Pensions Arena

July 2019

Article

ROOT and branch

For a picture of bac’s approach to DB governance, imagine a flourishing tree. The root system is not usually visible but it’s crucial to the health of the whole tree, as is the environment in which the tree lives.

In terms of good governance for a DB scheme, Risk management and, in particular, the risk register can be seen as the roots of the tree. The main trunk of the tree represents the trustees’ key objectives for the scheme over the short and longer term. Together the root system and the trunk support two main branches of governance:

  • Organisational, by which we mean the strategic decisions which trustees need to take about the scheme’s funding and investment strategy, based on their view of the strength of the sponsor’s covenant
  • Operational, which is focused on ensuring the smooth running of the scheme.

In our model, Technology reflects the environment in which the governance tree grows. Technology helps ensure that the recording and monitoring of risks can happen in real-time, so that trustee decisions, whether organisational or operational, are taken with a full understanding of the impact they will have on the scheme’s risk management.

Healthy roots

Our starting point is to make sure the scheme’s risk register is fit for purpose. For many schemes, this will mean moving away from a large ‘tick box’ register to a more focused and streamlined approach, with the register only dealing with a small number of key risks (10 at most). This re-design is critical if the register is to become the main roots of a scheme’s governance.

Too many schemes still fall into the trap of reviewing their risk register, along with the associated actions, just once or twice a year. By integrating the risk register into regular trustee meetings, we help ensure the progress of agreed actions is reviewed more frequently, which usually means they get done quicker too.

Strong trunk

Next, we consider the trunk of the tree and the question of what the trustees see as the key objectives for the scheme? Often trustees feel they have objectives but these are implicit rather than explicit. bac’s role as governance adviser is to help trustees articulate the high-level direction of travel, so that they are clear on what they want to achieve. This is increasingly the focus of the Pensions Regulator, who wants trustees to have a clear long-term plan for ensuring all benefits will be met in full.

After a thorough review of the risk register and confirmation of their key objectives, the trustees will be a in a good place to develop their business plan. This should be kept at a fairly high level and used to identify actions for the short (within one year), medium (1 to 5 years) and long term (beyond 5 years). These actions form the basis of the two main branches of the governance tree.

Organisational branch

The inter-relationship between covenant, investment and funding has been the focus of the Pensions Regulator’s extensive guidance on developing an integrated risk management (IRM) framework. IRM does not have to be complicated and the fact that it often seems so is not a weakness of IRM but of the way in which the framework has been developed.

bac’s role as governance adviser is to work with trustees and their covenant, investment and actuarial advisers to design an IRM framework that is appropriate for the circumstances of the scheme in question. We do not seek to supplant any of the incumbent advisers but rather, using our broad experience of trustee governance, to act as an honest broker in bringing the advisers together to develop a practical and cost-effective IRM framework.

Operational branch

Here the trustees’ natural focus is on areas like:

  • quality and security of data
  • accuracy and timeliness of benefits administration
  • sound management of scheme finances
  • effective communications with members
  • having the right advisers in place.

These are all important but, in our experience, they need careful summarising within the risk register so that they do not generate too many operational risks and take up too much trustee time.

Protect the environment

Whilst technology cannot replace good governance, it can make it much easier to implement it effectively. For an IRM framework, the inter-relationship between the key factors underlying covenant, investment and funding can most easily be captured using formulae. With that backdrop, technology is extremely helpful if trustees are to see and understand in a very immediate way the impact of changes in those factors. It can also be used to role play the impact of possible changes, so trustees can appreciate first-hand how an event like a no-deal Brexit might affect their risk measures. bac has helped develop bespoke IRM frameworks for several large DB schemes and provided the online dashboard that brings those frameworks to life.

The last word

As a result of their good governance, some very large DB schemes are within five years of being able to secure all their liabilities in the insurance market. Even if your scheme is unlikely to achieve that endpoint so quickly, good governance will mean you sleep better at night under the canopy of your governance tree.

If you would like to know more about how bac can help you improve your scheme’s governance, please contact us at governance@bathactuarial.com.

