A way through the maze: The challenges of managing UK pension schemes is an Economist Intelligence Unit report that examines the risks associated with running UK pension schemes, and explores the approaches to governance, funding, investment, and scheme design that companies use to manage these risks. The report was commissioned by Towers Perrin.
The risks associated with running UK pension schemes are becoming more severe.The majority of respondents questioned for our survey believe that the risks facing their organisation’s pension scheme have increased over the past few years. The key risks, according to respondents, are regulatory changes that could affect funding, which are cited by 48%, changes to mortality assumptions, which are cited by 47% and volatility of equities, which is cited by 40%.
Better knowledge and understanding is a key risk management tool. When asked about the aspects of their scheme management that they are keen to improve in the next few years, items related to “knowledge and understanding” score highly. For example, improving their understanding of funding options is seen as the main priority, cited by 42% of respondents, followed by improving their understanding of long-term trends, which is cited by 36%. With new risks on the horizon, and new techniques to manage, mitigate or transfer them becoming available, keeping abreast of new trends and often complex concepts has become more pressing than ever.
Performance management remains an important weakness. When asked about their strengths and weaknesses with regard to different aspects of scheme governance, respondents saw their strengths as the setting and monitoring of investment strategy and the managing of relations between trustees and the corporate sponsor. They were also fairly confident about their ability to put in place a formal process to identify risks and monitor those risks on an ongoing basis. The main areas of weakness were seen to be performance management—of investment consultants and trustees in particular—and enhancing trustee competencies. Many companies, it seems, have difficulties in determining the metrics that apply to their scheme, and in conducting performance management based on outcomes.
More innovative investment techniques have yet to enter common practice. Tools to optimize investment strategy, such as liability-driven investment or the use of derivatives, are widely discussed and written about in the business press, but they remain little used among UK businesses. Just 14% of respondents say that they already have liability-driven investment in place, and 17% say that they use derivatives to hedge interest rate and inflation risk. Appetites to use these tools in future are relatively strong, however, with 41% intending to apply liability-driven investment in the next three years and 39% intending to use derivatives.
The idea of transferring liabilities has its appeal, but practical considerations are preventing takeup. Appetites for the concept of bulk annuity buy-outs seem relatively strong, with 60% of respondents saying that they would transfer at least some of their liabilities if they could do so at a competitive price with the full support of stakeholders. In reality, however, most respondents say that they would be unlikely to adopt this approach: just 19% intend to transfer liabilities to an insurance company over the next three years, and 61% say that they do not intend to explore this option. The main barriers are cited as being the reluctance of trustees to support such deals, and fears about reputational damage should the third party fail to meet its obligations. A significant proportion also believes that the economic cost of buy-outs is simply too high to consider it.
