Consulting firms reply to the WPSC Inquiry

The Work & Pensions Select Committee (WPSC) Pension Protection Fund and Pensions Regulator inquiry consultation certainly attracted a good number of responses. I count almost a hundred in that list and presumably not all are yet published!

Most of the major investment & actuarial advisory firms are represented there, as well as  PPF and The Pensions Regulator.

Reading through the submissions of all the investment advisory firms (yes, I really did!) I must admit was struck by the quality of the submissions, the level of thought that had clearly gone into them and the ordered and lucid way in which arguments were presented. I didn’t agree with everything that was said by our competitors (you’d expect that) but I was impressed with the quality.

I’ve tried to summarise each of them below, naturally these are through the lens of my own reading and interpretation. If you think I’ve got any of them wrong, please let me know!

At the end I’ve tried to draw out the questions on which that group of respondents are clearly divided.

I’ve ordered the summaries below on an approximate scale of suggested change level, from those that argued for least >> most

Hymans

Big picture Hymans believe that the current regime is fine, there is not an issue with affordability subject to giving schemes and sponsors “time to heal”.

“Most schemes are well managed and should be able to pay benefits in full

Hymans would not propose any changes lest these have unintended consequences and damage the functioning of the majority of schemes. Floated the idea of conditional indexation in stressed situations but highlighted the need for “watertight safeguards”. On the regulator’s powers:

“The regulator has adequate power. It’s wrong to assume that committing more resource to the regulation of DB schemes will improve outcomes for pensioners. It might actually exacerbate the problem – because more onerous regulation could make DB provision more difficult for employers.

Hyman’s noted that the PPF has been managed in a sustainable way and indeed provides a good risk management model for all pension funds.

The PPF

Provided a timely reminder that the PPF itself is both necessary and stable – with a growth in assets to £23bn but a funding level of 116%, and total benefits paid out to members of £2.4bn.

Much of the response concerned considerations regarding the future level of the levy, describing enhancements to the models used and refinements based on data gained, particularly in taking a different approach to small companies compared to large ones. Improving predictiveness of models, using different variables.

The PPF indicated a belief that sponsoring employers have sufficient cash and financial strength to shorten recovery periods, and discussed their aggregate modelling of the number of schemes predicted to enter the PPF:

“. Indeed our modelling projections would indicate that given the strength of employers in the median case the vast majority of schemes should be sufficiently funded to pose little risk of making a claim on the PPF by 2030 (with less than 700 schemes falling into the PPF in in the median case by that time as against around 850 to date).

The PPF would support a more interventionist role from TPR, for certain categories of scheme, with the goal of tackling risks to member benefits. In particular PPF believe that for stronger sponsors shorter recovery periods should be targeted (interesting, this is the one area where the PPF appear at odds with TPR, with TPR indicating their willingness for more flexible terms for strong sponsors). PPF believe restrictions on recovery periods and “back-end loading” of contributions would be appropriate.

For stressed schemes – the PPF  suggests intensive scrutiny and consideration of the options for restructuring the scheme. They made a case for TPR to have the broad power to trigger the wind-up of schemes with request of PPF or the trustee. In transactions PPF believes avoidance powers could be enhanced by better targeting and faster implementation. Duties placed upon employers and trustees to engage with TPR would be appropriate.

PPF noted that options for scheme consolidation should be considered. Highlighted their concern at the suggestion of new business models that might allow a scheme to continue without a sponsor.

 

The Pensions Regulator (TPR)

TPR believe the current regime is operating as intended and most pension schemes are affordable for the majority of employers (backed up by data on ratio of contributions to dividends). Made some suggestions on how TPR could be changed with the benefit of experience: more powers to compel individuals and organisations to give TPR information and submit to scrutiny (including civil powers). More timely actuarial valuation information (narrowing the 15 month window in acknowledgement of technological enhancements). Powers to be more prescriptive on the overall funding and investment outcome, rather than focusing on individual parameters such as length. Shifting the burden of proof to schemes to justify long recovery periods etc. Mandatory clearance of corporate transactions could be considered (the current system being voluntary), which could extend to all actions that potentially weaken the standing of a pension scheme (eg dividends, share buybacks). Suggested enhanced whistle-blowing procedures could also be considered.

