Whether the endgame is buyout, run-on or just keeping all the options open, a capital-backed solution can help DB pension schemes make the journey with confidence.
Read this article to understand:
- How capital-backed solutions can bring greater certainty to DB pensions schemes
- How they are suitable for both buyout and run-on endgames
- The key benefits compared to traditional strategies
The landscape for UK defined benefit pension schemes has changed dramatically over the last few years. More than four in five schemes are now in surplus on a low-dependency basis, with an aggregate surplus of £160 billion.1 In addition, new surplus extraction rules are due to be introduced in 2027 setting out safeguards to protect funding levels.
With these changes, addressing the objectives and concerns of trustees, members, sponsors and regulators will require new solutions. This is where capital-backed solutions (“CBS”) come in.
A flexible approach
CBS are investment strategies that combine pension assets with external capital for a fixed period of time. The aim is to offer downside protection for the scheme while providing a greater probability of delivering their targeted returns. The solution is designed in partnership with trustees, with their investment objectives central to the design. A CBS can be calibrated to their risk and return tolerances, and tailored to dovetail into future endgame decisions, such as buyout or run-on strategies.
CBS use fixed income strategies that are familiar to DB schemes, focusing on the generation of contractual income to meet the liability benefits as they fall due. The inclusion of capital in the solution enables a greater allocation towards higher-rewarding asset classes, generating additional return from credit spread risk. At the same time, CBS allow schemes to maintain a full hedge of their liability benchmark and to continue paying member benefits throughout.
They can also generate attractive levels of spread returns, potentially giving schemes a targeted return above their liabilities (see Figure 1).
Figure 1: An overview of capital-backed solutions
Source: Aviva Investors, 26 August 2026.
How CBS work
Capital-backed solutions are implemented through a dedicated legal structure (Special Purpose Vehicle, or SPV) that contractually defines the rights and obligations of all parties, including the scheme, capital provider and asset manager. The structure is designed so that the external capital sits in a subordinated position to the scheme, providing a layer of protection against potential losses from credit defaults. The size of the external capital buffer and the return target are tailored to the scheme’s objectives, funding position and risk appetite. Those seeking a higher level of certainty may require a larger capital buffer or a lower targeted return. Schemes willing to accept a broader range of outcomes may target higher returns with less protection.
The external capital provider receives a contractual return in exchange for committing capital and absorbing any potential losses from credit defaults before the scheme is impacted. This creates an alignment of interests, as both the scheme and the capital provider benefit from achieving the targeted investment outcome and preserving value within the underlying assets. While the external capital provides meaningful protection against adverse investment outcomes, it does not eliminate all risks. The scheme remains exposed to losses that exceed the available capital buffer, as well as other risks associated with running the scheme, including operational, regulatory and longevity risks. As a result, a CBS should be viewed as a mechanism for improving the likelihood of achieving a given expected return.
The key benefits of capital-backed solutions
We see three key benefits of CBS compared to alternative endgame strategies (see Figure 2).
Figure 2: Key benefits of CBS
Source: Aviva Investors, 26 August 2026.
A flexible endgame solution – CBS have a typical term of five to seven years. The capital provider is paid at maturity, but after the scheme has been paid their targeted return. Importantly, the trustees retain the long-term flexibility on what to do next. This could be a buyout, an independent run-on, or another CBS with new terms. The design of CBS also affords greater future flexibility for the trustees, given that the asset mix upon cessation is expected to solely comprise cash and government bonds.
Enhanced downside protection – The introduction of external capital acts as a credit enhancement to the scheme. The investment approach is entirely composed of fixed income assets with contractual income providing an improved certainty of outcome. A more traditional investment approach relies on asset class returns and uses asset allocation as a de-risking mechanism. Under that model, returns can prove higher or lower than the central expectation and, if performance deteriorates, schemes might expect the sponsor to provide some deficit contributions. With a CBS, the central pathway can be calibrated to meet the desired outcome, but the variability of potential future outcomes is significantly reduced – substantially lowering reliance on the sponsor’s covenant.
Trustees retain control – Unlike with a buyout, a sponsor swap or a superfund, with a CBS, the existing sponsor remains attached to the scheme. All terms, including the investment mandate, are agreed with the trustees at the outset and are maintained throughout the CBS’s term. Any variation requires mutual consent from the trustees, the capital provider, and the asset manager. In addition, quarterly bespoke reporting throughout the fixed term includes key metrics to demonstrate compliance with the mandate.
Using CBS to your endgame objective
Capital-backed solutions are well suited to a variety of schemes at different funding positions and can be designed to meet each scheme’s unique objective. But we broadly see CBS used in two key areas:
Bridge to buyout – For underfunded schemes looking to buy out in the next few years, a CBS can increase the likelihood of achieving the funding objective in a defined timeline. The external capital enhances the security of member benefits by reducing reliance on the sponsor’s covenant and guarding against adverse credit events. A CBS also defines a path to close the scheme’s funding gap and reduces funding position volatility through the journey. In addition, the asset manager can supply schemes with regular indicative bulk purchase annuity pricing towards the end of the CBS term. This allows trustees to review their long-term endgame options.
