Is the wave of risk-modelling software worth the price tag?

These online tools bring a range of functionality, allowing trustees and sponsors to assess the impact of different assumptions on pension scheme deficits and recovery plans, model value-at-risk measures from different investment strategies and measure the probability of meeting a scheme’s objectives over the long term.

These models are unlikely to change the fundamental processes of running a pension scheme, but access to real-time data means they can provide flexibility in how information is communicated, particularly for reporting. However, the greatest benefit is undeniably the gain in time efficiency.

Near instant access to this data can help the company budgeting process

It is useful to draw a parallel between these and the first generation of online modelling tools, which enable individuals to make projections in relation to their defined contribution pension plan.

Second-generation tools

Those first models have a simple set of inputs: return assumptions, contribution rates, salary and expected retirement dates are most typical. Whether the actual outcome is close to the forecast depends on a number of highly fluctuating factors: annuity rates and investment returns being key offenders. 

Ready access to such models allows individuals to check whether they are on course to meet their targets and how to set their contributions and investments. 

There is a risk, however, that if appropriate advice has not been taken or there is a misunderstanding of the drivers of the change in projection, an unintended decision could be taken. 

In the same way, the new generation of online modelling tools are helpful in providing trustees and companies with the impact of changing assumptions, strategies and market movements.

A company knows that increasing contributions will reduce either the time or the required return to meet its funding objectives, but understanding the magnitude of that change can support the decision-making process further.

Historically, this data would be regularly supplied by professional advisers during and between their meetings with companies and trustees. With online modelling, trustees and the company representatives can review a range of scenarios in advance, thus focusing the time with their advisers on evaluating scenarios and options.

Faster comms

Online tools can also help trustees and company representatives to revisit discussions and consolidate their understanding, as well as communicating the pension strategy to other key stakeholders, such as the management board, in a timelier manner. 

For example, many finance directors often wait with trepidation to see whether the deficit has increased or decreased. Near-instant access to this data can help the company budgeting process.

While the gain in time efficiency is obvious, we need to be conscious of what the software does not offer. Online functionality and the results of the modelling are only the preparation step, after which decisions need to be made – and human advice at this stage cannot be substituted by a system. It is also important that the assumptions used are understood and that risk numbers are translated into real-life outcomes.

The appearance of such software can also raise the question of whether it could shift the focus on making short-term decisions based on market movements instead of the traditional long-term funding objective. However, it is improbable that trustees would abandon such a fundamental principle.

Overall, there are clear benefits to using online modelling tools, although trustees need to be aware of the pitfalls of relying on the inputs. The question is whether users really feel those benefits outweigh the costs.

Jignesh Sheth is a director at JLT Employee Benefits