The Pensions Regulator has endorsed an integrated approach to risk management in its first annual funding statement since the publication of the revised code of practice for defined benefit scheme funding.
Aimed at scheme trustees undertaking 2015 triennial valuations, the latest statement echoes the messages of the revised DB funding code, advocating an integrated approach to risk management on a scheme-specific basis.
It places upcoming valuations in the context of the current economic climate, in particular the detrimental impact that negative long-term real gilt yields and low interest rates will have on scheme deficits despite strong asset performance.
Trustees are encouraged to undertake contingency planning with employer sponsors to better facilitate “prompt action, where necessary to ensure risk levels remain appropriate”, the regulator stated.
Stephen Soper, executive director for DB at regulator, outlined a number of options trustees could pursue and combine to create a forward-looking funding strategy.
Risk management
Investment risk: schemes can increase their investment risk but must make sure the covenant is strong enough to sustain any downside resulting from increased risk tolerance.
Extension of recovery plan: schemes can extend the time horizon of recovery plans but need to relate that to the long-term strength of the employer.
Adjust contribution rate: trustees can renegotiate employer contributions but must consider the broad impacts on the sustainable growth and development of the employer sponsor.
“It’s a very difficult balancing act between them,” he said.
“There are a chunk of schemes that can manage well within the boundaries that they’re dealing with, but for a smaller number this is going to be quite a challenging period for them to work out where they want to position themselves."
Soper said the code was designed to open the eyes of trustees and employers to the risks present within their schemes, to enable best practice in risk management.
“We want people to be looking up and looking forward,” he said.
Asset performance
Sarah Brown, head of scheme funding research at consultancy Punter Southall, said many trustees may consider adjusting their discount rate to account for strong asset performance since the last valuation.
“Many trustees have seen really positive returns over the past three years but it’s more a question of have the returns been keeping up with their liabilities?,” she said.
Brown questioned how much the performance of certain asset classes would be reflected in the valuations.
“Just because gilt yields are lower, how much of that reaction in gilt yields will come though to their asset returns?” she said.
Lynda Whitney, actuary and partner at consultancy Aon Hewitt, said current market conditions had driven schemes to seek opportunities for diversification in return-seeking portfolios.
I find it concerning, indeed puzzling, that the economy is recovering, assets are performing quite well, deficits are increasing but generally speaking, contributions to those deficits are decreasing
Darren Redmayne, Lincoln Pensions
“There are no longer easy wins,” she said, adding: “In each of the asset classes it’s really important to look beneath the surface and seek out niche opportunities.”
Balancing the risks
According to research on FTSE 100 pension schemes published by consultancy JLT Employee Benefits in May, employer contributions in the latest accounting year amounted to £14.1bn, down from £16.3bn in the previous accounting year.
Darren Redmayne, head of covenant specialist Lincoln Pensions, said this downward trend in contributions was building risk in schemes.
“I find it concerning, indeed puzzling, that the economy is recovering, assets are performing quite well, deficits are increasing but generally speaking, contributions to those deficits are decreasing,” said Redmayne.
“That’s okay if the investments are improving the covenant but actually, as sometimes is the case, if they’re to increase dividend payments to shareholders and not invested in sustainable growth then maybe that’s not okay."
