When is the right time for schemes to derisk?

Marian Elliott: It is really important that schemes consider their particular objectives and the circumstances of the sponsor to ensure any derisking plans and automatic triggers they put in place remain appropriate.

In terms of opportunities for derisking, mortality risk at the moment is one that is relatively inexpensive to insure. Insurers – life insurers in particular – get a diversification benefit from Solvency II regulations if they are writing mortality business, so they are relatively keen to do so.

What I would say to all of my clients is that at each stage along your derisking plan, check where it is appropriate to do certain things, where there is value. Also, make sure you have got everything in place so that you are able to act when you see an opportunity. 

Julie Stothard: We run a daily monitor for some of our clients and we have seen a lot of triggers going off recently.We do not do the switches automatically, because we believe it is right the trustees should have the chance to double-check they still want to go ahead.

The scheme actuary will do a quick check as well to make sure the schedule of contributions is unaffected by the switch – that is, additional contributions would not be required.

In terms of longevity hedging I agree there is appetite out there. The problem at the moment is the size of the deals – the smallest to date being £400m. This is in part because the legal work required... is extremely complex and extensive. 

Ian Smith: What kinds of actions are being triggered?

Stothard: Moves from equities into bonds.

Smith: So it is still just that first step?

Stothard: Yes, very much so. In terms of moving into buyout-type policies, gilt yields have risen quite significantly, but the gap between gilt yields and corporate bonds has narrowed quite a lot, so the pricing is not as attractive as it was a little while ago.

That might surprise some people, and it is those sorts of things trustees need to be looking at, it is not just [about] looking at the gilt yield. Buyout is where most schemes want to end up, so they need to be looking at that and – as Marian said – get the house in order. 

Myles Pink: There is a difference between perception and reality. Obviously when gilt yields are low everybody gets troubled by the actual size of the numbers we are talking about.

But if a pension scheme has its longevity assumptions appropriately struck and it is on a journey to derisking from equities into bonds, it should be a relatively smooth path to proceed on to a bulk annuity.

For a scheme that is invested in gilts, when purchasing a bulk annuity the real driver of pricing relative to those gilts is the cost of liquidity in the market – whether that cost is derived from a corporate bond spread or another investment strategy.

So without the derisking journey it would actually take quite a significant event to go from a relatively risky strategy into a fully derisked one. It’s all about the journey.

Robin Bell: This derisking strategy, from an Irish perspective, starts and ends with sponsor covenants and the concerns around them. But the comfort of herd-like behaviour, which means more and more defined benefit schemes are going down a derisking strategy, is ultimately going to make the schemes more and more expensive in the longer term for the sponsoring employers.

This is escalating the amount of schemes closing to future accrual, and I think we are almost planning for the endgame as opposed to any real moves to increase the prospects of DB schemes being a viable pensions alternative for the medium term.

Elliott: In 2007, conditions in the market were such that most schemes could have derisked at a really attractive rate into gilts and locked out most of the investment risk in their schemes. About 5 or 6 per cent of schemes in the UK did so and reduced their investment risk when it was affordable to do so.

Since then deficits have spiralled. Taking into account the cost to the employer of running those schemes since 2007, and the cost of deficit reduction contributions, I really question whether a sensible derisking strategy is necessarily costing employers more. 

Bell: It is far too early to say that. You have used a selective time from 2007 – and of course timing is everything in life. But if you take that back 15 years earlier – and obviously pensions is not a decades-long game, it is a multiple-decades projection we are looking at – schemes that derisked in 1995 would be a lot more expensive to sustain than schemes that had a good equity risk premium contained within the actuarial assumptions.

If they had derisked back then they would now be in a position where I believe they would have missed out on the market uplift that we are now seeing the correction of. 

Elliott: But you have got to look at your liabilities and assets together, rather than in isolation. We are not trying to benefit from every equity market uplift and leave ourselves exposed to every crash. What we are saying is, when you get to a funding level where it is not expensive to buy in to that lower deficit, then do so.

Kim Nash: Derisking means something very different depending on what schemes you are looking at. For those that are 50 per cent funded now, a broad move in the right direction may be sufficient – whereas if you are further down that road you need to be more specific as to what actions you actually wish to take. So it is key to link your covenant, your investment and your funding together.

I have seen a lot more employers driving the derisking strategy now because they have had enough of the volatility in the scheme and are asking what they can do to put themselves in a position where they can take advantage of market opportunities. They want to do what they can to take risk off the table while they can afford to.