Ending the model wars: How the Royal Mail Pension Plan revamped its governance to focus on what really matters

In 2012, some £28bn of the Royal Mail Pension Plan's assets were transferred to the government as part of the Royal Mail's privatisation process - and the plan went from being a scheme with £30bn of assets to one with just £2bn of assets almost overnight.

But the new-look RMPP was in good shape - being both fully funded on a technical provisions basis and growing fast, with net income of around £500m a year.

Royal Mail Pensions Trustees chief executive Chris Hogg believes the change in scale meant the scheme had the potential to become much more nimble but also meant it needed to think hard about how to make its governance process as effective as possible to allow it to do all everything it needed to.

Working with the sponsors

Hogg says: "One of the things we thought about in particular was transparency and we have worked very hard on building up the relationships with all our stakeholders - essentially with a view to achieving a position of no surprises and also to speed up decision making. We take the view that, while the Pensions Act 2004 has perhaps pushed trustees and companies apart, there is actually a lot of benefit in pulling them back together."

One way in which the RMPP has tried to pull the relationship between the sponsor and trustees together is by asking sponsor representatives to attend investment sub-committee meetings wherever possible.

Royal Mail Pensions Trustees chair Joanna Matthews explains: "It is very important the sponsors not only understand but have positively bought into the investment decisions trustees are making rather than being told after the event because the decisions trustees are making can have vast implications in financial terms."

The scheme also believes including sponsor representatives in investment sub-committee meetings can also speed up decision making significantly.

Royal Mail Pensions Trustees chief investment officer Ian McKnight adds: "Most trustee boards would go through their process of decision making and then they would consult - and this is just an extra layer of to-ing and fro-ing.

"By the time you've done this, months or sometimes whole quarters have gone by and you haven't done anything. Including representatives from the sponsor in investment sub-committee meetings has enabled us to let them know what's coming, get their feedback in real time and get stuff done in a very short time. That's really important."

Management information system

But the RMPP has also improved governance with the implementation of a bespoke management information system it has developed in association with Kempen Fiduciary Management (the former UK arm of MN) - a system that provides detailed risk management analysis and asset/liability modelling to the executive team, trustees, sponsors and other interested stakeholders.

Hogg explains: "It's got two very significant benefits. First, it gives us a lot of visibility and it gives us a lot of control - which aids understanding and helps to speed up decision making.

"The second benefit is the ability to use it to increase transparency. So you can share that visibility and that awareness of the plan's dynamics across stakeholders beyond the trustee. By doing this you can then speed up decision making because people are coming along for the ride, they're comfortable with where the plan is."

McKnight says the scheme looked across the market at all the data analytics tools that were commercially available but felt none could offer the functionality they were looking for.

He notes that while Kempen is known for its fiduciary management services, that is not the role they are undertaking for the RMPP.

He says: "It is really bespoke - and far above and beyond what you can get off the shelf from any of the major providers. I think it's as good as you can get.

"We are in essence an open architecture fiduciary manager being supported by Kempen." He says: "They're like a back office, we plug them in and they do our reporting and our modelling. So we still have trustee advice, consultants and so on, but the modelling is centralised so that trustees, sponsors and interested stakeholders can all see the same numbers."
 

 

Model wars

The main driver behind the management information system was to improve the flow of information between stakeholders but the scheme also wanted to try and reduce the time and cost incurred by having several different advisers produce numbers for each of the different parties.

As Hogg explains: "Ultimately what happens is you spend a lot of time in rooms reconciling why someone across the table from you has a slightly different number. We wanted to take that away; we wanted to focus the time in those meetings and discussions on actually solving the challenges that lay in front of us."

Matthews agrees. "One of the things I had found frustrating in other roles in the past is when advisers get into so-called ‘model wars' where one set of advisers has produced a set of figures for example, and then the company's advisers suddenly say their figures don't look like that and then the principals just end up sitting there twiddling their thumbs while the two sets of advisers argue over the figures, which is obviously a frustrating waste of everyone's time.