Protected run-on – For schemes looking to run on and/or extract surplus, CBS give trustees greater predictability of surplus extraction at defined funding thresholds. The calibrated certainty of outcome over the fixed period changes the dynamics of surplus extraction and may allow sponsors and trustees to take a significant portion of any existing surplus upfront. The expected return also generates a future surplus that will be available at the end of the CBS. Again, trustees retain long-term flexibility on their endgame options, including entering another CBS.2
Protected run-on: How a CBS works in practice
Let’s consider a £500 million scheme that is 105 per cent funded on a gilts-flat basis and is looking to run on to extract a surplus. Before the scheme enters a capital-backed solution, the sponsor can extract £20 million of surplus. The proceeds are distributed as agreed with the trustees, reducing the funding level to 101 per cent. The scheme’s remaining assets, alongside £20 million of external capital, are committed to the CBS, where the investment strategy is calibrated so that the scheme receives gilts plus one per cent (annualised) over a five-year term with with c.99 per cent certainty (based on 10,000 simulations).3
The combined fixed income asset base maintains an effective hedging with a well-collateralised Liability Driven Investment (LDI) portfolio. Compared with traditional strategies with the same return target, a higher allocation is devoted to spread-generative assets (a highly diversified private debt portfolio). The scheme’s liabilities are cashflow-matched with investment-grade credit, with a prudent allowance for expected losses embedded from the outset to ensure sufficient liquidity throughout the five-year period. The high-quality, diversified private debt is designed to have a weighted average life that is no longer than the maturity of the CBS, with a keen focus on natural liquidity via maturity proceeds (see Figure 3).
Figure 3: Example of a five-year CBS portfolio
For illustrative purposes only and not intended as an investment recommendation.
Source: Aviva Investors, August 2026.
At the end of the five-year period, the CBS is unwound and the scheme receives its expected return via a liquid asset mix, achieving a funding level of 106 per cent. Capital is returned to the capital provider with the gains net of any realised losses that the buffer protected the scheme against.
By contrast, employing a traditional investment strategy targeting the same return would expose the trustees to a much wider distribution of outcomes (see Figure 4). We believe the challenges of potential negative outcomes far outweigh the possibility that performance could surprise to the upside, because of investors’ loss aversion, which can be amplified around the 100 per cent full-funding cliff-edge.
Figure 4: Asset allocation outcome in traditional investment strategies compared to a CBS
For illustrative purposes only and not intended as an investment recommendation.
See appendix 1 for methodology.
Source: Aviva Investors, August 2026.
The draft Occupational Pension Schemes (Payments to Employer) Regulations 2027 propose that schemes should expect to remain above a low-dependency funding threshold for at least three years after releasing any surplus.4 Capital-backed solutions go beyond this, with an increased concentration of outcomes over five to seven years. Therefore, CBS makes for an attractive investment solution for those schemes looking to trade unpredictability for greater certainty in achieving their endgame objective.
The case for CBS
DB schemes can use capital-backed solutions to more reliably achieve their endgame objective over a defined period. Most schemes already deploy fixed-income-heavy investment strategies. CBS add a layer of downside protection while providing greater certainty of outcome and can be designed to fit any scheme’s objectives while retaining long-term flexibility for both trustees and sponsors.
Appendix 1
The model in Figure 3 uses a Monte-Carlo simulation of a portfolio through the term of the CBS. The likelihood of outcome is based on 10,000 scenarios. The model allows for credit migration and expected losses via a one-factor Gaussian copula model. Any excess capital generated above the scheme’s liabilities in each period are reinvested in cash. Figure 5 shows further details on the assumptions made in the modelling.
Figure 5: Modelling assumptions for Figure 3
|
| Value | Description |
|---|---|---|
| Date | 29 May 2026 |
|
| Discount curve | GBP Nominal Govt curve |
|
| Discount spread basis | 0 | Spread above the discount curve used to value the liabilities |
| Inflation curve | UK RPI |
|
| Hedging level | 100% | The rates and inflation exposure the LDI sub-portfolio hedges |
| Surplus release | £20m | Release capital to 101% funding level on a low dependency basis |
| CBS term | 5 years |
|
| External capital | £20m |
|
| Rates path | Deterministic |
|
| Default assumptions | Yes | 1 year expected default rate applied in each period |
| Credit rating migration | Yes | One-factor Gaussian copula model applied in each period |
| Probability of receiving Gilts+1% | c.99% |
|
| Median end funding level | 106.2% |
|
Source: Aviva Investors, 25 August 2026.
References
- “Annual Funding Statement analysis 2026”, The Pensions Regulator, 6 May 2026.
- “Aviva launches flexible solution for DB surplus transfers to DC schemes”, Aviva, 15 December 2025.
- See Appendix 1.
- Department for Work and Pensions, “Open consultation - Surplus flexibilities for defined benefit pension schemes: Unlocking value for employers and scheme members”, GOV.UK, 10 June 2026.
