Keith Ashton explains why pension schemes should be taking a different approach to the ‘journey planning’ form of de-risking

If you mention de-risking in pension schemes the phrase ‘journey planning’ usually follows close behind – it is the ‘in vogue’ concept and most sponsors and trustees claim to be doing it. But what precisely are they doing and should they be doing things differently?

The first issue usually mentioned in the context of journey planning is the destination. There is a tendency to assume that all schemes aspire to the same destination, buyout, and it is just a question of how long this journey might take. This is not the case – a scheme’s journey plan is personal. For example, very large schemes and those with strong sponsors may have their own vision of a longer term, self-sufficient state.

When setting the destination, the two questions which need to be answered are: What are the sponsoring employer’s aspirations for the scheme and what are the key concerns from the trustees’ point of view? The level of risk the employer and the trustees can afford to take can impact how long it takes to get to the destination. Whilst higher risk investment strategies are expected to cut the journey length through higher returns, there is also the possibility that they will lead the scheme seriously off course. There is a critical solvency level below which assets become too small in relation to pension outgoings and no manner of investment returns on the rapidly diminishing assets will save the scheme. Is there a case for taking a lower level of investment risk to avoid this and accept it will take longer to reach the destination? A strategic risk review will help to clarify thinking.

Whilst investment strategies are important, they are not the only tool. Liability, settlement and covenant strategies should also feature. Any well-designed framework will enable the employer and trustee to weigh up the different options and understand how these affect the risks being taken and the journey path to the goal.

For example if inflation hedging looks an expensive option currently, are there other ways of achieving a similar result? Could a pension increase exchange exercise help to reduce the inflation risk for example? If a primary concern is volatility in the employer’s cash contributions to the scheme, removing liabilities from the balance sheet can help as well as investing in matching bonds and gilts. It is crucial to find the most efficient combination of strategies.

Planning the sequence of certain actions is also important. When thinking about a possible pensioner buy-in do you try to run an early retirement exercise first? This would bring more liabilities within the exercise and ensure that any savings from commutation fell to the scheme. Delaying a transaction to facilitate this will not be sensible if market conditions are attractive. Yet, when negotiating the contract, building in up front a facility to add future retirements for a certain period can allow the employer to run the early retirement exercise after transacting and still achieve the same result.

It is no good simply setting a journey plan - you need to keep close to progress and have in advance a detailed plan to ensure appropriate action is taken when triggers are reached. Successful de-risking involves a combination of regular monitoring of clearly defined triggers and a good governance structure which ensures the appropriate action happens quickly. There is absolutely no point having a plan, monitoring progress, and then taking several weeks or months to decide to act.

The plan should not be set in stone, things will change and new solutions may present themselves. The important thing here is that everyone has a clear agreement of and keeps their eye on the long term goals. This prevents being taken in by the latest ‘trendy’ product. For example if the plan is to buyout in
three to four years’ time, does the fact that longevity hedging appears attractively priced mean you change track? The answer is to make the journey planning framework flexible enough to reassess the options and identify the optimal way forward, taking advantage of the right opportunities as they arise.

A good journey plan should keep up to date on developments, close to progress and be personal to the scheme.

Written by Keith Ashton, Senior Consultant, Towers Watson

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