"We put in place the shared information system to make sure that, at the very least, we are starting from common information and it is accessible to both the trustees and the company. This means when you go into valuation discussions, you can do it meaningfully and very openly.

As part of implementing the management information system, the scheme has established an asset liability management (ALM) committee which meets periodically to ensure all actuaries, consultants and advisers are comfortable with the assumptions being used in the system. All advisers have agreed to base their advice on this central model.

RMPP says it plans to continue to develop the system. Hogg says: "We want to evolve this and we want to challenge the current ways of doing things. One thought is around real-time liability evaluations. For instance, can you have a direct feed of data from your administrator into the model so that at all times you've got a completely up-to-date picture? It's a concept that we intend to explore."

Creative tension

The RMPP is also using its advisers in a different way - and while it has long term relationships with its actuary, Towers Watson, and its investment consultant, Mercer; it uses a range of consultancies for project work.

It believes this willingness to use a range of advisers can improve the overall level of advice the scheme receives.

McKnight explains: "In a traditional model, you select your adviser, they tell you what to do and they'll take ages. We're not like that at all.

"Over the past three years, we have used all the major consultancies on various projects - picking the best in each area and bringing it all together. By utilising what we call creative tension, they are incentivised to bring you really, really good ideas. And they bring it in and they support you on implementing. By having a fleet of advisers on board, you can pick the best ideas across the market.

Hogg agrees: "We talk about this creative tension concept quite a lot. In this way an in-house resource is a tool that can be used for cost reduction purposes and elevate the solutions that you're able to achieve. So if you've got the right relationships with your advisers and if you've got the right resource internally, then you can have a discussion of intellectual equals that takes a solution and elevates that solution to a better place.

"So we look for advisers that we are able to have those effective discussions with. We look for advisers who are happy for us to tell them that we disagree with them, and who are happy to tell us that they disagree with us. Because it is in those discussions that you get that process of elevation."

Benefits of improved governance

RMPP has used the enhancement to its governance structure to be able to become more nimble and to achieve a very strong level of diversification - including a significant alternatives portfolio and a roster of nearly 30 separate asset managers.

This has proved to be a profitable strategy for the RMPP - and returns on return-seeking assets have been well ahead of the benchmark, with the Royal Mail Group section of the scheme posting annualised returns of 8.3% per annum over the three years to 31 March 2015 and the Post Office section posting returns of 6.2% per annum over the same period (see table: How the RMPP's portfolio has performed).

McKnight says that while there are no obvious investment ‘buys' out there currently he believes there are some areas that look relatively attractive and can help eke out value.

He says: "By eking out value, you focus on two things. One you try to make slightly more money for the same risk, but two, you focus on costs. So we've done both of those this year."

One good example of this is how the RMPP has focussed on increasing yield as spreads on investment grade credit have reduced.

As such it is looking at credit substitution assets such as infrastructure debt - and has just invested £130m into an infrastructure debt mandate.

McKnight explains: "While infrastructure debt may appear dear it can increase your yield and impart some liability hedging characteristics which lower your cost of dealing. So it's a double whammy. "

In addition, the scheme has also just invested £130m into a collateralised loan obligation portfolio - an investment that has almost double the spread available on investment grade credit but is comparable in terms of risk.

Liabilities

While the scheme has had strong growth from its return-seeking assets it also focuses strongly on risk - and has had a Sharpe ratio well in excess of two over the past three years, meaning the scheme has good risk-adjusted returns.

The RMPP has also put substantial effort into structuring its liability matching assets - hedging much of its exposure and avoiding the consequences of a sharp fall in gilt yields over the past year.

Hogg explains: "The vast majority of our hedge went on before the real falls of the past 12 months. And if we hadn't pushed as hard with that, then the funding position of the plan would be in quite a different place. You can only speculate on what that would be - because obviously it depends on what other investments you might have made ¬- but it would certainly be of the order of £1bn worse off if we didn't have the hedge at all."

Trustee board

Getting trustee boards to understand the level of investment complexity inherent in portfolios such as the one the RMPP has constructed is never easy but the scheme has managed it with the assistance of the executive.

