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The Actuary The magazine of the Institute & Faculty of Actuaries

Move to de-risk pension schemes could backfire

Instead, the firm's latest Strategy Group paper suggests that pension plans should look to ‘right-risk' rather than de-risk. This can combine appropriate interest rate hedging on the fixed income part of a plan with smart diversification in the return-producing assets, thus ‘right-risking' a portfolio.

"Companies and pension plans have differing views as to how to de-risk," comments Paul Sweeting, European head of strategy (pictured). "Some look to purely [de-risk] their pension plans, while others seek to benefit from tax arbitrage opportunities, simultaneously reducing risk in their pension plans and increasing corporate levels of leverage.

"However, the combination of low risk-free rates and high credit spreads means that the opportunities for tax savings are limited. What's more, such exposure can raise risks for shareholders by increasing exposure to the company's profitability while losing the benefit of diversified returns in the pension plan."

Mr Sweeting cited other reasons given for de-risking, including attempting to make member's benefits more secure, even though reducing the expected rate of return in a plan may reduce security for some members, while others working for stronger companies would take the risk of deficit if there was the prospect of increased pensions at some point in the future.

The J.P. Morgan paper highlights that there are always some unhedgeable risks that exist in pension plans that means there will always be some residual risk - and that these risks should be diversified with market risk.

Mr Sweeting said, "It is understandable that pension plans and firms feel that de-risking is a necessity at present. But we want to challenge that belief as some risk, if taken rationally, can have benefits."