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Governance key to reducing pension risks

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  • Governance key to reducing pension risks

UK - Around 60% of senior executives believe improved governance and decision-making is the best way to reduce the impact of pensions risk on company finances.

Findings from a report by the Economist Intelligence Unit, which was sponsored by Towers Perrin, revealed two-thirds of 200 board level executives, including chief executives and chief financial officers, believe pension risks have become "more severe" over the past three years.

In particular, regulatory changes that could affect scheme funding was the key risk for 48% of the respondents, while 47% were most worried by changes to mortality assumptions and 40% highlighted the volatility of equities.

As a result, the report entitled ‘Challenges of managing UK pension schemes' revealed 60% of respondents believed governance changes to improve decision-making are successful or very successful at reducing the impact of pension risks, rating it higher than changes to benefit design and the use of derivatives.

The survey highlighted evidence suggesting schemes are most worried about risks they cannot control, such as longevity increases, as products to sufficiently hedge out mortality risk do not yet exist.

And while market volatility is considered more manageable, through technical solutions such as derivatives and liability-driven investment strategies (LDI), the report warned results "can be imperfect".

This has led to multi-asset funds "sucking in assets at a breathtaking rate" as schemes start adopting a "new balanced approach", although over the next three years more than one-fifth of respondents expect to increase their private equity allocation, and more than 25% said they intended to reduce equity exposure.   

Findings from the report also showed an increasing number of schemes are trying to remove investment benchmarks altogether, with 44% believing LDI is the best way of reducing the impact of pension risk on the company's finances.

Currently, 17% of schemes use derivatives to hedge inflation and interest rate risk are becoming popular, and 39% intend to use them in future, however LDI as a concept remains relatively new as just 14% admitted to having already implemented it and 41% intend to apply it in the next three years.

Increased knowledge is also a high priority as 42% of respondents want to improve their understanding of funding options, and 36% want an increased knowledge of long-term trends, although attitudes to bulk annuity buyouts remain mixed.

The findings showed 60% of respondents are prepared to transfer at least some of their liabilities to a buyout company, if the price is competitive and the action had the full support of stakeholders.

However, in practice just 19% are intending to conduct a buyout in the next three years, while 61% do not intend to explore the option at all as there are fears about reputational damage to the trustees if the buyout company fails, as well as a possible reluctance of trustees to support the deal and the high economic cost.

Mark Duke, head of pensions at Towers Perrin, said although many companies know they've got a big pensions problem, "it's technically complex, often challenging to define a solution and sometimes near impossible to get all the stakeholders to take the necessary decisions".

"Effective decision making has to be underpinned by good governance. The people who do this best are the ones who get to the right answers first and stop their problems getting bigger," he added.
 
If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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