Dashboard

Investment returns by asset class

Investment yields

Annual rate of inflation (%)

30/06/2018 30/09/2018 31/12/2018 31/03/2019 30/06/2019
Expected RPI inflation over 20 years
3.42%
3.52%
3.58%
3.59%
3.55%
Index-linked gilts
-1.59%
-1.50%
-1.59%
-1.86%
-1.90%
Fixed interest gilts
1.76%
1.93%
1.81%
1.54%
1.44%
Corporate bonds
2.72%
2.81%
2.76%
2.36%
2.25%

Investment yields

30/06/2018 30/09/2018 31/12/2018 31/03/2019 30/06/2019
Expected RPI inflation over 20 years
3.42%
3.52%
3.58%
3.59%
3.55%
Index-linked gilts
-1.59%
-1.50%
-1.59%
-1.86%
-1.90%
Fixed interest gilts
1.76%
1.93%
1.81%
1.54%
1.44%
Corporate bonds
2.72%
2.81%
2.76%
2.36%
2.25%
  • 30/06/2018    ~    3.42%
  • 30/09/2018    ~    3.52%
  • 31/12/2018    ~    3.58%
  • 31/03/2019    ~    3.59%
  • 30/06/2019    ~    3.55%
  • 30/06/2018    ~    -1.59%
  • 30/09/2018    ~    -1.50%
  • 31/12/2018    ~    -1.59%
  • 31/03/2019    ~    -1.86%
  • 30/06/2019    ~    -1.90%
  • 30/06/2018    ~    1.76%
  • 30/09/2018    ~    1.93%
  • 31/12/2018    ~    1.81%
  • 31/03/2019    ~    1.54%
  • 30/06/2019    ~    1.44%
  • 30/06/2018    ~    2.72%
  • 30/09/2018    ~    2.81%
  • 31/12/2018    ~    2.76%
  • 31/03/2019    ~    2.36%
  • 30/06/2019    ~    2.25%

Annual rate of inflation (%)

Sources for market indices​

  • UK equities: FTSE Actuaries All-Share Index
  • Global equities: FTSE All-World Index (Large/Mid Cap) – in sterling
  • Index-linked gilts: FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
  • Fixed interest gilts: FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
  • Corporate bonds: iBoxx over 15 years AA corporate bond index
  • Expected RPI inflation over 20 years: Bank of England RPI implied inflation spot curve at 20 years (force of interest)
UK equities
FTSE Actuaries All-Share Index
Global equities
FTSE All-World Index (Large/Mid Cap) - in sterling
Index-linked gilts
FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
Fixed interest gilts
FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
Corporate bonds
iBoxx over 15 year AA corporate bond index
Expected RPI inflation over 20 years
Bank of England RPI implied inflation spot curve at 20 years (force of interest)

Almanac

Governance actions

Regulatory

  • For your DC arrangements, have you reviewed your default strategy and associated charges recently? There is a growing body of evidence on member retirement decisions, i.e. what proportion have taken cash, drawdown or purchased an annuity, which will help your thinking about the appropriate DC default strategy.
  • The volume of DB transfers remains high. Are your anti-scam procedures up-to-date?

Governance framework

  • How has your risk register changed over the last two years? Is it possible for you to use it to audit how effective the trustees have been in managing the scheme’s risks?
  • Consider running more realistic “What if” scenarios through your integrated risk management framework. As well as providing a helpful training session for your trustee board, such role play will also highlight weaknesses to be addressed.

Resourcing

  • Trustees have been looking carefully at the resources at their disposal to achieve their strategic aims. There is a growing recognition that having a “perfect” governance model is pointless, if the resources are not there to implement decisions.

Corporate actions

March/April 2019 valuations

  • Results should be available now, do they meet your expectations?
  • When finalising your valuation strategy, make sure you consider how TPR’s 2019 funding statement will affect your trustees’ thinking, for example about your future dividend policy.
  • If not already a feature, you will need to introduce a long-term secondary funding target. You will want to be on the front foot in framing the structure for this and its flexibilities. And you will want to think through the implications of the secondary target for investment strategy and actuarial factors, particularly for transfers out.
  • The slowdown in the pace of mortality improvements should mean at least a 5% reduction in liabilities at this valuation, but the scheme actuary may resist the full extent of this change.
  • Have you reviewed recent transfer experience? It may be possible to build an allowance for a modest flow of transfers out into the recovery plan.

Brexit

  • How is your business likely to be affected by the continuing delay and uncertainty over Brexit and have you been managing your trustees’ expectations carefully? Be ready for their follow-up questions as the structure of the UK’s exit becomes clearer, eventually!

