Jonathon Land says 'wait and see' is no longer an option and trustees should be proactive to ensure they are on a robust footing ahead of 29 March
With Brexit on the horizon and certainty still appearing out of reach, you don't need me to tell you there could be a few rocky roads to navigate in the future. But while many economic forecasts point to challenging times ahead, for pension scheme trustees it is all about being properly prepared. There are a number of preemptive steps that defined benefit schemes can take now to ensure they are on the strongest footing for the journey ahead:
1. Ask management how they have considered the risks
Schemes should engage with management to ask how the business is preparing for Brexit. Any impact will be especially important if the scheme has a significant deficit that will require contributions from the business going forward.
As a trustee, the key is asking the right questions of the business in terms of Brexit preparations and strategy. For example, has management adequately considered the impact of different kinds of Brexit including no deal?
The level of planning from management as well as the answers you get will give you a sense of the resilience of the business, so that you can make informed decisions about adjustments required by your strategy. Without the information a more prudent approach might be considered, so it's in the interests of businesses and trustees to work together and be open about their Brexit strategy and planning.
2. Understand the impact on the employer covenant
Trustees should use this planning and apply it to their understanding of the strength of covenant of the underlying business. Brexit will affect many businesses, and some potentially seriously. For example, in the event of no deal being agreed manufacturing businesses could find that input costs rise, which will affect businesses with tighter margins. Transport and travel could also be hit with regulatory challenges potentially leaving goods unable to cross borders and visa challenges impacting availability of staff.
For some businesses, Brexit will affect the amount of cash they generate, even if only in the short term, and that will in some cases translate into financial difficulties and lower contributions to pension schemes. Now is the time to identify potential issues, develop and implement an action plan covering what the impact could be on your pension scheme.
3. Consider how this could affect the investment strategy
What you do next really depends on the strength and resilience of the business.
The toughest decisions will be reserved for trustees of funds where the businesses are more exposed or less resilient. In this case, trustees and sponsors should review the level of risk that is appropriate for the fund and investigate whether action is needed now to reduce risk. This could involve interest rate, inflation and equity hedging, diversification of risk by investing across different geographies and assets which are less correlated to each other, as well as examining whether some assets should be sold if their risk-adjusted return is no longer appropriate.
We recommend developing a robust framework which starts with an understanding of the best estimate benefit outgo over the scheme's life and working out how best to invest to deliver those cashflows. You can then decide how much risk capital is needed in case this doesn't play out as you expect and whether you would have that much capital available from the scheme and/or sponsor if adverse scenarios do materialise.
4. Model the economic scenarios
Trustees need to examine the potential impact on both assets and liabilities.
If assets and liabilities are not matched then a shock could see some UK assets such as property fall while an increase in inflation will push liabilities up. We think it is important to model the impact of different Brexit outcomes and to be able to explain these to your stakeholders.
For contingency planning purposes extreme scenarios can be modelled. For instance, the Bank of England's Financial Stability Report tested market shocks which included commercial UK property prices moving down by 48%, inflation spiking to 6.5% and interest rates rising in response to 5.5%.
5. The most important thing is to take control
Brexit will affect the economy. The problem for pensions trustees is that ‘wait and see' is no longer an option given the risks outlined above and indeed The Pensions Regulator's recent advice that trustees "should review actions and contingency plans in the context of a no deal" - guidance that trustees told us during our recent webcast that they were keen to have.
Trustees need to consider the range of outcomes and apply them to both the business and the scheme. We believe if put together, these steps will put integrated risk management plans to the test and demonstrate trustees are doing what they can to meet and protect future obligations.
Jonathon Land is pensions partner at PwC
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