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Be honest about the cost

Flood protection is generally reckoned to be a sound investment, given the relatively small outlay compared with the high cost to life and property when water inundates homes, shops and factories. When the British Isles were pounded by the severest storms in living memory in February, attention naturally focused on whether budget constraints had jeopardised flood protection, and whether greater expenditure would be needed to secure communities and prevent future floods.

The Netherlands is the country with the greatest historical expertise in water management and the Rijkswaterstaat, the agency responsible for water management and flood protection, has a total budget of over €5bn. By way of comparison, the budget of the UK’s environment agency is €1.5bn.

Like the ravaging tides of the Atlantic or the North Sea, the increasing ferocity of volatile markets wreaks havoc on the carefully determined asset portfolios of pension funds, and everyone recognises the need for pension funds to have actuarial buffers or to build these up over time. Perhaps it is no coincidence that the Netherlands has a strong culture of risk control, both in pensions and in water management.

Determining the extent of the protection needed ex ante is, of course, an inexact science. In pensions, if you are under-protected you risk the pension promise; if you are over-protected you face high contributions and low returns.

Rebuilding flood-damaged communities carries a considerable cost, which is ultimately met by us all through marginally higher insurance premiums. The real economy now also bears a considerable cost for insufficiently protected defined benefit (DB) pension funds.

It was much easier to repair deficits when pension funds were cashflow positive; now, since there are fewer active members left to pay higher contributions, they are more dependent on sponsor contributions and therefore much more reliant on the overall economic health of the sponsor’s business.

In countries with a strict supervisory regime, such as the Netherlands, funds with a deficit also face the so-called solvency trap if they are forced to sell the risk assets that would allow them to reach their funding target.

The arsenal that sponsors and trustees have at their disposal has never been stronger in terms of the sophistication of LDI strategies and other liability-minimising techniques such as bulk annuities or full buyouts.

As pension funds all over the world have edged closer to full funding, and even exceeded it, trustees must act to avoid the mistakes of 2008, when many sailed blindly into the turmoil of that year with no credible de-risking strategy. A DB promise requires an honest assessment of the cost and a recognition of the resources to fulfil it.

 

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