Schemes with strong employer covenants could find it easier to take on more investment risk, experts have said, in light of the Pensions Regulator’s increased focus on integrated risk management.
The regulator endorsed an integrated approach for dealing with risks in its funding statement last May aimed at encouraging schemes to consider the financial health of the sponsoring employer when analysing funding and investment risk.
Joanne Livingstone, technical director at consultancy Punter Southall, said integrated risk management gives schemes with strong covenant arrangements “permission not to derisk”.
If you’re a finance director you should be trying to add risk within reason, but if you’re a trustee it’s more nuanced.
Aidan O'Mahony, Aon Hewitt
She added: “If you can tolerate the risk and can be seen to tolerate the risk, you can continue [holding your level of investment risk].”
Livingstone said that since the regulator began pushing its integrated risk management agenda, the increased drive towards documenting and systematising among schemes has led to “better alignment of funding and investment risk”.
“Once you get that in place you have a better monitoring system,” she added.
Number crunching
Aidan O’Mahony, partner at consultancy Aon Hewitt, said there was greater call for schemes to formalise scheme targets.
“The big change this time around is the regulator pushing [schemes] to put hard numbers on key performance indicators and trigger points.”
O’Mahony said integrated risk management had led to a lot of schemes examining their dependence on the covenant.
He said: “If you’re a finance director you should be trying to add risk within reason, but if you’re a trustee it’s more nuanced. You should be looking at the risk and saying, ‘If something goes wrong, how do I know you’ll still be there?’”
He suggested schemes may want a contingent asset to act as a guarantee should the covenant change.
Simon Kew, assistant director of pensions advisory at consultancy Deloitte, said: “There is now this increased focus on investment and how it interacts.” He suggested schemes begin by assessing the strength of their covenant as a base on which to build the rest of their approach.
“Everything starts with covenant,” he continued. “Get that bit right and then the actuary can do their funding calculation and get that right.
“Then you get the investment and with the appropriate level of prudence, you get the strategy.”
The key to successful risk management, Kew said, was a high level of communication and transparency between the scheme and its different advisers.
“The whole ethos of IRM is managing risks in the round and getting people talking to each other,” he said.
Barry Mack, head of governance at consultancy Hymans Robertson, stressed the importance of good governance to risk management, warning that blind spots could mean a scheme is taking too much risk.
“You need to have good governance,” he said. “You understand your risks better, and if you understand them better you’re able to take more risk and put mitigations in place.”