McKnight explains: "We need our trustees to understand what we're doing and we don't go for complexity for the sake of it. But we do take them with us on the journey so they understand fully what they're invested in."

Matthews adds: "Such complexity is only possible because we have a dedicated executive team to help with the monitoring, the visits and the compliance that needs to be in place. Unless we had this team, I don't think the more complex investments would be possible from a governance perspective and trustees would have to go down a complete fiduciary approach to get the same level of complexity and diversity."

Reducing costs

The RMPP has also had considerable success over the past few years in reducing cost. It has managed to reduce its cost base by just over 5% over the past six months by negotiating fees down with its asset managers, advisers and other suppliers.

RMPP calculates the aggregate improvement to net return - the cost savings plus net income improvements - achieved through this process is just over £4m per annum, a figure which is expected to persist over the next five years resulting in a cumulative saving of £20m.

Hogg explains: "Our suppliers were completely understanding about our position and we have managed to go through that exercise and retain all of our suppliers. There have been no issues with anyone so we've come out of it in a really good place. We've still got the relationships and we feel as though we've challenged the contracts that we have."

Communicating to members

While a lot of the scheme's focus has been on improving its governance, information flow and investments, the scheme has also paid considerable attention to its communications. It felt that the closure of the scheme to new members in 2008; the shift to career average accrual and an increase in retirement age for future service and the split of schemes at privatisation - with pre-2012 accrual being moved to the Royal Mail Statutory Pension Scheme - had led to a complex scheme that members didn't always understand.

While there is a good level of engagement among members - who know they have a good pension - they are very much less clear about what they get and when.

Matthews notes: "The trustees felt the complexity of the scheme meant many members didn't understand the benefits they had and how valuable this was to them."

Royal Mail Pension Plan head of membership & benefits Mark Rugman says the scheme began addressing this issue by conducting a survey towards the end of last year among 3,000 members. This was followed up with face-to-face interviews with 80 members.

Rugman explains: "The survey really helped us get a feel for how members see their pension, how they talk about it, what language they use, and what they do and don't like."

One of the key findings of the survey and the subsequent interviews was the benefits statement sent annually to all members was hugely valued but many respondents found it hard to understand.

As such, improving its benefit statement became a key focus for the scheme.

Rugman says: "So while the survey told us that over two-thirds of people didn't understand how their benefit was calculated, when you sat down with people and spoke to them, they said they didn't want to know how it was calculated, just what they were going to get."

The scheme set about redesigning its benefit statement using simple language and key information to help educate members and getting input on the new design and approach from a panel of 12 members it recruited from among the people who had done the face-to-face interviews.

Rugman explains: "We tried to move from a fairly regulatory requirement to more of an education and engagement process - getting people to understand their benefits, what they're going to get, when they're going to get it. This in turn is starting to get people more interested."

Modelling benefits

The scheme has also refreshed its website, introducing a simple early payment modeller to help members plan for the future, especially those approaching 55 who may be considering their options for flexibilities such as reducing their hours and taking some pension immediately.

The RMPP hopes the new-look website and the modeller will reduce the number of people calling the helpline requesting a quote. This will allow it to focus more on information around that quote and their options when they have decided to proceed.

Rugman explains: "Hopefully this will change behaviour. Not necessarily reducing the number of calls to the helpline but changing the way that people are calling the helpline and freeing up some time to actually speak to the members about the benefits that are in front of them as opposed to just simply running off a query to send a quote out."

The scheme is now considering re-running the member survey in the near future to both continue the discussion with members and to help see how understanding has improved. It is set to start the second phase of its improvement programme, redesigning the rest of the plan material along the same lines as the benefit statements, imminently.

Continual improvement

The proof of the pudding is so often in the eating but the fact that the RMPP has achieved solid investment returns, implemented a management information system, improved governance and overhauled its communications over the past few years must surely be an indication of success.

But, while the scheme has had success over the past three years, it is certainly not resting on its laurels and shares a mantra of continuous improvement with its sponsors.

As Hogg says: "You can always improve. And it's our job to find where those improvements are."