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How can you adopt a more integrated approach to fund deficits?

The landscape for managing pension schemes continues to change..

Now, more than ever, pension trustees and corporate sponsors are facing a number of challenges: lower yields, sponsor balance sheet and new regulations to name a few. However, the fundamental problem still remains the same. To secure and protect member benefits, funding deficits have to be repaired.

In the past, deficit repair discussions have happened in a silo way. Every three years, trustees and sponsor would get together and have what is more of a negotiation over contributions, rather than aim to agree a long-term feasible and balanced strategy to repair the deficit.

This is changing!

The Pensions Regulator’s 2013 Annual Funding Statement encourages trustees and sponsor to take a more integrated approach to managing pension scheme risks. The recent guidance (click here for a summary of the guidance) provides practical help on how an Integrated Risk Management Framework can be developed and implemented.

We believe this is a step forward in promoting better pension scheme governance and risk management, potentially leading to improved outcomes.

This integrated approach is one which our clients have been following for a while now and they are testament to its benefits. All our clients which have implemented this approach are better funded with lower risk and have better engagement between employer and trustees compared to where they were before the framework.

How can you adopt a more integrated and collaborative approach?

In our experience, the key to success lies in working with all stakeholders and advisors right at the start. The aim is to understand where the scheme is, where it wants to go and to agree a realistic path of how it will get there. To assist in these discussions, we have found it useful to have an interactive tool. This can be used live in the meetings to assess the interaction find the right balance between investment returns, sponsor contributions and time required to fund the pension deficit.

Following the discussions, the agreed funding objective and risk budget are articulated in a one page document – something we refer to as the “Pensions Risk Management Framework” (PRMF).

On an ongoing basis, the PRMF provides clients with a transparent way to measure the scheme’s progress against its objectives. It also provides context for investment strategy discussions for all stakeholders.

What have been the key challenges faced in getting schemes to adopt this approach?

Based on our experience, I share below three top challenges clients have faced and suggestions on how they can be overcome:

1.Challenging the status quo: Having run a pension scheme a certain way for the last few years, it is difficult for all to change their approach – sometimes it can be construed as admitting what you did earlier was wrong.

A better understanding of the current position of the scheme and the recognition that the requirements of a pension scheme change over time (for example, as it closes to new members or/and becomes cash flow negative, its ability to withstand losses materially reduces) can help all to be open to considering a different approach.

2.Engagement on the long-term objective: Getting engagement to focus on the long-term objective (especially from employers), rather than recovery plan and contributions, has often proved challenging.

Advisors working together to help both trustees and sponsor focus on setting a long-term balanced strategy to repair deficit and framing the problem in a different way. For example, rather than measuring “how much deficit can increase by over a one year period”, asking the question “how much can contributions increase by over a one year period” and focussing on certainty of outcomes can help to get sponsor buy-in to the process.

3.Focus on managing risk as well as returns: Historically, the focus of pension schemes has been on asset side and, as such, more on investment returns rather than risk.

Further education on the key risks faced by pension schemes, agreeing a risk budget at the start with the sponsor and ensuring decisions are taken in the context of a scheme’s overall requirements rather than on a standalone basis can help trustees to focus on risk management.

So what now?

An integrated approach to managing risks and repairing deficits makes sense and has proved successful. Done well, it can help align trustees and sponsor to focus on key objectives and ultimately, help achieve better outcomes for the scheme. Is your approach sufficiently integrated to take advantage?

Here is a summary of tPR’s 5 steps for implementing an Integrated Risk Management Framework – feel free to share or embed on your site:

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