As the White Paper and our consultation set out, as schemes mature, their ability to deal with volatile and poor investment outcomes is limited and the impact this could have on the sponsor could be significant. There is consensus that it makes sense for trustees to plan to reach a position of higher resilience to risk and less reliance on the employer when their scheme is very mature.
Indeed, this is what many schemes are doing. This is not new; it is good risk management. But we need to be able to address the challenges posed by trustees not thinking about this properly.
Our key focus is on those schemes carrying more risk than their covenant can reasonably support and who are not considering that they don’t have time for their investments to repair any damage.
This is a problem for them, their members, their employer and for the Pension Protection Fund (PPF). We think it is right to address this problem as part of giving clear guidance to the market as a whole. I doubt many would argue against this.
TPR Fast Track proposal
We have developed our fast track proposals with the below in mind:
- Closed schemes mature and move towards their Long-term Funding Objective (LTO)
- Open schemes that have few or no new entrants move towards LTO more slowly
- Schemes open to new entrants remain immature and don’t move towards LTO.
It seemed elegant to us that a truly open scheme could not mature, would not be expected to de-risk and would be able to continue to invest in a long-term way.
But a scheme that started to experience lower levels of new entrants and began to mature would start to recognise that the period to ride out volatility was reducing and, therefore, plan some de-risking (hence the benefit for all schemes of setting a low dependency LTO as a good long-term planning tool irrespective of their maturity).
Similarly, an open scheme that closed would not see an immediate change to its funding or investment strategy but, over time, would need to change both to reflect increasing maturity.
So, this is about being able to plan for these changes and be in a position to manage them should they come about. Fast Track would enable a…well… fast track way for a scheme to sail through.
In Bespoke, we could see perfectly acceptable scenarios where open schemes propose to fund and invest based on their expectation that they will remain open. But trustees should be able to evidence to us how they could (among other things) manage the risk of their scheme closing or maturing faster than expected. All part of good integrated risk management.
Going Bespoke may mean more regulatory engagement but, in many cases, there is unlikely to be any (or only minimal) additional engagement if the thinking has been done, is clearly explained and well documented.
This is almost exactly what we said, but we would go further and say that just ‘planning’ is not enough; it needs to be something more concrete and evidenced. However, I’m comforted that we may not all be as far apart as we thought.
The importance of liquidity
As a final mention, I want to add that liquidity is important for all schemes and is especially acute for those that are maturing, be they open or closed. But that doesn’t mean that investment in illiquids is a bad thing. Far from it.
One of the benefits of being a long-term investor is that you can take advantage of the additional premium that being able to hold less liquid assets brings you. We are supportive of this and there is nothing in our funding consultation that means schemes will need to stop investing in illiquids as some have said.
Trustees just need to be cognisant of their liquidity needs, what this means for their scheme and be able to manage scenarios where things don’t go as planned. For some, this is about ensuring that they have enough liquidity available so that if markets move in ways they were not expecting they can manage the risk without being forced to sell assets. For example, for those that may be looking to buy out soon, some insurers may not be willing or able to take on those illiquid investments.
We will, of course, regulate the legislation we are given. As always, it is important that decisions are taken with a full understanding and acceptance of the risks to members’ accrued benefits, sponsors and the PPF that each approach brings.
Unfortunately, in this area, as in most if notall areas of life, there is no free lunch.
This article was featured in Pensions Aspects magazine February 2021 edition.
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