Defined benefit (DB) schemes need to plan their endgame approach and consider the risks posed by volatile markets, according to advice from Aviva Investors and Lincoln Pensions.

The advice, offered by Aviva Investors client solutions manager, Joachim Sudre, and Lincoln Pensions associate director, Felix Mantz, suggested that trustees look to augment covenant support in order to reduce reliance on their sponsor.

They also recommended ensuring scheme members are treated fairly compared to other stakeholders, monitoring key risk relationships and having contingency plans for scenarios where risk relationships become unbalanced.

As a first step, the guide said schemes must consider the risks they are facing and ask whether their sponsor will still reliably provide support until the last pensioner has been paid out.

If they are likely to be able to and residual risks are covered, the piece recommended that a low dependency end game target may be appropriate, though it is possible that a buy-out or consolidation might be preferable.

Then, schemes need to work out how quickly they need to reach their target, with more volatile industries likely needing to achieve their endgame sooner.

Schemes also need an idea of how to actually achieve their goals in this timeframe, with Aviva noting that “affordability and risk capacity shape the combination of contributions and investment returns needed to reach the target”, adding that these should be “varied over time” based on the sponsor’s outlook.

Amid the current volatility, the piece noted that, in order to minimise risk, some schemes have adopted a cash-flow driven investing (CDI) approach and addressed the challenges posed by cash flow negativity by structuring a portfolio of income generating assets to match, within tolerances, the anticipated future benefit payments from a scheme.

“Such a low-risk approach may not be suitable for everyone but, where funding levels permit, it can help improve the certainty of achieving the desired outcome,” said the firms.

The firms noted that CDI strategies could be built using investments such as public debt, infrastructure debt, real estate debt, private corporate debt, real estate long income and unlevered infrastructure equity.

In order to deal with times of high market volatility, Aviva and Lincoln recommended that schemes adopting a CDI strategy address any governance issues so that market stress can be dealt with in a timely manner.

The firms added that as assessing their RPI and CPI liability split before proposed changes come into force.

“Trustees have access to a wide range of tools to address the risk of insufficient covenant support in the short term, but the best long-term protection is ultimately offered by managing scheme risks to a point of low or no covenant reliance,” they noted.

The piece stated that investment opportunities “continue to exist and tactical responses, implemented quickly and efficiently, could add value”, while public and private market developments “are likely to provide opportunities for attractive entry points for long-term investors like DB pension schemes”.

It concluded: “While assessments on the depth or duration of the current crisis cannot be made with precision, we can expect the de-risking trend to continue as schemes look to reduce sponsor reliance.

“In which case, advisers and managers of DB schemes should, more than ever, work in an aligned way with trustees to identify suitable solutions to manage covenant and investment risks in both the short and long term.”

Share Story: