By Chris Ramsey, FIA, Barnett Waddingham
Risk management is an essential part of managing the funding of a defined benefit pension scheme – trustees need to understand the risks they are running, and have a plan to manage these. Small schemes may have smaller budgets, but applying basic risk management principles doesn’t need to be an expensive exercise.
TPR helpfully gives some guidance on what it believes the key risks are for different types of schemes, and its expectations of how these should be managed. For example, for a scheme that is well funded with a strong employer, the key risk relates to downturn in the employer’s business either in the short or long term. TPR expects trustees to manage this by considering strengthening the funding of the scheme and ensuring that the scheme is treated fairly relative to shareholders (a common theme throughout the statement).
To satisfy TPR, trustees should (as a minimum) be able to show that they have considered its guidance and have looked at the impact of these potential future downside scenarios. TPR also promised to proactively engage with more small schemes through their valuation processes, including asking the trustees questions about their approach to risk management. Indeed, we have already seen evidence of this happening in practice. Documenting trustees’ discussions and conclusions on risk management will make this process go much more smoothly.
The importance of contingency planning
TPR also continued to emphasise the importance of contingency planning – planning for the “what-if”, not just what we expect. It says that contingency plans need to be “documented and workable”, and be designed to put the scheme’s funding position back on track.
This year TPR has helpfully acknowledged that legally enforceable contingency plans aren’t always possible, something notably absent from its previous statement. However, it made clear its expectations that trustees and employers should still at least agree in principle the actions they would take and document this. Ultimately, if trustees aren’t satisfied that their contingency plans are adequate, and there is nothing more that can be done, then they need to reconsider their strategy and potentially reduce the amount of risk they are taking.
Interestingly, Brexit uncertainty also gets its own section in the statement. TPR expects trustees to quiz employers about the risks they face due to Brexit, and where these are material to assess the expected impact on the sponsor’s balance sheet and cashflow short and long term. This is very good example of where contingency planning can help manage a scheme’s risks.
The overriding message on risk in TPR’s statement is that risk management is an essential part of a trustee’s duty, and that trustees, even of small schemes or those with strong employer covenants, need to take it seriously. The threat of TPR intervention appears stronger than ever, and trustees need to be prepared to demonstrate to TPR that they have considered its guidance and done the best they can to manage the risks in their scheme.
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