Special Report - Pensions Risk Management: Snooze you lose - convincing trustees to take the risk out of pensions

There can be very few finance directors at FTSE companies who feel relaxed and at ease with their company’s final salary pension scheme. The constant media headlines around defined benefit scheme closures, buyouts and benefit cutbacks highlight the continued struggle to get out from under the crushing burden of what has become a seemingly unstoppable drain on the company’s resources.

The final salary scheme is not a problem FDs can simply walk up to and grab by the ears given their distance from the levers of power ­ held by the trustees ­ putting them in the unenviable position of having to proceed with tact and charm on matters pertaining to their own bottom line, since their trustee body is not obliged to listen. And even if they do listen, they are certainly not obliged to act on the advice being given.

Not exactly a happy position, but, as Kevin Wesbroom, UK lead for global risk services at pensions adviser Hewitt observes, there are ways an FD can influence the trustee board if they can engineer the relationship correctly. “Companies get the duties of FDs and trustees terribly wrong and that is the first thing that needs to be straightened out,” says Wesbroom. “For example, if a finance director decides that he or she wants to go for a buyout immediately, the most likely response from the trustees will be: ‘Sounds interesting ­ give us all the paperwork on the proposal and we’ll review it at our next meeting in three months’ time, after which we’ll give it to our actuaries and see what they advise’.”

What Wesbroom is pointing to is the startling difference between the speed with which companies make decisions and the kind of decision timeframe that trustee boards typically feel happy with.

Slow response
Marcus Hurd, lead principal for Aon Consulting’s corporate advice team, says the ponderous way in which pension fund trustee boards tend to react has caused companies to miss out on some of the best opportunities to de-risk their final salary schemes over the past few years.

Last year in particular there were some very good opportunities to take risk out of the scheme at very attractive price levels. However, while a number of FDs might have seen the opportunity, their trustee boards simply couldn’t get their act together quickly enough.

This is not through any antagonism between the FD and the trustee board ­ quite the contrary. As Hurd puts it, “I have not known a trustee board yet which did not welcome the FD taking an active interest in the scheme.” Trustees realise the company and the FD must live with the consequences of everything the trustee board does. But trustees also take seriously the need to deliberate and to take full and detailed advice before they act, since the decisions they make affect their members’ future and the quality of their old age very directly.

“What this means is that, in our experience, trustee bodies take months to make even the most basic decisions and they can easily take up to 12 months to make the more complex decisions, such as whether or not to enter into an interest rate or an inflation swap,” he says.

Why does this matter? It matters because the conditions that favour particular courses of action fall into place for relatively brief periods of time. Hurd cites the fact that, for a few months in 2008, it was possible for schemes to insure pensioner liabilities at below the cost that many schemes were holding for those members. “Schemes that could move rapidly took advantage of this pricing anomaly and took a substantial amount of volatility off the books,” he says.

Most schemes, however, couldn’t move fast enough and the moment came and went. The schemes that were able to take advantage could do so because the company and the trustee board had already put considerable time and effort into improving the trustee board decision-making process.

Increase your influence
The FD must look to strengthen their influence with the trustee board. Wesbroom and Hurd agree that the best opportunity FDs have to pressure trustees comes when they are about to give the trustee board a cheque or when they are going to put assets in one shape or form into the scheme.

“One of my key bits of advice, at such times, is to look down the list of things you would like in return from the trustees,” says Hurd. If the company is putting up contingent securities, for example, which obviously strengthens the scheme covenant, then if there are things in the scheme trust deeds, or old (and potentially worrisome) ‘agreements in principle’ between the company and the scheme, now is the time to address these. The trustees will be much more amenable to giving the company something back if they feel they are securing something for the scheme.

Dave Robertson, worldwide partner in Mercer’s financial strategy group, agrees. “If you’re being pressured into providing a large cheque, try to use it as leverage to get the trustees to make changes that they would not otherwise be minded to make,” he says.

Of course, in theory trustees can simply tell the FD to take a hike, since it is likely that the contribution is not exactly being made voluntarily by the company, but is part of a general plan to move towards a fully-funded position. However, Robertson points out that trustee bodies would far rather get contributions without their case having to find its way to the Pensions Regulator.

“If the company is being reasonable, there is no certainty that the regulator would side with the trustees. They may be able to chase the money with or without the company being willing to hand it over, but there is good mileage for the trustee body in accepting constructive discussion as a reasonable price to achieve a more certain outcome,” he says.

The list of things FDs may want to change varies from the drastic, such as moving to a full buyout, to various de-risking strategies covered elsewhere in this report, to what might look like mere housekeeping issues, such as removing a few restrictive elements in the trust deeds. However, old trust clauses can sometimes turn out to have a sting in the tail disproportionate to how they might have been viewed previously.

Robertson cites the example of a scheme whose trust deeds, having been written in a more optimistic era, include a provision for pensions increases to be provided to members whenever the scheme is fully funded. That is not a proposal that any sensible FD would want to entertain now, since more benefits equals more liability just when they are doing everything they possibly can to plug that hole. Trustees know this well enough, of course.

If the FD, apropos of nothing at all, simply asked the trustee board to eliminate the clause, they would ask the FD what they would do in return. Having this conversation with that large cheque in one hand is the right moment and broaching it on any other day of the week is not the right moment.

Importantly, getting the trustees to drop this provision can have a significant impact on the amount the company needs to reserve for pensions, thus freeing up real cash for actual, revenue-generating projects.

One of the critical things FDs should be doing, either when they have moments of leverage with the trustees, or simply through the fact that they have a good working understanding with the trustee body, is agreeing in advance what the key trigger points will be for a range of actions regarding the scheme. The aim here is to clear the decks, as it were, and get the trustees on side so that they can make decisions rapidly when market conditions are right.

Trigger point
Robertson gives the following example. “If you are in a market where interest rate swaps are too pricey, trustees should be thinking about the trigger pricing levels that would enable them to do a swap. So when the market delivers those numbers the trustee body is ready to move and can take some risk out of the scheme at a price that they know makes sense.”

Right now, there is a shortage of counterparties for interest rate swaps, but if the FD works with the trustee board, they can clarify in advance that a real rate of, say, 1.35% would create a satisfactory position to cover both the cost of the swap and make the swap viable. The point when interest rates look to be reaching 1.35%, in other words, becomes an action trigger agreed by both the FD and the trustee body, with no need for further discussion.

That, at least, is the theory. However, Dave Robbins, pensions partner at Deloitte, says that admirable as this strategy sounds in theory, it is fiendishly hard to make work in the real world. “Setting trigger points for actions and agreeing it in advance with the trustee body is obviously a good thing. But what tends to happen once you get a committee sitting down to agree to action the pre-agreed trigger is yet more debate.

Someone is bound to say, “But if 1.35% is good, why don’t we wait till 1.5%?” Or someone says, “OK, the FTSE has hit 5,500, but why don’t we leave it for six months and see if it hits 6,000 before we act?” Once you get committees starting to talk, the agreement to act unravels fairly quickly,” he says.

However, experience is supposed to be a great teacher, and both advisers and FDs can now point out concrete examples of missed opportunities to trustee bodies. Trustees are not wilful or stupid. They are as capable of disciplined action as anyone else, once the proper case has been made. So it might be that with pre-agreed actions, FDs will find themselves in a better position to take advantage of market movements and take some risk out of their pension scheme without missing the boat entirely.