Investment - Articles - Excess risk is a greater issue than affordability

Hymans Robertson state that risk is the main issue facing UK DB schemes, and must be their key focus in response to the DWP’s DB Green Paper. Excellence in risk management, and using the funding flexibilities available, should be schemes’ main priority, putting a spotlight on improving benefit security. There are no legislative or regulatory barriers to achieving this. Many schemes are simply exposing themselves to too much risk and jeopardising that ultimate goal of paying benefits in full.

 or UK DB schemes, says Hymans Robertson’s DB Green Paper response

 DB schemes remain broadly affordable but are still running significant risks
 A focus on deficit figures has been a distraction from what really matters: improving the security of pensions
 This has manifested in £250bn of unnecessary risk of benefit loss[1]
 An integrated approach to risk management is key to tackling the £423bn p.a. risks of DB in drawdown
 Shorter recovery plans could be a false comfort – more time should enable less risk
 Where affordability is strained it would be better to use the flexibility that is already in the system rather than a wholesale change in indexation
 Asset pooling can achieve savings more easily than superfunds and without re-distributing risk or compromising effective scheme specific risk management.

 Calum Cooper, Head of Trustee DB, Hymans Robertson, said “The DWP‘s view that DB schemes are generally affordable is absolutely right, so focussing on cost efficiency, whilst important, is not obviously the number one driver for the industry. Instead, it is vital we recognise the cost of running unnecessary risk. Each year there is still £423bn p.a. of risk in the system.

 “It is blatantly clear that DB benefits no longer come with a cast iron guarantee. Indeed the Pension Protection Fund’s (PPF) modelling suggest that in the worst 10% of outcomes around 1000 sponsors could be insolvent by 2030, so this needs to be tackled. Yet, excellence in integrated risk management is not yet prevalent across the industry.”

 Commenting on the industry’s ongoing focus on deficits, Calum continued: “We are concerned that the industry response to the DB Green Paper will continue to focus on short term deficits when this is an opportunity to look at improving outcomes in the long term. It is important to manage risk through a long term lens, using all avenues and levers available, to improve the security of benefits.

 “The attention given to deficits has distracted from improving the security of pensions. As a strategy, simply pouring more money into schemes hasn’t worked for the last 15 years so it is fair to assume it won’t over the next 15. For too long schemes have viewed an increasingly complex web of investment, funding and strategy decisions through the narrow filter of deficits and discount rates. This can be improved by £250bn1 without increasing cash contributions if schemes are patient and take a truly integrated approach to risk management. This integrated approach to risk management is key to tackling the £423bn risks of DB in drawdown.”

 “Current regulations are no barrier to excellent risk management but the evidence is that schemes are not managing risk as effectively as they could. Before looking at alternative ways to create more flexibility for schemes, we need to review and make better use of the flexibility that’s already there. This is likely to be far more palatable for the vast majority than a move to conditional indexation or a wholesale move from RPI to CPI, for example.

 Commenting on the false comfort of shorter recovery plans, Calum said: “When it comes to shorter recovery plan it’s too simplistic, not least a step backwards, to say ‘long recovery plans are bad’. If used to manage risk, longer is typically better. If used to reduce cost, longer is worse. Blanket discouragement of using the lever of recovery plan duration could be a mortal blow to scheme-specific risk management.

 Proposing asset pooling as a better way to achieve scale benefits than the creation of a private sector ‘superfund’ Calum said:
 “Given that many schemes are well run and affordable irrespective of size, making consolidation mandatory would be wrong and unfair. If we are concerned with reducing DB risk, the creation of a ‘superfund’ doesn’t remove that risk. Instead a more pragmatic solution would be to introduce asset pooling which would keep costs down while recognising that scheme specific risk management is key.”

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