Redington

We stressed the importance of considering all this from the member perspective, and emphasised the benefits to schemes of enhanced governance (which many UK schemes are of insufficient scale to deliver). We also highlighted the existence of a number of success stories around the industry that we believe through better knowledge-sharing of best practice. We acknowledged the tricky balance that regulation must strike between security for members and sustainability of firms, noting that it is usually in the best interests of pensioners to continue to have an ongoing firm backing the scheme. We argued for small-scale changes to existing regulation to strengthen the hand of trustees in funding negotiations, provide more guidance on parameters and shift the responsibility to sponsors to offer additional security in the case of lengthened recovery plans.

LCP

LCP’s response took things back to the highest context level, highlighting the key tensions and spelling out the fact that there aren’t any easy political choices. LCP believe a “significant minority” of schemes will be unable to pay full benefits. Resolution will require political change now which may be painful in the short term, but carry long term benefits for security of pensioners. Setting out the three different political options facing the government LCP described the broad choices as (1) leaving the balance between DB members and employers broadly the same (2) shifting the balance in favor of member security at the possible risk of “significant negative impact” on corporate sponsors and (3) shifting the balance to soften the pension promise, creating “welcome easement” to firms at the expense of reducing the value of pensions paid to members. Beyond that point LCP said they broadly agreed with the response of the ACA (summarised below). LCP believe that small changes (to regulation) are unlikely to have a positive impact:

“We think it unlikely that small changes to the current pension regulatory environment will have a major positive impact, and they may have negative unintended consequences. We strongly recommend that you do not propose changes to Government in order to be “seen to do something” in response to BHS.

LCP also commented that the exit from the European Union might present opportunities to change legislation.

Mercer

On the issue of regulating the effect on pensions of corporate action, Mercer believed the onus could be moved to the other relevant regulators (such as the FRC, PRA or takeoever panel), to take into account pensions issues in the context of corporate activity, rather than the “single issue” pensions regulator becoming involved in corporate activity. Mercer suggested that advisers themselves could be an enhanced source of regulation by increased use of “whistleblowing” type activity and an enhanced focus on the need for members of professionally regulated bodies to do this.

On the question of TPR’s powers, Mercer made the point that before considering new powers the way TPR exercises it’s current powers should be evaluated, as it is possible the current powers are sufficient, but not being fully utilized. New powers would not necessarily reduce the risks faced by pension schemes. Making TPR more interventionist would not guarantee better outcomes, and might impose additional costs on trustees for no gain.

On the question of whether the current market conditions warranted an exceptional approach:

“Unfortunately, it is not possible to tell if the current environment is exceptional, and so difficult to say it warrants an exceptional approach.

“Our view is that the purpose of a valuation is to impose some controls over the future expected cost of providing the scheme and the pace at which that cost is met. The statutory funding regime achieves that. If a non-market related approach were introduced, the results might be different, but they would also have no context, be virtually meaningless (for example, they might not give appropriate signals to inform investment strategy), and inevitably short lived.

Association of Consulting Actuaries

Made some very similar points to Mercer in the role that other regulators could play with regard to pensions, and much of the wording in other areas also bears a lot of similarity, suggesting there was a lot of common input.

In particular the ACA highlighted a possible role for other regulators:

“Consider the role of all regulators that could possibly have authority over actions that might affect pension scheme outcomes, and how they could use their powers to influence good governance in relation to decisions and advice affecting workplace pension provision.

Gave examples of the Takeover Panel, PRA and FRC, noting that the TPR itself does not regulate the way companies are run, and how they balance the demands of DB pension provision against other things.

