Ask pension trustees of defined benefit schemes what is top of their lists for areas of focus for 2022 and popular answers will likely include grappling with the requirements of the new combined Code of Practice and the long-expected new Scheme Funding requirements, ESG considerations and progressing GMP equalisation. I would argue there is one important action that all trustees of defined benefit schemes should be considering as soon as possible and that is reviewing their investment strategies to ensure they are fit for purpose in the backdrop of a changing economic outlook with rising inflation and consequent expected rises in interest rates.

The annual CPI increase to October 2021 was 4.2%, the highest level it has been since November 2011, and for pension schemes, where benefits are often linked to RPI rather than CPI, the annual increase to October 2021 was a dizzy 6.0%. Trustees would therefore do well to review the level of interest rate and inflation risks they are running in their schemes and consider what, if any, action may be appropriate. For example, there might be scope to adjust the level of LDI inflation hedging to increase the level of inflation protection afforded to the scheme, or there might be scope to review the composition of growth assets and their correlation with rising inflation pressures.

The investment strategy of a defined benefit pension scheme can have a material impact on the ultimate cost of a pension scheme to an employer, and the risk of unwelcome increases in deficit appearing at times when an employer might be under more financial strain due to inflationary pressures can be mitigated, where possible.

 

Employer covenant – the impacts on the economy of Covid-19 and Brexit are only just starting to bite. Rising inflation and wage inflation will pile pressure on employers, making covenants more vulnerable.

Trustees will also need to consider the pricing-in of climate risk to asset values. CoP26 may have been a bit of a cop out, but pressure remains for asset owners to be more responsible. If this applies across all asset owners (not just pension funds, who hold a relatively small amount of the total investment market) we will start to see asset pricing moving to properly reflect it.

We could even see a radical shift in investment approaches as the demand for investments with a lower carbon footprint grows. Unless trustees think and plan ahead, they run the risk of holding assets worth a lot less than currently priced.

 

All schemes will need to assess their governance against the requirements of the new single code of practice. Sole trustees are likely to have the vast majority of processes in place but will need to ensure that they can demonstrate and assess this in a cost-effective and efficient manner, so that value is added within an existing professional and streamlined governance model.

Under the sole trustee model, there is usually less opportunity to include the employer in training given to the trustee board. This presents a risk that the sponsor falls foul of the new requirements of the Pension Schemes Act 2021, through a lack of understanding of the impact of the changes. We expect to put in more formal information sharing arrangements where these do not already exist.

The biggest left-field challenge? Sponsor’s diversity and inclusion aspirations and policies could lead to an actual or perceived incompatibility with the sole trustee governance model.