Many Trustees are missing the opportunity to reduce risk

Things are looking up for pension scheme funding – at least from an investment point of view. However many Trustees are failing to seize opportunities as they are presented, or simply believe that better times await.

Gilt yields have risen from their lows in 2012 and this has resulted in the present value of liabilities reducing. For a typical pension scheme, the impact of rising yields is expected to have reduced the present value of the liabilities of a typical scheme by approximately 10% to 15% since July 2012. Inflation pressures (at least in the short term) have eased with CPI falling below 2%.

Trustees should also have seen strong improvements in investment returns with the MSCI World Index providing 16.8% p.a. returns over the five years to 28 February 2014 – certainly ahead of the likely investment returns assumed in the average pension scheme’s funding assumptions.

What does this mean for Trustees and sponsors? For those that haven’t planned, it simply means that any deficit could be made good sooner, and employers may hope that any recovery plan payments will reduce or cease early.  The belief is that investment risk needs to be maintained if that hope is to be realised.

Trustees don’t need to go that far back to recall similar ‘feel good’ moments, such as the end of 2007 when many schemes were in a much healthier funding position before the financial crisis of 2008/2009 set in.

For any scheme that is closed to new entrants or accrual, or whose liability is having an impact on the balance sheet of the sponsor, simply doing nothing should not be an option.

There are three issues the Trustees should be considering:

·    Given the improvement in funding above where we thought we would be at this point in time, can we reduce the current level of return required (i.e. can we have less exposure to growth (or risk) assets without impacting on the schemes ongoing funding basis and recovery plan?

·    Where growth assets are still needed. Is it possible to deliver growth more efficiently, with less risk?

·    Given the rise in gilt yields and falling inflation expectations can we use this as an opportunity to reduce funding level volatility that arises from changes in interest rates and inflation?

Of course those Trustees who do not have a plan in place, answering these simple questions can take time. With Trustees typically meeting on a quarterly basis, there is the risk that opportunities would have evaporated by the time they are ready to act.

According to the Pensions Regulator’s ‘Occupational Pension Scheme Governance Survey’ (2013), 45% of pension schemes do not have a long term de-risking ‘flight plan’ in place.

BROADSTONE has a five step de-risking plan to help guide the trustees through the design and governance process to ensure that opportunities to de-risk are not missed.

Peter Dean

Investment Consulting Director

Telephone:  +44 (0)20 7893 3456

Email:  contactus[@]broadstoneltd.co.uk