Time for sponsors to fIRM up their thinking

Broadly speaking, sponsors, and their embattled finance directors and treasurers, struggle to balance competing demands on cash.

Trustees have been through several defined benefit triennial pension valuations and, with the help of expert advice, have secured robust recovery plans, security, information protocols, etc to address sponsor covenant risk.

Corporates have often become too distant from their legacy pension schemes and should integrate the subject in their strategic planning more clearly

Trustees started to examine the strength of corporate covenant more than a decade ago and doing so is now widely seen as good practice.

With the help of regulatory guidance and greater availability of professional advice, trustees have successfully tooled-up and secured additional covenant protections and funding.

They are also progressively taking risk out of their schemes through liability management and liability-driven investment strategies.

Sponsors, however, have been left somewhat behind. Focused on driving the strategic and financial objectives of their operating business, buffeted by trading volatility, a credit crunch and the odd recession, they can be forgiven for leaving pension risk management to the trustees.

Working together

What is very clear – and the Pensions Regulator confirms this in its guidance – is that the sponsor and trustees must work together to understand the needs of the business and those of the pension scheme in order to produce an integrated approach to managing risk.

A few years ago the term ‘financial management plan’ began to be used and, more recently, in December 2015, the regulator released its new guidance document on integrated risk management.

Conducting a thorough IRM exercise highlights the interconnections between the three corners of the regulator’s risk triangle, ie covenant, funding and investment.

IRM helps trustees identify and manage the factors that affect the prospects of meeting the scheme objective, especially those that affect risks in more than one area.

The overall strategy to achieve this objective will be dependent on the scheme’s and employer’s circumstances from time to time.

In addition, it is paramount to exercise informed judgment about how to balance the interests of all stakeholders. 

Key questions that can be considered as part of IRM are:

• • What is the ability of the sponsor to underwrite investment and funding risk?

  • What is the cash flow profile of the scheme and when do payments to members peak?

  • What are the current contribution expectations of the scheme trustees?

  • What is the agreed funding objective set, and is there a reasonable plan in place to deliver it?

  • How well do the trustees and the corporate sponsor understand each other’s objectives and challenges, and what further information sharing is needed?

  • Can a collaborative approach be established so there is recognition of the sensitivities and the strategic thinking of the parties?

Understanding risks

IRM in 2016 is comparable with covenant advice in 2006. It is a new and unfamiliar concept that could be easily misunderstood for being simply another costly regulatory burden, rather than a collective opportunity to drive better joined-up thinking between the sponsor and their scheme.

Despite this, as with any good idea, we expect IRM will become mainstream over the next decade, with early adopters gaining the most.

Corporates have often become too distant from their legacy pension schemes and should integrate the subject in their strategic planning more clearly, while trustees have raised their game and are well placed to review their objectives.

IRM is a new, well developed methodology set out by the Pensions Regulator. Sponsors and trustees should use it as a reassessment tool for their respective strategic plans to ensure they understand and can tolerate the risks they are exposed to.

Darren Redmayne is head of covenant adviser Lincoln Pensions