Last month I had the pleasure of attending a session with Charles Stanley Pan Asset, for a seminar entitled “Can pension schemes cut risk and cost without sacrificing investment performance”. The slots were covered by two speakers, John Redwood of Charles Stanley Pan Asset and our very own Alan Collins, Director & Head of Trustee Advisory Services.
What struck me at the sessions was the challenges ahead for Trustees of Defined Benefit (DB) Schemes in relation to funding, investment risk and cost. However, thankfully, I did see a potential light at the end of the tunnel.
What we’re dealing with now
Interest rates have fallen significantly over the past year. For schemes with un-hedged investments, funding levels will have plummeted. Similarly, inflation is low and schemes with fixed increases and un-hedged investments will be hit hardest.
The number of DB schemes in deficit on a S179 basis averaged 1,500 in January 2007 rising to over 4,000 at the peak of the credit crunch in 2009. The current estimate for 2015 is well over 5,000! Surely this trend can’t continue…..can we let it?
Looking at both bides of the coin
In short; No. It is no longer viable to manage investments and funding independently. Liabilities should not be considered in a silo – the best measure of success is funding level. Trustees and sponsors should define their objectives for the scheme (i.e. buyout, self-sufficiency) and develop an investment strategy that supports these objectives.
Understanding the ultimate objective for the scheme is key. Sponsors can then define an acceptable level of risk (in a holistic manner) in relation to achieving this objective and set the investment strategy accordingly.
The Pensions Regulator’s updated Funding Code of Practice for DB Schemes promotes an integrated approach to risk management. Risk should be assessed across three main strands:
The Regulator suggests that both qualitative and quantitive methods of analysis should be undertaken to understand the risks of achieving set objectives, and more importantly – the probability of success.
Where to begin…
The technology is there and readily available to provide sponsors and trustees with real-time asset and liability information for them to take control of scheme funding. Having everything feeding into one key place is vital to making better funding decisions.
Think of managing a DB scheme as a funnel with all information in one key place from actuarial modelling, payroll, accounts, administration and not forgetting investment management. Access to this kind of reporting gives Trustees true scheme visibility allowing them to act quickly when it counts. Putting trustees back in the driver’s seat.
However there is a caveat to this… Any valuation system will only be as good as the data that goes into it, and it will only value the benefits you tell it to – it is important that trustees ensure accurate scheme data is valued, and the correct benefit structure is in place to ensure objectives remain on track and there are no surprises along the way.
Setting the strategy
Trustees need a clear funding plan, and an agreed investment strategy that supports this to ensure you’re on track to meet your objectives.
Once a strategy is set, trustees have a choice on the best way to implement it:
- Active/passive management?
- Fiduciary management?
Working closely with investment advisors with structured monitoring processes in place is key to achieving your goals:
- Monitoring investment costs
- Monitoring manager performance
- Monitoring overall strategy
Find comfort in-doors while the storm is raging outside
Will Pension Freedoms lead to a flood of DB to DC transfers? Will the end of contracting-out see the acceleration of scheme closures? It’s been a busy year for pensions and these are but a few questions we need answers to… unfortunately only time will tell.
Trustees need to be prepared for whatever changes lie ahead, and an integrated approach is integral to managing these. Trustees can no longer afford to let opportunities pass them by.