“…corporate responsibility for balancing the security of company pension schemes with their other priorities seems a matter for other regulators, such as the FRC or PRA, with responsibility for good corporate management and governance.

Believe making TPR more interventionist, from it’s current supervisory and guidance stance is not a guarantee of better outcomes, not helped by the TPR’s internally inconsistent and conflicting objectives.

On the TPR’s powers the ACA response (again similarly to Mercer) emphasis the belief that existing powers have perhaps been underused or in practice are “illusory”

TPR has seldom used those of its powers that would directly impact company decisions, which has perhaps led many to view that its powers are illusory (for example, because the hurdles to cross before they can be used are too onerous). It is possible that the threat of using them has always proved sufficient, but that is not obvious to many in the industry. TPR has to produce reports about when it does use its powers; some clarification around situations where it chooses not to might also be helpful.

The ACA noted that TPR’s objective to minimize claims against the PPF skews it’s focus (towards larger schemes, even if they are at lower risk of default) in a way that is not necessarily optimal for the functioning of the system as a whole.

The ACA suggest a statutory override to RPI benefits (moving them to CPI) in the context of generating inter-generationally fair outcomes in relation to money purchase pension recipients. ACA note that the intention of trust law probably wasn’t to hardwire benefit increases to a particular index and also that mandatory indexation was enshrined by the Pensions Act 1995, suggesting that it is appropriate for the government to legislate to overcome problems created by previous legislation.

Mentions consolidation relatively briefly, makes the point that benefit complexity is one barrier to this happening, suggests that introduction of a facility whereby historic benefits can be converted to a single standard would facilitate this.

Aon

Aon believe that the inquiry into DB should be considered in the context of DC – money spent on DB  can’t be spent on DC. Aon believe that an intermediate solution should be available to some schemes between full benefits and PPF levels. Focusing more on bigger regulatory changes rather than tweaks AON made some quite developed suggestions in regard to intermediate solutions, for workable changes to the existing regime. Broadly these suggetions were in favor of an intermediate benefit solution based on conditional indexation and moving to more of a “with-profits” style system with  regard to pension increases (pay increases conditional on the performance of growth assets). Aon suggested that a change to a with-profits system (including within the PPF) might make it easier to push for consolidation of schemes without subsidy.

Of the consulting firms Aon came closest to advocating changes to the funding approach- articulating the benefits of a cashflow and probability of success measurement regime as opposed to a present value and funding level, however overall Aon reflected a balanced view here, arguing for a “wider range” of approaches, including both present value and cashflow approaches, rather than a replacement of the present value approach.

“A present value approach is not wrong. It encapsulates the valuation in a single figure, which probably does reflect where the scheme is trying to get to in the long-term. It also tends to encourage more immediate action in response to changing circumstances, although this means reducing deficit contributions when deficits reduce, as well as increasing deficit contributions when deficits increase. However, the present value approach does have a number of disadvantages which are becoming more apparent in the current low yielding and volatile environment

Aon suggest giving company directors a responsibility to consider the funding level of the pension scheme when deciding upon dividends.

AON “called out” the practical challenges associated with consolidation – namely that it’s tricky to do it in a way that both avoids cross-subsidies between schemes AND achieves the enhanced governance objectives of consolidation. This is important as the concept of consolidation seems an easy one to agree upon, but much harder to find workable ways to achieve it in reality.

Cardano

Cardano believe that the regime should be changed to engender (1) greater prevention – by focusing on the economic value of the liabilites (rather than the technical provisions basis which allows for asset returns) and (2) more flexibility – with the ability for trustees to negotiate with employer to get to an intermediate solution between full benefits and PPF benefits, in advance of a full corporate insolvency process. Cardano believe that there is a systemic affordability issue that government needs to address.  Cardano believe that the current system of Technical Provisions gives a false sense of security, they also referred to the increased cashflow negativity of schemes and path dependency issues this creates as schemes pay out full benefits while being substantially underfunded on a full economic basis.

