The 2009 Hewitt Global Pension Risk Survey showed that interest in pensions and dealing with pension risk remains at an all time high. Companies, trustees and poor beleaguered pension managers, all face unprecedented levels of activity to deal with pension risk and deficits. And actions are needed in all major areas – benefits, investments, covenant and financing. What is most definitely required is a clear action plan – a Risk Action Plan or RAP. Actually given the state of many pension plans, it might be more appropriate to sing the Blues! But based on the feedback received in the survey, and conversations with some of the ‘best in class’ participants, here are our top 10 tips on what to put into your 2010 pension RAPs.
1. Think about Freezing
Considering freezing your plan – closure to existing members or ceasing current accruals - is now a realistic option given the very public moves made by employers elsewhere.
Indeed you may come under pressure from management or non-executives or shareholders generally to give the rationale and the economic case for not freezing your plan. The survey showed that while only 20% of respondents had already frozen their plans to existing members fully (compared to 12% in 2008) 70% of replies said they saw this as more likely than before. The prospects for open private sector DB plans look bleak – only 2% of respondents predicted their DB schemes will remain open to new entrants.
2. Think about anything BUT freezing
Freezing a plan is still something of a Rubicon which many companies are reluctant to cross. They are perhaps right to proceed cautiously, since this can often attract member or union resistance, and can lead trustees to defensive investment positions. The survey shows that many companies will be exploring all the options other than freezing the plan, in order to reduce their pension plan risk and the impact on their cashflows. Caps on pensionable pay, enhanced transfers and pension increase conversion exercises are now becoming more mainstream. Some of the previous barriers and pre-conceptions may no longer be there. Despite sabre rattling from the Pensions Regulator, enhanced transfer value exercises do not have to be against members' interest and deserve serious consideration. Changing increasing pensions for higher, but level, pensions can form part of a plan to reduce longevity exposure. And caps on pensionable pay can deliver as much benefit to a finance director's profit & loss account. Indeed they can deliver more, if you set the cap very low – but this may come back to bite you if you subsequently want to freeze the plan.
3. Know your Enemy
Measure your pension plan exposures – assets, liabilities and risks – well in advance of major exercises such as actuarial funding valuations and year end accounting figures. Understand the variability and sensitivities of the outcomes and what actions you can take to minimise or mitigate these. Quarterly dashboards of risks exposures are now starting to become as common as getting asset manager reports and updates on liability positions.
4. Think Contingently
Look at all sources of finance or contingent finance to meet the increasingly onerous funding targets you face. The type of contingent asset will be very situation specific but may be more palatable than substantial cash demands. The Pensions Regulator's latest Purple Book shows that contingent assets have become more mainstream – typically in the form of parent or cross company guarantees to help reduce PPF levies. Their use in meeting gaping funding deficits is less well developed – but may represent the only realistic solution for some sponsors.
5. Know your Covenant
Put in place the appropriate framework to identify the key issues around employer covenant. Sponsors need to show willingness to give trustees access to quality information as they do with other creditors. Trustees should avoid focusing just on historical financial performance – consider industry, business and financials in that order. Make sure that your covenant analysis is relevant, timely and proportionate – and you have agreed in advance what will happen if there is a significant change for the worse – or hopefully even for the better!
6. Optimise your Governance tolerances
¦ Financing policy
The survey looked at changes in strategic asset allocation positions. Two themes emerge here – greater diversification of rewards seeking portfolios, while at the same time a greater emphasis on liability matching. Both of these themes place increasing demands on trustees to increase their knowledge base of different asset categories and different risk reduction mechanisms – physical investment, swaps or derivative based strategies. This need for knowledge takes place against markets which continue to act in fast, volatile and often seemingly irrational ways. Trustees and sponsors need to ensure that they have the right governance structures in place to deal with the fast moving, increasingly complex investment market-place. For many, the right response will be to consider the extent to which they can or should delegate all or part of the implementation of their investment policy. This does not mean letting go or losing control. It is time to boldly go - for Next Generation Governance structures!
7. Remember the Long Term!
Formulate your longer term pension plan objectives and desired outcomes. Set up the framework or flight path that will deliver the objectives and what actions will be needed to get there. It is all too easy amid the noise and confusion of current activities not to spend time working out just what the longer term objectives should be. But without that agreed view, there is a danger that tactical activities may not have the desired effect.
8. Set your Triggers
Consider whether trigger mechanisms will help you to capture favourable market movements or other buying opportunities. Do the groundwork well in advance to ensure that trustees and employers are both comfortable with the eventual decisions but then formalise the triggers that can lead to execution of your desired outcomes. Sensibly applied triggers can help de-risk investment policy as scheme funding improves – but the survey shows they are also being set to take interest rate and inflation risk off the table as markets move towards what are considered fair value. Triggers can become overly mechanical, and need to be kept under regular review in the light of market changes – but they can stop you feeling like the Grand Old Duke of York; watching inflation march down the hill, but not acting, only to see it march up the other side of the hill!
9. Learn about Longevity
Make sure you have a deep understanding of your longevity exposure and whether the new options available to manage longevity make sense in your context. Ensure that you have the right framework to be able to decide whether longevity swaps represent good value for you. The first few longevity swaps have now been executed in the UK market and the Hewitt Global Risk Survey showed that many are intrigued by this option. Over 60% of respondents say they are actively considering hedging their longevity risk, most likely via the longevity swap market. With the buyout market temporarily stalled, as prices drift out of range for schemes with their reduced asset base, dealing with longevity risk could be one of the biggest activities during 2010. The survey suggests that two-thirds of those interested in dealing with longevity risk expected to continue to take other rewarded risks elsewhere – usually to help fill their pensions deficit.
10. Slice and Dice your Risks!
Look in detail to ensure you know what the options are now for slicing and dicing your pension risks – equity, interest rate, inflation and longevity. Which ones do you want to retain and what price will you pay to remove the others? Is a DIY strategy cheaper and more efficient than buying the bundled proposition that a buy in represents?
So, given the activities above, your 2010 pensions year is unlikely to be all that laz-y (or even Jay-Z) and your chance of an Eminen-tly quiet year may be slight – but at least your funding should be more than the 50 Cent in the dollar. Happy RAPping!