 By Julie Stothard, Director of Actuarial, Investment and DB Consulting, Capita Employee Benefits
When Bank of England governor, Mark Carney, made his first big speech since taking office in August, gilt yields stood at a 10 year high of 2.8%. Late August saw a rise of approximately 0.2% in gilt yields but this is merely the continuation of a trend observed over 2013. Gilt yields have now risen by nearly one per cent since the key valuation dates of 31 December 2012 and 31 March 2013.
This trend is likely to continue and a number of de-risking opportunities will arise for those trustees who are best prepared to act. For many trustees faced with seemingly never-ending deficits, the notion od de-risking must seem daunting, but working innovatively, as LV did with the first longevity swap that included deferred members, can reap rewards.
Innovation – more precisely the lack of it - is an issue, in particular, for those who are trustees of smaller schemes – perhaps schemes with a few hundred million pounds of assets. This is a market that has been traditionally poorly served by consultancy firms and insurers alike, many of whom have focused on the very largest schemes. However, things are changing and we have worked together with insurers for a number of smaller clients to achieve significant de-risking successes.
Legal & General, for example, entered into a buy-in agreement with the trustees of the Kenwood pension scheme to insure some £23m of defined benefit liabilities covering mainly members yet to retire from the scheme. The transaction incorporates a deferred premium facility, which means that the covered members' benefits are fully insured from the point of signing but part of the full premium will be payable over a number of years in way that suits the sponsoring employer, Kenwood.
We also worked with Imperial Home Decor to enable them to complete an enhanced buy-out of the defined contribution part of its pension scheme – a scheme with just 140 members. The scheme has been in wind up since October 2003 when the organisation was declared insolvent and the deal that has been secured will see almost 140 DC members benefit from an enhanced annuity worth approximately £5 million.
So there are increasing opportunities, with the right support, to carry out targeted de-risking exercises. But trustees must first satisfy themselves on a number of key points:
• are we paying a fair price for our core services?
• is our data accurate, up to date and complete?
• do we understand the relationship between our assets and our liabilities?
Core scheme services consist of the actuarial work on funding and valuations, keeping trustees up to date with the impact of legislative and regulatory change and advice on governance alongside an on-going investment framework. Clearly these services are part and parcel of running a fully compliant scheme but they are fundamentally good housekeeping services that do not in themselves actively move the scheme towards self-sufficiency.
We still find many smaller schemes are using up a large portion of their resources – time and financial - on these core services. Sometimes different elements of a core service are being provided by a number of firms or each service is carried out by a separate team within a single organisation.
It goes without saying that accurate and up-to-date data is critical for the proper operation of a pension scheme and trustees do have the ultimate legal responsibility for the quality and accuracy of member records. The Pensions Regulator has been very clear in its views and trustees have been obliged to comply with its guidance since the end of 2012. So many have been cleaning up their basic data, seeing this primarily as a compliance issue – without, possibly, seeing the wider role good data can play.
High quality data is also a prerequisite for the completion of many de-risking projects and can have a very material effect on the cost of some exercises. Aegon, for example, recently estimated that missing spouse data can add as much as 15% to the cost of a longevity swap arrangement. Even for smaller schemes, this price differentiation can run into millions of pounds and have a material impact on the feasibility of an exercise.
Finally, trustees need to be able to access advice or tools which provide insight into the asset and liability dynamics of a scheme.
A great deal of attention is sometimes paid to the absolute returns achieved on a scheme’s assets. Clearly this is very important, particularly when assessing how a manager is performing against expectation, but where de-risking is the focus, trustees need to target their energies on improving the scheme’s funding-level and reducing funding-level volatility.
Too often this is handicapped by a lack of up to date information: knowing that an opportunity to remove risk existed several months previously is of little value. Even though many trustees receive information more regularly than the annual funding update, the reality is funding levels fluctuate on a daily basis and trustees can benefit enormously from the monitoring technology that is now available in the market.
A daily monitoring service allows trustees not only to make informed decisions but also to agree investment triggers to take advantage of market opportunities.
By sourcing the most cost-effective core services, enhancing the scheme’s data and putting in place technology to provide daily insights into the scheme’s asset and liability profile, trustees can then open up a raft of de-risking opportunities and begin to make the daunting doable.
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