Cardano are critical of the Technical Provisions as a measure of scheme health and believe this has not fostered the best decision making:

“The recovery plans, approved by The Pensions Regulator (TPR), have also been sliding. As schemes have become more severely underfunded, longer recovery periods and higher future return expectations have been accepted. So a fuzzy measure of the health of the pension fund (Technical Provisions) contributed to poor risk management on behalf of trustees, which led to deteriorating funding positions, and that has been met, broadly, by TPR simply relaxing the parameters, and tacitly accepting the new status quo.

Summary

What are the key questions that divide the respondents?

I think you can boil it down to the following subjective questions with the above respondents divided on pretty much all of these points

  1. Is large-scale reform of the DB system needed (to generate better and more optimal outcomes for members and sponsors)
  2. Are small-scale tweaks to existing regulations worth considering
  3. Should an intermediate solution between full benefits and PPF levels be investigated
  4. Should there be consolidation among schemes
  5. Would additional interventionist powers in TPR be overall helpful to pension security

What common themes were there among the responses?

I think there was broad agreement on what the key challenges are – namely balancing security for members with sustainability for employers. This question seems to frame the debate at the right level for government consideration, rather than getting too absorbed in the particular details.

I think there was general agreement that changes to the funding regime, particularly moving the basis on which the liabilities away from one which references bond yields are not warranted.

Scheme consolidation and conditional benefit indexation were two frequently occurring suggestions that while not universally agreed upon, would appear in my view to have enough advocates for further investigation.

A considerable number of suggestions were made regarding smaller incremental improvements to current legislation, although there was disagreement on the question of whether incremental improvements is in itself worthwhile or beneficial or wholesale reform needed. Again that question seems framed at the right level for government consideration.

There seemed to be agreement that the current system is not set up to deliver inter-generationally fair outcomes, given that younger employees (particularly in the private sector) have no access to DB provision and are likely to receive lower pensions in relative terms than previous generations. There were several suggestions that the DB reforms should be considered in the context of/alongside the DC system in the knowledge that imposing increased costs on the DB side will impact DC.

So there you have my take on the consulting community responses to the WPSC BHS pensions inquiry. Do let me know your thoughts.

Why Anthony Hilton is Wrong on Pensions 

“Expected returns don’t pay benefits, cash does”

Anthony Hilton recently wrote a stinging attack on pension consultants -like myself- who advise defined benefit pension schemes to measure, and hedge, their liabilities with reference to gilt yields.

Here’s one (of several) reasons why he’s wrong.

His argument – that you could fund based on the much higher expected returns on risky investments – might perhaps be justifiable in a world where all corporate sponsors were rock solid and would last forever (clearly we do not live in this world – and even then it would expose companies to some needless nasty surprises along the way, but anyway).

However this completely misses the point that a major reason we fund pensions at all is precisely to provide security in a situation where the corporate sponsor ceases to be able to make payments itself. The reason we need to measure deficits is to get a picture of how secure the benefits might be in the absence of the employer, and to take corrective action (eg topping up contributions) if the situation is off-track, before it is too late.

And in those situations of sponsor company failure, we would hit a major snag under Mr Hilton’s approach: it’s hard cash that must be used to secure the benefits – Mr Hilton’s expected returns won’t cut it I’m afraid. Just ask the pensioners of BHS scheme, or indeed the allied steel and wire groups, still campaigning for their pensions over a decade later. This second example pre-dates the Pension Protection fund, so thankfully pensions today are better protected, but the conclusion for scheme funding – that you can’t rely on high future expected returns to discount liabilities – remains valid.

Pensions need to be paid to members in real cash, and it flies in the face of both accepted theory, and common sense, that the amount of money needed to provide these benefits can be reduced depending on the assets held to deliver them.

