Springing into action: four steps to take advantage of funding improvements

It’s not just the clocks that are springing forward at this time of year: our analysis shows that, as of 26th March 2021, funding levels in many DB pension schemes had improved by 5-10% since the start of 2021.

This was particularly the case for smaller pension schemes that typically have a lower level of interest and inflation protection within their asset allocation. After a difficult 2020, many small schemes were back on track to reach their long-term funding target.

Schemes in this position have an opportunity to execute pre-agreed plans to lower investment risk. The key for trustees and employers is to fully understand their scheme’s specific circumstances and, potentially, act quickly and decisively to lock in any gains that have recently been achieved.

Here are four things that schemes should consider doing to seize moments like these:

Implement postponed investment changes

Many schemes had previously agreed to reduce their interest and inflation risk but were waiting for interest rates and funding levels to increase before making the change. We’re now contacting those we work with to discuss whether the time is right for them to execute the pre-agreed changes.

Demand live access and monitoring

Due to the unusual level of uncertainty surrounding the global economy, sponsoring employer strength and the UK pensions legislative landscape, employers and trustees are putting much greater emphasis on receiving up-to-date information. This makes implementing changes so much easier. When they get a disinvestment instruction to sign, they can simply check online that the funding level shows that they are on track.

We’ve seen this trend in action: client demand for online access to our actuarial and investment analytics software is up 150% over the last six months.

Change course in funding negotiations

Many schemes were in the middle of agreeing a valuation on the back of an increased funding deficit in 2020. They could be considering making allowances for the recent improvement in funding through the Recovery Plan  and, consequently, agreeing to lower contributions. However, we recommend that trustees and employers consider the following in these circumstances:

• A lower-risk funding strategy so that the funding level is less likely to decline
• Contingent contributions from the employer if things deteriorate again
• Closer funding and covenant monitoring to allow a quick response if things go wrong.

Again, schemes are really seeing the value of having live access to funding information and investment risk when negotiating on, setting up and monitoring such arrangements.

Set simple triggers for action and govern efficiently

We’ve already seen some schemes executing automated triggers to change their asset allocation to lower their investment risk, reducing the chances that they will lose the gains that have been achieved recently.

That sort of quick reaction to new events requires planning and strong governance. We implement changes within days of a trigger going off by setting clear goals and simple rules:

• Set your long-term funding target and timescale for getting there, otherwise it’s impossible to know whether you’re on track.
• Simplify your decision rules. Typically, triggers are based on a long-term funding target that doesn’t vary with the short-term asset allocation. Any targets that require the scheme actuary to reassess contribution requirements and funding assumptions are doomed to fail, as the advice process is likely to be too slow.
• Trust your process. Inevitably, there will be some approximations when updating funding levels each day. Approximations should, of course, be scrutinised at the outset and reviewed periodically – but questioning the methodology once a trigger has gone off can create chaos.
• All stakeholders need to be ready to perform their role quickly. A trigger can go off on any working day but, as long as you plan in advance and set up the required governance model, this is totally practical and workable for even the smallest pension scheme.

Conclusion

The pensions industry remains in a position of unusual uncertainty. However, it’s gratifying to see that financial conditions, technology and good governance have recently combined to give many schemes a boost, particularly in February 2021. We’re pleased to say that a significant number of our clients have taken advantage of this opportunity but, if you haven’t done so, let’s talk about how you can make the most of this and / or future opportunities.