Pension developments/news

Pension developments

April

Pensions dashboard

  • The Government published its response to the pensions dashboard consultation, saying it will compel all pension providers to make consumers’ data available to them through a dashboard. It expects most schemes will be ready to “go live” within four years, whilst State Pension information will be included “as soon as possible”. Schemes will be required to provide their data in line with a timeline that prioritises membership coverage, so large DC schemes will be first. Legislation for the dashboard is expected to be in this year’s Pensions Bill.

May

DB funding code delayed

  • In a blog by TPR’s executive director of regulatory policy, analysis and advice, two consultations on DB funding were announced. The first, due this summer, will focus on options for a clearer framework for DB funding. The second consultation on the new DB funding code itself is now not planned until 2020.

PPF benefits

  • In a German case, the Advocate General of the CJEU argued that the Insolvency Directive requires member states to protect all pension benefits affected by an employer’s insolvency. If the full CJEU agrees, this would have important ramifications for the level of PPF benefits.

GMP data delay

  • HMRC annouced a delay in the provision of GMP reconciliation data until late November 2019.

June

More SIP changes

  • Regulations were laid by the DWP that will require changes to every scheme’s Statement of Investment Principles no later than 1 October 2020. Trustees will need to have a policy in their SIP covering the arrangements with their asset managers and how they are incentivised, including how trustees monitor portfolio turnover costs. The SIP will need to published on a website from 1 October 2020.

CMA proposals become law

  • The CMA issued a legally binding order bringing in its investment consultancy and fiduciary management reforms. Trustees will need to set strategic objectives for their investment consultants and consultants will need to report on how they have met these. Trustees appointing fiduciary managers for more than 20% of their scheme’s assets will need to run a competitive tender (those with such existing fiduciary managers will need to run a competitive tender within two to five years).

DB transfers

  • The FCA published data about DB transfer advice which was out-of-line with its starting point that transferring out of a DB pension scheme is unlikely to be suitable for the member. Of 2,426 firms who had provided DB transfer advice for almost 235,000 members, nearly 70% of those members had been advised to transfer out. The FCA is now writing to firms setting out its expectations.

Updated DC investment guidance

  • TPR published updated guidance for trustees on DC investment, taking into account changes required to statements of investment principles by October 2019. The Regulator’s guidance also provided further clarity around what is meant by financially-material considerations and stewardship, and how to prepare an implementation statement.

Pension news

Plan design

  • After a six-year legal battle, British Airways agreed an out-of-court settlement with the trustee directors of the Airways Pension Scheme (APS) that, subject to some affordability tests, will see members’ pensions increase by RPI from 2021.
  • The John Lewis Partnership announcedplans to close the DB section of its pension scheme to future accrual from April 2020, after a year-long review and consultation.
  • The Court of Appeal overturneda previous High Court decision about the validity of pension increases, granted in 1991 by the Trustees of the BIC UK Pension Scheme for members’ benefits accrued between 1992 and 1997, due to the required process not having been followed. The overpayments will now need to be recouped from members.

De-risking

  • The Rolls-Royce UK Pension Fund agreed a buyout with Legal & General for £4.6 billion. The deal covered 33,000 pensioners, just under half of the Fund’s members.
  • A further tranche of buy-ins was completed by M&S totalling almost £1.4 billion. Pension Insurance Corporation insured around £900 million of liabilities for 10,700 pensioners, while Phoenix Group covered £460 million of benefits for 5,000 pensioners.
  • The trustees of the Dresdner Kleinwort Pension Plan completed a £1.2 billion full buy-in with Pension Insurance Corporation. This covered both the final salary and money purchase sections.
  • The trustees of the QineteQ Pension Scheme agreed a £690 million bulk annuity with Scottish Widows, covering about a third of the Scheme’s liabilities.
  • Phoenix Group ran a pension increase exchange exercise for pensioners of the Pearl Group Staff Pension Scheme. 39% of eligible pensioners accepted the offer and the Scheme’s liabilities were reduced by around £20 million.

Regulatory

  • Trustees of the Henry Davidson Limited Pension Scheme were ordered by the Pensions Ombudsman to repay £2.4 million of mismanaged funds to the Scheme following a complaint lodged by 14 members.
  • A professional trustee firm, Link Pension Trustees Limited, was fined a total of £103,750 by the Pensions Regulator for multiple breaches of pensions law in relation to the McDonald’s Franchisee Pension Scheme.