Today’s unfortunate reality is that the defined benefit system in the UK is on average chronically under funded compared to the benefits it has promised. Time and effort would be far better spent on considering the tough choices that might need to be taken, rather than on attempts to deny the existence of a problem in the first place.

Unfortunately Mr Hilton’s ill-judged remarks from an otherwise respected journalist damage the hard work that many of us in the industry have been doing for many years to try and secure the benefits and financial futures of those members dependent on defined benefit pensions for their retirement.

Grim Summer for DB Pensions

It’s not been a good summer for the financial health of UK DB pension funds.

Data released by the PPF in September underlined a summer of bad news for schemes and scheme sponsors.

A continued trend of falling gilt yields have seen liability values increase dramatically – adding more than £200bn to the aggregate deficit compared to the start of the year. The aggregate funding level (on the PPF basis) fell to 76% at the end of August, the lowest value in the 10-year history of the series. For context the funding level on this basis was close to 100% at the end of 2013.

Long-dated gilt yields have fallen from around 2.5% at the start of the year to around 1.2% by the end of August.

The result of the referendum vote certainly added impetus to the move lower in gilt yields, as “lower for longer” became a more likely scenario, and this was re-enforced by the BoE’s announcement of renewed bond purchases (quantitative easing) and a cut in interest rates to 0.25%.

While asset markets have generally performed positively – especially overseas equities in £ terms, these good results have been insufficient to keep pace with unhedged liabilities.

It seems likely that actuarial valuations as at 30 June or 30 September are likely to contain bad news for corporate sponsors, prompting tough conversations such as those happening at plastics manufacturer Carclo, and negative headlines such as those at Associated British Foods. These are likely to become more and more common as we move forward, as highlighted by LCP in their Accounting for Pensions report.

august-2016-a-decade-of-db-pensions

 

Black Box Thinking

The best book I read over the summer was Matthew Syed’s Black Box Thinking.

The central theme of the book is really fear of, and reaction to, failure.
We have an allergic aversion to failure. We try to avoid it, cover it up and airbrush. The phenomenon of cognitive dissonance  is the name for the deeply-rooted behavioural trait that causes us to naturally reject ideas or even evidence that conflicts with our own worldview. This can be incredibly damaging to progress in many cases.
There’s a huge need to learn from failure, it can be extremely helpful (Syed cites the example of the aviation industry learning from air disasters to vastly improve the safety record).
Readers of similarly themed books (eg the work of Charles Duhigg, Khoi Tu or even David Eagleman)  will find a lot of the examples used by Syed a little tired and overdone by now. However I found that Syed was able to extract sufficient new insight from some of these well trodden case studies and weave them together with the central theme effectively.
Creating  by experimenting is often more effective than creating by blueprint.

Cognitive dissonance / confirmation bias

There are some powerful behavioural psychological forces at play that can be quite counter-productive to progress in today’s world. For example, the tendancy of reframing when faced with evidence that we’re wrong … divorces us from the pain of recognising that we were wrong. It’s not even conscious when it happens.
For example –

Open vs closed loops.

Syed defines open loops as operating by benefiting from feedback for example aircraft black box & medical randomised control trials.
Closed loops do not systematically collect feedback AND more seriously do not have the mindset to confront, recognise and learn from failure. Closed loops systems are dangerous because they  block progress – whether that be progress in safety, improving care, innovation or surviving in the commercial world.

Evolution itself is the best example of learning from failure.

Narrative fallacy Vs RCT

Narrative fallacies arise inevitably from our continuous attempt (need) to make sense of the world around us. The explanatory stories that people find compelling are simple and concrete. But they often assign a greater role to talent/stupidity/intentions than to luck and often rely on a few events that did happen rather than the countless that didn’t.
Stories are good but beware the narrative fallacy. Eg scared straight. Statistical biases.
Need counter factual and control group.

