The self-sufficiency approach regarding pensions occurs when
pension schemes reach a certain threshold in relation to assets that enables
them to feasibly sustain themselves solely by investing such assets. In doing
so, they rely less on funding from sponsors.
However, there are certain obstacles that need to be overcome
for pension schemes to be successfully self-sufficient. We look at the main
self-sufficiency challenges that are often experienced within the pensions
Limiting risks involves balancing pension scheme assets, to
ensure that they are invested in a way which minimises risks to the pension
scheme’s investment portfolio. This is particularly pertinent for those aiming
for self-sufficiency, particularly as we approach cash negative scenarios as
they will be trying to establish ‘what are the most effective investments for
capitalising on income needs?’ and ‘how can we maximise investment gains?’
By focusing on these objective questions, pension schemes
can mitigate some degree of risk and concentrate on achieving adequate returns
that promote self-sufficiency. Once self-sufficient, a pension scheme is
usually 100% funded based on its own investment choices, so underperformance
within an asset category has minimal impact on their sponsor.
De-risking Strategies for Investments
Certain changes to
de-risking strategies can be controlled or taken into account by trustees and
sponsors more so than others. Monitoring market conditions and the performance
breakdown across the assets your pension scheme invests in, will enable you to
make appropriate changes to your risk strategy.
Trigger-based de-risking strategy is centred around this concept and
remains a long-standing, popular approach to determining how to adapt to
changes that affect your asset classes. If applying this method as part of your
asset strategy, you will need to establish well-defined rules to determine when
changes are needed based on actions (triggers) within the financial market. The
setting of such triggers is increasingly part of investment consultant guidance
and is also incorporated into a Fiduciary Managers mandate.
It’s also important to decide on a plan of action regarding
the amount of time that’s needed in order to reach self-sufficiency. This is
known as the recovery period. If adequate time is not allowed to obtain the
required level of self-sufficiency, then you increase the likelihood of pension
scheme assets being invested in asset classes which are more volatile and
therefore carry larger risks. The length of the recovery period is coming under
increasing scrutiny by the Pension Regulator and features in the new
consultation so is likely to form a major part of many a valuation discussion.
A longer recovery period can result in higher returns being
expected within a market whose long-term future is by its very nature unpredictable
and therefore higher risk.
Finding the balance between short-term investments that will
gain value and long-term investments that carry greater risk, but also greater
potential reward has always been tricky. The integrated risk-management approach
has started to incorporate the impact of the employer covenant strength and
modelling tools are developing that can assess risk in terms of both exposure
to the Scheme investments and corresponding impact on employer business plans.
Trustees and employers now need to factor in the most recent consultation and
what this may mean to valuations.
Cashflow is becoming a primary consideration due to a combination
of maturing membership, the reduction in ongoing contributions and the
increasing tendency of transfers to access DC flexibilities. This can all
become a significant challenge to self-sufficiency, and we are seeing
increasing developments in the way in which some of the more innovative
consultancies are placing cash requirements at the heart of their investment
Pi Partnership provides specialist independent consulting to
employers, occupational pension schemes and Boards of trustees. We are one of
the leading providers of independent scheme secretaries and provide
professional trustee services to a wide range of pension schemes. Over the last
20 years we’ve worked with clients ranging from FTSE100 companies to small
charitable organisations. For more information about the services we can offer
your business contact us today.