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Using tech to tackle pension risk

PENSION DEFICITS are an inescapable problem for much of the FTSE 350. Figures from consultants Mercer show that employee pension scheme accounting deficits amounted to £104bn at the end of January – an increase of £8bn on the previous month, writes Graham Jarvis.

Perhaps for this reason, PwC’s pensions support index also revealed last year that support for defined benefits schemes had remained flat between December 2011 and June 2013, while Wolseley’s chief financial officer, John Martin, announced in July plans to close his company’s scheme by December and to introduce a new competitive pension scheme that would comply with the UK’s auto-enrolment legislation, which came into force in 2012. In spite of the closure of the company’s defined benefit pension scheme, he promised to protect its defined benefit pension scheme’s retired and deferred members.

Wolseley nevertheless joined a growing trend. According to pensions consultancy Aon Hewitt, this has seen the closure to future accruals of 44% of the UK’s plans. This may be caused by a concern about how they can reduce the financial risks and the volatility of their defined benefits pension schemes over a long-term period.

Answering the conundrum
So with CFOs showing so much concern about the risks of their defined benefit pensions schemes, how can they de-risk them and enable them to remain open? Technology is part of the answer.

“Recent economic pressures and market volatility have led to a number of new systems being introduced to the defined benefit scheme market, which provide sponsors and trustees with some sophisticated real-time modelling tools,” says Jacqui Woodward, a senior consultant at Punter Southall Transaction Services.

These systems, Woodward says, bring together pension scheme data and information alongside actuarial and financial modelling tools to allow CFOs to monitor and model the financial position of their pension schemes on a funding, accounting and solvency basis.
The days of waiting for weeks for a clear analysis and calculation of the value of a pension fund’s assets and liabilities can now be a thing of the past.

According to Steve Clayton, CFO of Fujitsu UK and Ireland, those days are long gone. “CFOs will have tools in place to help them to see updates of their pension plan’s position,” he says.

Yet Paul Bosse, principal and pension specialist at Vanguard’s Investment Strategy Group, rightly points out that no technological system will, in itself, reduce liability growth directly. “Systems can help the plan sponsor to shape his corresponding assets to act like the liability, and thereby managing volatility of the funding ratio, which ultimately determines the contribution plan and the impact on the company’s financials,” he explains.

Liability-driven investment (LDI) strategies are typically used within this scenario, but Bosse emphasises that the main way to mitigate liability growth is simply by changing the agreement that the company has with its employees by closing or freezing a current pension plan in the same way that Wolseley has done. Another way of going about it would be to consider a defined contributions plan, which places the risk on the shoulders of employees.

Structuring benefits
“In terms of structuring benefits and with a blank sheet of paper, the CFO would prefer a defined contributions rather than a defined benefits basis because with a defined contribution plan the risk is shifted to the employees”, says Phil Cuddeford – a partner at LCP. He also points out that if employees were given the choice, then they would opt for a defined benefits plan. Yet this means that the company would have to underwrite all of the equity, market and longevity risks. A defined contributions plan makes life simple, and with the spur of auto-enrolment will make it increasingly popular because both employee and employer pay a defined percentage.

As for LDI, Clayton describes it as being a helpful way to look at investing, “but like any investment it is important to make sure that you understand exactly how it will perform for you, and so making sure that the value in the investment being selected is correct is always my priority.” For this reason technology needs to be supported with an appropriately skilled team of experts. Technology’s role is therefore to support a company’s existing processes and to enable the stakeholders to understand the information that is being created by the system.

He adds that defined benefits plan funding is a challenge for any company due to the increases in people’s life expectancy and added to this is today’s market volatility. These with the quarterly accounting cycle mean “that it is important to make sure that everyone understands the objectives of the funding agreements in place over the short, medium and long-term.” Party to this is the need to ensure that a good level of robust risk management in place. The risks need to be understood in order to improve and maintain funding levels by adopting a dynamic de-risking strategy.

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