Marginal gains & feedback loop

Marginal gains is not about making small changes and hoping they fly. Rather it is about breaking down a big problem into small parts in order to rigorously establish what works and what doesn’t.
Break a performance into a component parts & you can build back up with confidence > brailsford
Some programs are hard to create controlled trials for, eg aid to Africa. Break down into component parts >> marginal gains
The existence of a local maximum reveals the inherent limitation of marginal gains. Sometimes you need a big leap forward to get past a local maximum. Need to do both marginal gains and big-picture thinking.

Innovation

Contradictory information jars us psychologicaly. It nudges us into looking for unusual connections. Innovation comes from making new connections between familiar things.
Find a hidden connection to solve a problem. Failure and epiphany are linked. Brilliant ideas can emerge from engagement with a problem for months or years.
Innovation is context dependent – a response to a particular problem at a particular time & place.
Big picture & small picture. Innovation + discipline = success. There exists a threshold level of innovation required for a firm to be successful, beyond that it depends on the discipline to implement.

Book review – Smarter, Faster, Better 

After really enjoying Charles Duhigg‘s excellent first book The Power of Habit, it was an easy choice  for me to grab a copy of his second book on the way to my holiday, having been given a recommendation from Mitesh. I wasn’t disappointed!

Essentially the book looks to explore ways in which we as individuals and teams can be more creative and productive. Some of the points and ideas are familiar, but I really like Duhigg’s style of weaving neatly summarised academic literature into memorable real world stories and characters.

Here’s my top 4 takeaways-
1. Single most important tip for teams: build a commitment culture through fostering psychological safety.

A commitment culture (as opposed to a star culture) is one where the whole team is genuinely committed to helping each other reach a common goal. Psychological safety means that each person on the team can speak up, contribute ideas, and critique ideas. Everyone gets their turn to speak and meetings are not dominated by a couple of individuals.

2. Motivate yourself and others by making choices that put you in control.

It turns out that the need for control is pretty fundamentally hard wired into us from an early age (I don’t have kids, but my friends that do tell me this is something they experience frequently from the age of about 2). A perceived lack of control over a difficult of demanding task can be stifling for our motivation (just ask any student approaching revision for exams!) But as adults we can use this to our advantage. For ourselves, approaching draining or difficult tasks can be easier if we start by framing a choice (choose the location for a difficult meeting, taking control of your availability). When managing others it can be incredibly powerful and motivating to pass control to them – allow them to take key decisions relating to the project. This also ties in with agile principles.

3. Build mental models

Our brains are set up to build models of the world around us and constantly evaluate information received against the model (David Eagleman writes more on this in his excellent book on neuroscience, incognito). We can harness this in a working environment by constantly building a model of how we expect a given day, interaction, meeting or project to play out. Evaluating what happens in reality relative to this model can help better decision making. In the book, Charles Duhigg uses some excellent contrasting examples of aviation incidents to really bring this home.

4. Make data disfluent, in order to understand it better

We live in a world that has never been richer in terms of data. We each generate huge amounts of data everyday and carry in our pockets devices capable of processing data that previous generations couldn’t dream of. But how do we turn that data into actual information and insights?

Paradoxically a great way of doing this is often to go back to basics. Make the data harder to interact with at first. Draw graphs by hand, write datapoints out longhand on flash cards. By doing this we are forced to interact with the data more. We build theories about what the data contains, and in testing these theories we learn the important lessons. This is also why taking handwritten notes can be more powerful than typing notes, precisely because it is MORE labour intensive.

There’s plenty more in this very readable book, granted not all the concepts are revolutionary, but I would be surprised if you couldn’t find a few real actionable insights to take away and apply day to day. I certainly did and I look forward to implementing these with my team.

Two Days Among Actuaries

Just back from a couple of great  (sunny!) days in Edinburgh for the institute of actuaries conference which importantly this year incorporated pensions, investment and risk components together for the first time.

