Jeremy Lee talks to RiskFirst managing director, Matthew Seymour, about the differences in approach to pension risk management in the UK and US, and the role of pension risk analytics
Matthew, what do you see as the key differences between pension risk management in the UK and the US?
Working alongside plan sponsors, actuaries and investment consultancies on both sides of the pond, particularly through our alliance with Winklevoss Technologies, we have noticed a number of key differences. The UK has been one of the leaders in pensions risk management, driven by changes made by the UK regulator. However, the US is following hot on the UK's heels and is taking action quickly.
In the US, not having the same organisational structure - no separate trustees - appears to make a noticeable difference when it comes to how actively sponsors can push their advisors, and how more decisively they can act in relation to risk management.
There is also a lot more fragmentation and specialisation in the US intermediary market, which means more often than not, you have multiple advisors working with a single plan. Each advisor will have their own slightly different slant on risk management and will be pushing to provide advice in the 'middle ground'. So you see different types of intermediaries playing the lead role in providing risk management advice.
What are the big trends in pension risk management in the US?
Liability-driven investment (or LDI) has become very popular, and we are seeing a lot of asset managers building up LDI solution teams. Also, more and more plans are implementing long-term investment strategies to manage the risk - such as using glide paths.
In terms of risk elimination, bulk lump sum cash-out windows have become common practice in the US - allowing corporates to reduce both the size of the pension plan in dollar terms, and also reduce the administrative cost of running the plan. Elsewhere, the annuity buyout market is warming up, with high-profile cases such as GM, Verizon and Motorola paving the way for more activity in this area.
An interesting development is the release of new US mortality tables, which have already started to be reflected in accounting valuations - and will imminently be used in funding valuations. From what we have witnessed so far, the change will increase the accounting liability for plan sponsors by between 5 to 10%.
This is likely to have a dual impact. First, plan sponsors may want to beat the changes and pay out as much as the liability through lump sums as possible before the impact on funding valuations is felt. Second, it is making buyouts appear more attractive: annuity providers already use equivalent levels of mortality when valuing liabilities, so the relative cost of a buyout valuation in comparison to the accounting valuation is lower than before.
Whether in relation to risk management or risk elimination, there is a major trend of intermediaries looking for ways to differentiate themselves and demonstrate the credibility of their teams and their solutions. A number of firms have embraced the use of risk management platforms and more of their clients are implementing de-risking flight plans that use these analytics to better monitor their evolving position and decide when to execute changes in strategy.
Why has the US tended to follow in the footsteps of trends in the UK?
Good question. In general, US plans provide less valuable benefits than UK schemes and so the cost of running these plans has taken longer to come to the fore. Also, government regulation on inflation-linked pensions in the UK means that companies there have less scope to design schemes that can lower cost. So the incentive to implement de-risking solutions has been greater in the UK.
The US is now benefiting from replicating many successful UK practices - although only to the extent that they are applicable to the US market. For example, there is no big inflation swap or longevity swap market developing in the US due to differences in pension benefit plan design between the two countries.
Also, US accounting standards - where equity returns play a large role in determining the benefit cost - have also for a long time discouraged US plans from increasing their fixed income allocations with lower expected returns, or seeking to implement LDI or other de-risking measures.
Do you see a difference in focus between US advisors and their UK counterparts?
In the UK, because the advisory market is more consolidated, I think there has long been a focus on providing a broad range of advice. Most UK consultancies have a full-service offering encompassing actuarial advice, investment and risk consultancy.
I think we are witnessing somewhat of a replication of this model in the US - with many consultancies seeking to broaden their range of services, either to offer more to current clients, or to win new clients by displaying a broader understanding of the risks and issues they face.
Certainly, when seeking new clients and mandates, many advisors are very keen to provide a much fuller suite of analytics and to demonstrate their own understanding of a holistic, cross-balance-sheet view. This allows them to interact not only with the plans in a more credible way, but also with the other advisors the plan may be involved with. Ultimately, sponsors are becoming much more focused on the risks in their pension plans, and increasingly looking at these risks holistically.
Is this driving a changing skill set necessary to be an actuary in the US?
The role of a traditional pension actuary in the US is still very much driven by satisfying regulatory requirements such as annual valuations, determination of annual contributions, and completion of annual financial disclosures. Pension risk management activities are generally under the remit of the plan's investment consultant.
However, many investment consultants typically have experienced pension actuaries on their staff and as pension risk management in the US grows, it would seem likely that more opportunities will arise for pension actuaries in these roles. This will require actuaries to have a deeper understanding of both sides of the balance sheet.
Do different types of advisors tend to consume risk analytics in different ways?
I think the way advisors and consultants use technology - and the data and analytics it drives - depends heavily on what they are trying to accomplish. For instance, the actuarial consultancies are naturally much more focused on the funded status, so use technology principally to better value assets and liabilities, and to produce a 'big picture' view.
The investment consultants and the asset managers, on the other hand, are much more focused on risk or asset liability management (ALM). Obviously, the asset managers are trying to showcase their own products and want to do that inside a risk framework that includes the liabilities.
The investment consultants are trying to put together a long-term plan for a plan sponsor and therefore they often need systems with detailed ALM functionality. Yet, they are all increasingly trying to stretch beyond these boundaries.
What are the barriers to plans and consultants implementing external technology?
Barriers come from a number of different areas. A big one historically was the fact that many consultancies and intermediaries already had existing in-house analytics. The key question is whether it makes sense for them to continue to maintain those systems, and develop them to keep pace with the industry and technological change. Today we see intermediaries scaling their businesses in different ways, focusing on the elements of their work that are most valuable to clients - providing advice and solutions - rather than number crunching. They are also far more willing to outsource the development of technology to experts in the field.
What other markets have a growing demand for pension analytics tools?
We are seeing interest in Canada and also in the Eurozone. Demand is increasing for a global risk view and consistent analytics - across clients' numerous pension plans globally. We are developing our platform to meet this.