funding horizon. By ‘self-sufficient’ we mean carrying sufficient reserves – or margin – to protect us against future claims and longevity risk in the majority, 90 per cent, of scenarios.
Since 2010 we’ve assessed our margin and horizon each year and concluded we would need to be 110 per cent funded by 2030.
An important conclusion of our review is that we should move away from a fixed horizon – in other words moving away from 2030 as a defined point in time. Our approach to-date has been geared towards building our financial resilience, but as we now stand in robust financial health, it is increasingly important we focus on maintaining our resilience.
We therefore plan to redefine our funding objective to ‘maintaining our financial resilience’. In order to meet this objective, we plan to set out our funding priorities and how we expect future funding decisions will be guided by how our reserves compare to our priorities.
Another emerging conclusion is our intent to rebalance away from levy and rely more on our investments compared to our previous strategy. We previously envisaged that, as we approached our funding horizon, we’d dial down our investment risk and continue to use a levy to help us manage our funding position.
Our thinking on this has evolved – we now envisage taking some limited investment risk for longer, and moving towards a lower levy sooner than we originally envisaged.
We will say more on our new objective, our funding priorities, and approaches to investment and levy when we publish the outcome of our funding review this autumn.
Towards a lower levy collection
Our expectation has long been that, as we grew in scale and became better able to absorb claims, the relative importance of our levy would be likely to decline over time. When we look at the amount we’ve received in levy income to date we can see it broadly covers the amount we’ve received in claims.
We’ve now received more, in aggregate, from our investments than we have in levy, and we expect this gap to further widen over time.
The total amount we’ve been looking to collect in levy has fallen notably in the last few years, driven chiefly by improvements in scheme funding. In the past two years, our target levy collection has come down from around £600m to under £400m.
Based on how our current reserves compare with our emerging funding priorities, we now expect the levy can be meaningfully reduced in the coming years without imperilling the security of members’ benefits.
Our target levy collection (or Levy ‘Estimate’) for next year will be announced in the autumn.
We’re looking to evolve the way we charge the levy
As we expect to reduce our levy collection in the coming years, this presents a unique opportunity to re-think and evolve how we calculate the levy.
There are two key objectives our future levy system must meet:
- It must be flexible – we expect the levy will be meaningfully lower than now, but we’ll need to retain the capability to raise it in the unlikely event that should be required in the future.
- It should be simpler – our levy methodology has developed over time as we sought to appropriately reflect the many different circumstances of individual schemes and employers. As the overall amount of levy comes down, this level of sophistication can be reduced with benefits for schemes and us.
We also want to ensure the levy is more stable for levy payers and is transparent and predictable – all elements our stakeholders tell us are critical.
Developing our proposals on the long-term design of the levy will take time and might need legislative change. However, we plan to start taking steps towards a simpler, more flexible, future levy system in next year’s levy.
We plan to consult on our proposed levy rules for 2023-24 this autumn. We look forward to working with stakeholders and hearing your views.
Kate Jones, Chair & Oliver Morley, CEO