Quite a lot of interesting takeaways and observations from around the industry. As Marian Elliott said in the first session  “To the worm that lives in horseradish, the whole world is horseradish”. The point being it can be helpful to get a different perspective on things from the one you usually have.

Here are the big 3 things I took away:

 1. Integrated Risk Management (IRM). The pensions regulator continues to stress the importance of IRM in the latest funding statement here, and the IFoA working group has made progress thinking about the issues.

My  takeaway was that this remains a work in progress in that no-one has (yet) put forward the “perfect” framework for looking at these three components and bringing them together in an intuitive and practical way  (possibly, that doesn’t exist). What the working party has done is given considerable thought to a number of worked examples that act as  “corner cases” and challenge people to  think qualitatively about those different components of risk, what investment and funding strategies should result and  key metrics to track to best monitor.

With some of the current high profile cases in the news, the examples seemed very pertinent.  It’s clear that thinking in some of these cases has to come back to the member perspective, and what gets the best outcome for members benefits, and this inevitably includes thinking about the possible interaction with the PPF, something that clearly has to be handled carefully.

While this remains a work in progress I think the thinking that went into the worked examples, including legal opinion on certain points, is a welcome contribution to this important area. The suggested further reading (including  the Blake / Harrison paper  The Greatest Good for the Greatest Number looks interesting and I look for ward to reading further)

The session ended with a challenge to the audience – someone needs to take the initiative and bring these strands together. The working party proposed that actuaries are well placed, I would argue that the investment consultant is, too. The WP expect to communicate more toward the end of the year, I look forward to continuing the conversation.

2. British Steel

Not surprisingly this seemed to be one of the major talking points of the conference over many a coffee and beer. It’s putting the issue of pensions on the front pages of mainstream papers and into the general public discourse in a way that I haven’t really seen during the rest of my career (possibly you need to go back to the 1990’s and Maxwell to find a similar time). The panel discussion organised to address the consultation and the profession’s possible response was remarkable both for the number of people filling the room, and the strength of views expressed. This session was explicitly under “Chatham house rules” so I won’t share too many details, but fair to say there was a lot of questioning of the need to make this scheme a special case, and the danger of making up legislation and precedent “on the hoof”. A couple of interesting prior cases were mentioned including British Midland/Lufthansa which I need to read up on.

The discussion of the individual consultation options was interesting, albeit somewhat drowned out by the wider question of whether creating a special case is the right thing. What was clear is that there is an increasing acknowledgement that the ability (or not) of any scheme to move benefits from RPI to CPI may essentially be an accident of drafting and in effect is a lottery. I strongly suspect that whatever happens to British Steel we haven’t heard the last of the CPI/RPI debate which looks set to continue rumbling on.

3. Endgame & Self sufficiency management

Paul Sweeting of LGIM wrote a recent paper on a blueprint for self sufficiency management, and this got quite a few mentions. It’s a welcome contribution to the area and ties in with a lot of our thinking. The use of contractual cashflow, and alternative metrics for risk, with a nod to the practice and mindsets of the insurance industry makes a lot of sense.

the key findings of the paper are:

  • Focusing on the probability of paying all benefits is a helpful metric for end game schemes (more so than VaR or volatility);
  • For schemes that are well funded enough, corporate bonds are the best asset to hold to maximise this metric;
  • Allowing for defaults, downgrades and being dynamic with decision to reflect changes in spread level is important;
  • Conventional mark-to-market volatility becomes less of a consideration;
  • Where liability present values are needed, the corporate bond spread  can be embedded into the discount rate, to create matching of assets and liabilities.

While probably not that many schemes are in the end game yet, as we noted in this blog it is important to set out with this destination in mind, even if it is some way off. And as we know from survey data many schemes have self-sufficiency in mind as a goal. A useful first step is to make sure they have advisors and fund managers in place with a clear and sensible plan to construct and implement a strategy to deliver the scheme’s self-sufficiency goal.

Ri_End_Game_Infographic