An integrated approach to managing pension risk is vital, says Stephen Soper
While I hope the publication of the Pensions Regulator's new defined benefit (DB) code this summer was on your radar, you may have filed it in a part of your brain labelled 'to think about when I do the next triennial valuation'. Here's why you need to keep it in mind whenever you speak with scheme trustees.
We know DB schemes have had a hard time in recent years. The decline in equity returns, low interest rates, volatile markets and a recession have challenged the funding position of schemes and put pressure on sponsoring employers, an already difficult situation compounded by increasing member longevity and scheme maturity.
In the nine years we have been regulating, we have learned that having a good handle on the risks a scheme is facing is vital for trustees. Many schemes are already on top of this, but we also know from our regulatory activities that others aren't. This is why one of the most important features of the code is about managing risk in an integrated way.
Risk has always been part and parcel of the funding regime, so what makes the 'integrated' aspect different? It should not be approached as a radical departure from what you currently do, more a joining up of the dots, which requires consideration of how trustees' decisions about covenant, investment and funding interact.
The central concept here is the balance between new money from the sponsor, the expected investment returns from the scheme assets and the relevant timeframe.
Any material change to one area will have an impact on the others, which is why we want trustees and scheme sponsors to have a closer working relationship so that the needs of both parties can be better understood and factored in the decision.
A common misperception is that the regulator wants all risk to be eliminated. Risk isn't necessarily a bad thing for a pension scheme, if it is appropriate, understood and managed well in the context of the employer covenant. While the triennial valuation provides an opportunity to test and develop the overall framework, important events will occur between valuations and trustees need to stay on top of these, rather than pick up the pieces later.
Although this may be challenging for some trustees, we want them to take a proportionate approach, so small schemes can manage their risks effectively without breaking the bank.
We are not necessarily looking for an all-singing, all-dancing integrated risk management plan - trustees can use minutes of trustee board meetings or other scheme documents to record their thinking. And the sophisticated, expensive analyses appropriate for large schemes will not necessarily be suitable for small schemes.
What does this mean for actuaries? Are we expecting them to be covenant advisers as well, or take on the role of trustees?
Of course not - it is the trustees' responsibility to manage scheme risks and take funding decisions, with appropriate advice.
But as actuaries play a key role in the valuation process, looking at assumptions, funding targets and recovery plans, we think there is an opportunity to enhance this role by ensuring that it integrates well with the rest of the process.
Actuaries should be mindful that trustees will need to join up all the information they receive across covenant, investment and funding. So the advice given on, say, technical provisions and the recovery plan will need to be aligned to that of other advisers and framed in the context of the covenant assessment and investment strategy.
It is also crucial that you communicate with member-nominated trustees in plain English. As an industry, we need to make a greater effort to communicate with lay trustees in language they can genuinely understand.
We have developed an 'Essential Guide' for those who aren't steeped in pensions terminology, and would encourage you to signpost it to those who may need a more basic grounding in the principles of the DB code.
We are very keen to learn more about how trustees, employers and their advisers are applying the code, so we will soon be embarking on a series of roadshows around the country, where we hope to discover what works, and whether there is a need to develop more specific guidance in certain areas.
Stephen Soper is interim chief executive at The Pensions Regulator