We’ve been eagerly anticipating The Pension Regulator’s revised Code of Practice on funding defined benefits for quite some time now. Even though it has been delayed once again, we know pretty much what it will say. That schemes will be required to set a Long Term Funding Target and devise a Journey Plan setting out how they will reach their ultimate destination.
We are all familiar with the saying that the key to success is in the planning – failing to prepare is preparing to fail. This phrase should resonate particularly loudly with those involved in developing and implementing end game strategies for their defined benefit pension schemes. What is also undoubtedly true is that those who enjoy access to smarter technology will have a significant advantage over those who don’t, as they will be able to plot their journey plan and meet their objectives so much more easily.
Devising a Long Term Funding Target and devising a Journey Plan is really an application of the Actuarial Control Cycle, familiar to those of us who worked our way through the actuarial exams. The Actuarial Control Cycle involves specifying the problem, developing the solution and monitoring progress, whilst taking account of, and changes to, the economic, political, legislative and business environments around us. Rinse and repeat as required, and refine what we are doing each time to hone in on the desired target.
Plotting the journey
- The first step is to decide on our objective. For many schemes this is going to be achieving a buy-out with an insurance company and subsequently winding up.
- The second step is to develop our solution. This will mean determining measures of success and failure. One example might be that the measure of success is the scheme being sufficiently funded to achieve full buyout with an insurance company in the next 10 years. Failure might be coverage on a buyout basis worsening over that same period. We can then run a stochastic Asset Liability Model (ALM) to work out the optimum investment strategy for successfully delivering this objective. The ALM will need to take into account the current buyout position of the scheme and the expected future contributions payable by the sponsor. Thousands of projections are then run under different economic scenarios to determine the solution that is likely to give us the best chance of success and the lowest chance of failure.
- The third step is to monitor progress. This means tracking the scheme’s buyout position over time and comparing that to where it is expected to be on its Journey Plan.
It’s an iterative process – the rinse and repeat part. As we gather information on how our plan is developing, we also refine our solution by re-running and recalibrating our model.
Smoothing out the bumps
For some lucky schemes, typically those that are well funded, enjoy a strong sponsor covenant, and where the cost of buying out the scheme is not a significant outlay for the sponsor, the road to buyout is likely to be short, smooth and with no surprises. A bit like a pleasant Sunday drive before lunch.
However, many other schemes will experience bumps in the road which will lengthen and complicate the journey to buyout. Trustees, sponsors and their advisers are going to have to deal with their data, administration, actuarial and investment consulting, and governance matters in greater detail. Some are going to be far better equipped to embark on this journey than others, and this is where having access to smarter technology comes into play.
Advisers who use separate administration, actuarial and investment systems may well end up struggling. The main issue with this type of set up is that it can leave the advisers, trustees and sponsors somewhat lost on their journey and unsure of where exactly they are at any given time. It’s a bit like using a paper map instead of a satnav – it’s time consuming to find your way, it’s all too easy to take a wrong turn, and it’s outdated. Which means less time can be devoted to the key strategic matters, namely, developing the solution and monitoring progress. Rather than being a pleasant drive, the result could end up being a car crash as far as the pension scheme is concerned, with poorer outcomes for members the ultimate result.
Technology can and should be used to avoid the larger potholes and help smooth out the remaining bumps in the road so these schemes can reach their destination efficiently.
Joined up solutions
Smarter technology means a fully automated system that offers joined up solutions. See my earlier blog on Automation here for more on this subject.
These systems will have high quality data at their heart and be fully coded to deal with the different benefit options available to members. Where there are gaps in the data, the system will make it easy to identify what these gaps are so they can be closed down as efficiently as possible.
A fully automated system will mean accurate actuarial valuations and the ability to run Asset Liability Models whenever these are needed on any given day. Advisers, trustees and sponsors will all know exactly where they are at any point in time. Their focus can, therefore, be firmly on developing the solution, monitoring progress and refining the journey. The result is a much smoother path to buying-out the scheme and winding it up. The journey will be much more efficient and should reduce the likelihood of unexpected stops for fuel (requests for additional support from the sponsor).
This should also give the best possible chance for the best possible member outcomes, which should be the ultimate focus for the pensions industry. We shouldn’t settle for anything less.