There is something peculiarly appealing about things that come in threes; whether it is three musketeers, an Englishman, an Irishman and a Welshman walking into a bar or three strikes and you’re out. Orators and politicians have used the rule of three to great effect and it appears that the Pensions Regulator (“tPR”) is no exception, with the publication of its guidance on Integrated Risk Management (“IRM”) for trustees, employers and the advisers of trust-based Defined Benefit (“DB”) pension schemes. But, nearly 18 months after the formal introduction of IRM, have pension schemes truly adopted an integrated approach?
What is IRM?
IRM can be viewed as a tool to assist trustees in identifying and managing those factors that affect the prospects of meeting the scheme’s objective; with most schemes having the single overriding objective to pay pensioner benefits as and when they fall due. Whilst the IRM framework identifies employer covenant, investment and funding as the three primary risks facing DB pension schemes, it is the interaction of these three pillars that is of primary concern. IRM calls on trustees not only to consider those risks facing their pension scheme, but to formulate contingency plans if they come to fruition. It quickly becomes apparent that the framework calls for a greater understanding of risk and its potential consequences.
So, what’s the problem?
Sound easy? No, I didn’t think so either. In an ideal world, we would grade the strength of the sponsor covenant on a triennial basis, in line with the Actuarial Valuation process, identify the pertinent investment and funding risks and plan accordingly. However, we do not live in an ideal world and this approach misses a fundamental concept; risk (both rewarded and unrewarded) is not static. This point is well illustrated when we consider the recent decision by the UK public to exit the European Union (“EU”). Suddenly, UK companies face the very real possibility of losing EU trade deals, which will surely feed into the grading of the sponsor covenant and, therefore, the level of investment and funding risk that can be underwritten. It would appear that the days of isolated decision making have been thrown onto the ash heaps of history, paving the way for a more integrated and dynamic approach.
Sounds good, but how practical is it?
With the recognition that the risks facing pension schemes are ever changing, comes the realisation that a much greater level of involvement is required from trustees, sponsoring employers and advisers. However, with many trustees juggling a full-time job with their trustee role, a lack of company representation on trustee boards and the often lack of cohesion between investment advisers and scheme actuaries this can be a daunting thought.
It is these difficulties that often lead to the partial adoption of IRM. All too often, trustees, sponsoring employers and advisers identify the pertinent risks at the time of the scheme Actuarial Valuation and undertake a cursory review of said risks on an ad hoc basis. Whilst such endeavours start with the best of intentions, it is important to remember what the road to hell is paved with!
So, what is the solution?
The answer to this question involves a synchronised change in perceptions and the formulation of strong governance frameworks.
The relationship between trustees and sponsoring employers can often be contentious and adversarial. This needn’t be the case. Trustees want nothing more than to fully fund the scheme, whilst sponsoring employers wish to lock down risk and refrain from paying large deficit contributions. The objectives of the two parties are the same, not mutually exclusive. The relationship between the trustees and sponsoring employer can often be enhanced by ensuring company representation on the trustee board. After all, one of the best ways to foster good relations is to be completely transparent and inclusive.
A higher standard is also required from scheme advisers. Trustees should ensure that the scheme actuary and investment adviser are operating in harmony. Long-gone are the days where the liabilities were the sole remit of the scheme actuary and assets the sole remit of the investment adviser. Remember, whilst most schemes have the primary objective to achieve a 100% funding level, and thus be able to pay benefits as and when they fall due, the path the funding level takes is highly important (all too often trustees have seen the funding level of their scheme collapse moments before undertaking an Actuarial Valuation, with the sponsoring employer being called upon to underwrite the deficit). A collaborative approach between the scheme’s actuary and investment adviser can facilitate the efficient management of scheme assets and liabilities and thus smooth the funding level progression.
With regard to governance frameworks, there are at least three key areas that need to be considered:
- The roles and responsibilities of all parties should be clearly identified, with a streamlined decision making process being implemented; a point well made in tPR’s March 2017 guidance on investment for DB pension schemes. Whilst the various involved parties will have specific roles and responsibilities, it is important not to lose sight of the fact that the sum of the parts is greater than the whole. A collaborative approach should be sought by everyone involved, not least because the risks facing pension schemes span multiple areas.
- A degree of delegation has the potential to improve success. Whilst the trustees are ultimately responsible for the pension scheme, the delegation of certain responsibilities to investment advisers or fiduciary managers can be an effective means of freeing trustee time to focus on those areas that add the most value. Integral to the success of such an approach is the establishment of a clear framework in which the investment adviser or fiduciary manager should operate. Remember, delegation does not mean a loss of control!
- Monitoring and reporting is more than a box ticking exercise. Remember, the risks facing pension schemes are dynamic and it is crucial that we respond to such risks in a timely manner. Monitoring systems should be established, with streamlined channels for feeding the information to the relevant parties.
One thing is clear, the implementation of a strong, collaborative governance framework affords trustees and the sponsoring employer the ability to be responsive, whilst not demanding unpalatable amounts of time.
The introduction of tPR’s IRM guidance c18 months ago reinforced what the majority of trustees, sponsoring employers and advisers knew, that the greatest chance of success comes from an integrated and collaborative approach. Unfortunately, for too many trustees, sponsoring employers and advisers, this utopia has existed solely in the realms of theory. Hopefully, this article goes some way in assisting in bridging the gap between theory and reality … after all, everything that has been said is the truth, the whole truth and nothing but the truth.