Trustees and companies have a real task on their hands. Pension scheme deficits, costs and the seemingly endless scope for surprises are continuing to test their ability to effectively and efficiently deal with their pension schemes risks.
This video sets out five material steps that trustees and companies should consider. None of them are “new”, or bound to give magical results, but when combined into a joined-up one-, three- and five-year plan — along with appropriate monitoring — significant strides can be made in reaching a position where pension fund risk and cost are non-issues.
Number one is member options (that is pension increase exchange, retirement flexibility, etc.).
Over the last few years, member options have become a common way for pension schemes to help mitigate risks, whilst giving members additional choice over the form of their pension benefits.
Number two is alternative security.
There is tremendous uncertainty in the development of a pension scheme’s future financial position, and therefore on costs and member security. The traditional tools used to manage this uncertainty are investment strategies and additional company contributions. In supporting any disconnect, sponsor covenant is a factor, but may not provide the longer-term security required.
In some cases, rather than focus on additional contributions per se, alternative security (whether it be SPVs or simple escgrid-x arrangements) can help square the circle between trustees’ need for security and sponsors’ worries about trapped surplus or the impact of cash demands on other company investments.
Number three is longevity hedging.
Considerable strides have been made in managing equity, interest rate and inflation risk in recent years. Only a few pension schemes have, however, done anything about managing their other big risk: longevity. This is surprising, given the very unpredictable nature of this risk, and because longevity hedging is now feasible for small to medium-sized schemes as well.
A key additional attraction to longevity hedging at the moment is that other sources of de-risking may be less appealing. That is, with an overall desire to contain risk, doing yet more interest rate hedging, say, may not arguably be attractive (given that yields have fallen even further over the past 12 months). The question to ask is frequently not if longevity should be hedged, but when.
Number four is, of course, buy-in/out.
For some schemes, buy-in or buyout may at first appear to be a medium-term or long-term aspiration. However, with robust management information linked to a view of actual insurer pricing plus a realistic and well-thought-out strategy, a buy-in or buyout may be much closer than many trustees and sponsors thought feasible.
In addition, it is feasible — and increasingly common — for pension scheme trustees and sponsors to proceed with a buy-in or buyout in parallel with, or shortly after, a programme of member option exercises. An integrated programme, coupled with ongoing monitoring of insurer pricing, can highlight genuine opportunities.
Finally, number 5 is cashflow-driven financing.
A cashflow-driven approach can enable schemes to transition to a stable long-term strategy without the typical increased contributions and material risk associated with overly conservative targets. It involves investing in assets that generate cash flows that seek to match a large proportion of the projected benefit payments while hedging the residual interest rate, inflation and longevity risks as appropriate. It is sometimes called “investing like an insurer” and can be a viable alternative to buyout.
Having a robust governance and execution structure, with quick responses to opportunities and threats, is a fundamental step towards improving risk and cost management as part of an overall plan.
Previous white papers:
2017: 5 Big Opportunities to Manage Risk