It’s good to talk: how trustees and sponsors can avoid nasty surprises
11th October, 2019
If someone had said four years ago that we would have Boris Johnson in charge of the UK, Donald Trump leading one of the world’s major powers, that we would have voted for Brexit and that England would be Cricket World Cup holders, they would have been laughed at.
After all, Barrack Obama was still in power. As was David Cameron. England had just lost to the cricket might of Ireland.
We live in unprecedented times.
Then and now …
Back when I started in pensions, the world was a much simpler place. The trustees’ meetings typically started at 11am. An hour was taken up by an investment consultant explaining how the scheme had met the CAPS target. Allowance was made for smoothed asset values; discount rates of 7% or higher were not uncommon. The administration report was taken as read. There was no such thing as a risk register, a scheme business plan, contingency planning, technical provisions, LDI, GMP equalisation, S75 debt and PPF levies. The actuary couldn’t possibly be wrong in his/her mortality assumptions. And the company was brought into the trustees’ decision-making process once every three years – at valuation time. The company directors liked it that way – it allowed them to get on with the job of running the company. The news they were given at valuation time wasn’t particularly concerning … the company was on a contribution holiday.
Then we had the Minimum Funding Requirement (MFR) – which the public thought guaranteed that members would receive their benefits in full. It turned out to be a failed experiment, with many members losing their benefits as employers were able to walk away.
Now, how times have changed. Interest rates are at long-term lows. People are living longer. (Just not as much as anticipated a few years ago. Or are they?)
But a common misconception often remains – that it is dangerous for the sponsoring employer to know the trustees’ business.
Yes, it is only right and proper that there is a level of independence in terms of decision-making between the trustee board and the sponsor. However, that doesn’t mean to say that both shouldn’t have full visibility as to the challenges that each faces.
Pensions is a complex subject (with a great many acronyms – IRM, LDI, GMP, VAR, PPF etc.). In my opinion, it is frightening that there isn’t always open and transparent engagement between trustees and sponsor.
The next actuarial valuation that defined benefit schemes face could be exceptionally painful. Gilt yields have fallen by 1% in the last 12 months. As an incredibly rough rule of thumb, a 1% fall in Gilt yields for an average scheme might increase liabilities by 20%. If trustees haven’t fully hedged that exposure, the contribution demands could be considerable. For example, £20m in additional contributions for a £100m scheme might be the entire profit of the organisation supporting that scheme in the last three years.
My first concern is that the trustees don’t see this coming. They don’t have visibility of what is happening to the funding position in the inter-valuation period. Most consultancies offer some form of valuation tracker system. It doesn’t need to be massively accurate – we are talking about 20% swings here. But some trustees will get a shock when the triennial valuation is presented.
This concern is compounded by a lack of shared understanding between trustees and employers. Employers may only see the accounting position once each year. Many schemes are in accounting surplus with employers worrying about recognising surpluses on balance sheets. If employers can’t see what is coming, how can they be expected to prepare? And, how can they be expected to actively participate in the development of preventative measures or mitigations? Particularly if they can’t see a problem on the accounting basis.
Some might point to basic trustee training around conflicts of interest and incorrectly conclude that sponsors should be excluded from trustee business. However, there are a limited number of times when the sponsor should be excluded. Maybe the only time, for many schemes, is during negotiation and development of strategy around valuation results. The rest of the time collaboration is highly beneficial. Both trustees and employers want to see positive member outcomes.
Agreeing the long-term strategy for the scheme is key so that all parties understand what they are aiming for. If you can get agreement here, then valuation discussions and investment decisions should be easier. But it is also important to prepare for the unexpected. Scenario analysis, looking at the position should the economic world change again, will prepare both sides for possible bumps along the road.
In summary, improved communication between trustees and scheme sponsors will mean fewer surprises. When both parties are better informed they can work collaboratively towards shared objectives with a proper understanding of the risks faced. Should the future not be as rosy as expected, measures can be agreed to improve the chance of members receiving the benefits they expect.
After all, that is what the scheme is there to do – pay members’ pensions.