As integrated risk management has become the way of approaching defined benefit, Lincoln Pensions' Richard Farr asks if the industry needs to change to be able to deliver it.
Given the monumental headwinds facing defined benefit schemes, it is common sense and should be at the top of trustees’ minds. Why then has it taken so long for it to become a topic for a dinner party conversation?
The industry has a shortage of cross-disciplinary experts. Have you heard the joke about an actuary who wanted to become an accountant? There isn’t one
Risk management is especially important when considering factors that bear risks in more than one area. This encompasses risk capacity, risk appetite and contingency planning, as well as the assumptions to be used for calculating the scheme’s technical provisions and any recovery plan.
IRM should bring together the identified risks faced by the scheme and the employer with a view to analysing the potential relationships between them.
Silo approach misses interaction of risks
The three underlying risks of any DB scheme relate to:
the ability of the employer to underwrite the employees’ pension (the covenant);
what the employer, and often the employees, have paid into the scheme to help fund those pensions (the investments);
the actual value of the past, present and future pension promises made to the workforce in today’s money terms (the funding).
Each area has its own unique characteristics: credit market, return on assets, interest rates, inflation and longevity, all of which are historically advised upon by specific groups of experts – accountants usually advise on covenant, investment consultants on investments, and actuaries on funding levels.
The problem with this silo approach is that the interaction between the various risks is missed out.
Overlay the commercial and political agendas of the employer and trustee boards, add a dollop of economic uncertainty, and you can see how this can end in undercooked, tasteless or wrongly ordered cuisine.
Shortage of lateral thinkers
What is the answer? The trustee must do away with the silos and consider their content holistically while making sure data is fresh and up to date. It is a skilled and time-consuming job, so in the event that they cannot do it themselves they should ask someone to do it for them.
However, the industry has a shortage of such cross-disciplinary experts. Have you heard the joke about an actuary who wanted to become an accountant? There isn’t one. Or the investment manager who wanted to be a credit specialist in non-listed companies? Try again.
The 20th century professional skillsets in pensions were not tailored for the 21st century challenges of IRM, so what should the market do about it? Asking the many experienced insolvency practitioners in the 'big four' accountancy firms – Deloitte, PwC, EY and KPMG – who have made their careers in covenant assessment to return to the classroom to understand actuarial risk stretches the imagination.
Requesting our leading actuaries and investment specialists in the 'big three' pension consultancies – Willis Towers Watson, Mercer and Aon Hewitt – to venture into the realm of business economics may be a step too far.
However, the answer is clear. There is a pressing need for cross-training, and perhaps the best place for this to happen is at the younger level.
Look behind the credentials
While the new generation of IRM experts are being trained, trustees should be scrupulous about who they choose to advise them. It has never been more important to look behind the credentials and the CVs to see if the advisers are truly trained in IRM.
Time for sponsors to fIRM up their thinking
For corporates, pension funding is an issue that just will not go away, so perhaps it is time for some fresh thinking before embarking on any more rounds of discussions with their trustees.
We have had this uncertainty once before, when the concept of the employer covenant was first introduced in the Pensions Act 2004 Guidelines. What happened was a new breed of advisers materialised, straight out of the distressed banking market.
While there was a short-term inefficiency in the pricing model to the benefit of these new advisers, the trustee market soon adapted to the concept of competitive pitches and fixed fees, although some may say it has gone too far.
As the pension advisory market retools itself, trustees need to recognise that there is a premium for this new skillset, and be prepared to look for it, and pay for it. What trustees should be seeking is a Michelin-starred IRM. Now that’s a dainty dish in anyone’s language.
Richard Farr is managing director at covenant adviser Lincoln Pensions
