Helen Morrissey gauges industry reaction to TPR's investment guidelines for defined benefit schemes
The Pensions Regulator's (TPR) recently published investment guidelines for defined benefit (DB) schemes form a comprehensive guide to how trustees should set and monitor their investment strategy.
The document, which is the latest stage in the regulator's campaign to improve scheme governance, lays out its expectations for how trustee boards should assess and monitor risk, get the best from their advisory relationships and look at areas such as cash flow management.
The document has been welcomed by many in the industry who felt the guidance demonstrates what good practice looks like.
"I felt in terms of overall content then it is very comprehensive," says KPMG UK head of investment strategy - pensions, Simeon Willis. "There have been some who have said trustees should know this already but I feel we have been through a time of real change and some trustees will approach some of the newer developments with caution. It is really helpful for those who may be unfamiliar with some areas to see how much flexibility might be available."
He added: "It was great to see the guidance highlighting the importance of good advisers. I feel these advisers can use the guidance as a reference point by which to guide discussions with clients."
First Actuarial head of business development Henry Tapper described the document as "a good upgrade on what has come before" and praised its clarity and tone.
"The guidance makes it much clearer to trustees what their obligations are and what they need to be doing in terms of governance. Overall I feel it sets the right tone."
However, Tapper highlighted some areas where the guidance could be improved: "I like the guidance in terms of what it tells trustees they should do. Where I have difficulties is where it tells them what they should not be doing. For example it says trustees should not take account of the potential for the Pension Protection Fund (PPF) to step in and pay compensation to members when devising investment strategy. I can see where TPR is coming from in that it doesn't want trustees to think they can game the PPF but it also might deter trustees from taking risk at a time when their long-term investment horizon means they should be investing for growth."
The breadth of the document also highlights the importance of considering areas such as sequencing risk. However, such topics may not currently be top of many trustee board agendas.
Tapper agrees that while such areas may not be widely discussed at the moment, the guidance will help bring them into the mainstream.
"There are some areas in there that trustees will need to get to grips with and that is because we are moving in a different world now," he says. "This is a progressive document that addresses how the market is evolving and I think it will also help advisers to move their advice in a different direction. I think that has to be a good thing."
However, KPMG's Willis argues that issues such as sequencing risk have been an issue for schemes for some time and that the document gives guidance on how it can be approached.
"The issue of sequencing risk has often been discussed in terms of when a scheme becomes cash-flow negative but we would argue sequencing risk isn't just a factor for those schemes and has been an issue for years," he says. "There is also a tendency for schemes to think that if they are cash flow negative then they can't take risk but does that mean you can take more risk when you are cash flow positive? We would say it is more complicated than that and what was good about the paper was that it highlighted that more factors need to be taken into account before making such decisions."
The guidance will no doubt provide trustee boards with much food for thought and trustees should take the time to fully consider its implications.
However, Willis says the guidance should be seen as a baseline for good DB investment governance as opposed to being seen as all encompassing.
"I see this guidance as being like The Highway Code in that it sets a baseline but doesn't cover everything," he says. "Trustees should expect their advisers to go above and beyond this when helping them determine what approaches are most appropriate for them."
Redington's head of defined benefit Dan Mikulskis highlights the key questions trustees should be asking.
- Do you know the risk capacity of your sponsor, the risk budget of your scheme, and what the difference is? Understanding the risk-bearing capacity of the sponsor and how this should affect the risk budget is fundamental. Do you know what your risk budget is, and are you clear in which situations this would increase/ decrease?
- Are your assets working as efficiently as they can for your scheme? Are you using the full range of diversifying strategies, including illiquid assets?
- Do you know what you need to pay, and how this affects the scheme's risk? High levels of net cash flow out of a scheme leave the scheme more vulnerable to underperformance, as it can change the effect asset volatility has on a scheme. Even if your scheme is not materially cash flow negative today, advance planning can identify thresholds and tipping points which can inform your Integrated Risk Management (IRM) planning.
- Are you clear on your beliefs? It is worth getting clear (documented) agreement on your beliefs as a trustee board - such as what risks are rewarded, your attitude to liquidity, active management etc - so you don't have to repeat the conversation.
- Can you get everything you really need to know about your scheme on a single page? In our experience, better scheme outcomes have been associated with a relentless focus on a small number of the most important scheme metrics.
- Are you clear what actions you should take in response to changes in key scheme metrics? Having a dashboard is a great start. Reviewing the outputs it generates regularly (we would suggest quarterly) is even better, but what really matters for good decision making is knowing exactly what actions you will take if particular metrics decline or increase.
- Do you have the right metrics to get a handle on risk? There are a number of different 'lenses' that can help trustees get a handle on risk. No single measure gives the perfect answer in all situations. What matters are measures that help inform better decision making, and give trustees a better handle of the chance of ultimately paying the benefits due.
- Do you know what implicit assumptions are embedded in the models used to calculate your risk? Models, by definition, will always be a simplification with inherent limitations. There can be inherent assumptions baked into some of these models and it is important trustees understand what they are as they represent risks that are not explicitly measured.
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