With the European debt crisis continuing to reverberate throughout the financial markets, the economic outlook remains uncertain and stock markets volatile. Mercer believes that 2012 will be a tumultuous year for the pensions industry with increased focus on governance, flexibility and tactical decision-making.
“2012 will be a year of threats and opportunities,” said Christian Hardy, Partner at Mercer, “Given immensity of the tasks of deleveraging Western economies, resolving the Eurozone crisis and coping with a weak economic outlook, where markets may well continue to be spooked easily, trustees and sponsors will need to stay alert as conditions could change quickly.
“Most pension schemes are seeking to reduce risk, but not at any price. While it remains important to maintain focus on a long-term funding objective, success in volatile conditions will require speed and flexibility when changing investment strategy or taking advantage of opportunities to reduce risk. Those trustee boards with sufficient time and resources should consider establishing rapid response sub-committees which can convene and respond swiftly to events. Those with more limited governance budgets could consider whether some of these decisions should be delegated.”
To date many scheme have not begun de-risking programmes because they perceive hedging as too expensive. Yet opportunities have come up, but have necessitated prompt action. “Trustees who have put in place asset or liability management structures will have fared better in the downturn than those who have not,”added Mr Hardy.
According to Mercer other hot topics for 2012 will be:
Market volatility and risk management
- Scenario planning - Trustees should consider scenario planning to understand how their funding position and the sponsor’s covenant would respond in distinct economic situations. It may also be helpful to understand how specific macro events such as a break up of the Euro might impact the scheme assets and liabilities as well as the covenant.
- Governance - Having long-term funding and investment targets are good starts but not thinking about the best governance structure to enable nimble decision making and effective implementation of changes will lead to wasted opportunities.
- Hedging opportunities – Whilst some markets look decidedly unattractive there may be selective opportunities to increase the level of hedging e.g. inflation and or longevity. As above Trustees and Sponsors need to be nimble to ensure they can take advantage of such opportunities before they disappear. With volatile markets it is entirely possible that different opportunities arise.
- Covenant review - If the economy slumps, firms may fail, regular monitoring of the sponsor covenant will give trustees up to date information on a company’s ability to support the pension scheme. With increased deficits, and increased cash demands, contingent assets will continue to be used to enhance security.
- Actuarial valuations – If bond yields persist at current low levels, the present value of liabilities will stay high. This creates a real “double whammy” when coupled with weak equity markets. “There is certainly scope for 2012 valuations to present significant challenges to sponsors and trustees,” said Mr Hardy. “Companies will need to approach the valuation discussion armed with the right arguments if they wish to persuade trustees to adopt a different approach to that used at the previous valuation.”
- Liability management activities – 2011 has seen a marked increase in the number of exercises designed to transfer benefits to members such as Enhanced Transfer Value exercises or exercises designed to adjust the form the promise (pension Increase Exchange exercises). Whilst there has been cautionary comments from the Regulator and the Pensions Minister we would expect Companies to continue to look to these approaches as a way of managing down the risk within their defined benefit schemes.
- Data cleansing –The Pensions Regulator continues to press the case for schemes to improve the quality of their data. “This can have a very immediate and direct impact on the pricing of certain contracts,” said Mr Hardy. “Longevity swap providers or annuity providers will charge a premium for inaccurate or incomplete data – quite possibly many more times the cost of a data cleanse - so it really makes financial sense to get onto this sooner rather than later”.
- Increased debate on the future of the UK’s lay trustees – Although the level of knowledge and understanding of the average UK trustee has improved over recent years, there is still a journey ahead. 2012 will intensify discussion over the suitability of those trustees unable to perform effectively during a time when quick decision making is vital.
Auto-enrolment
There is growing recognition by companies that this is not just a pensions issue and that it is critical to involve HR, payroll and finance in the strategy and planning. Engaging them early will enable companies to make sure they use auto enrolment to build a strategy which is fit for the future, rather than trying to quickly put something together a few months before their staging date, when capacity at providers is unlikely to be available to support them.
“With the October 2012 deadline for the larger companies fast approaching there will be a panic as the implications of auto-enrolment become apparent“, said Clare Owen, Principal and Head of Mercer’s Governance and Trustee Services team. “Despite industry exhortations that they move forward, companies are simply not prepared..”
Pensions Reform
- Getting the balance of regulation right - The challenge for Regulators in 2012 will be to get the balance right from the proposed adoption of Solvency II for pensions regulations to allowing practical measures for Special Purpose Vehicles (SPVs) to support a solid pensions system while helping companies manage their costs. “The government seems interested in exploring risk-sharing structures which is certainly welcome. Whether it is all too late remains to be seen - we’ll continue to watch this space,” said Deborah Cooper, Head of Mercer’s regulatory team.
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