Teach-in Balancing Risk, Return and Contributions 6 May 2014
Balancing Risk, Return and Contributions
1
Balancing Risk, Return and Contributions
© Sacker & Partners LLP 2014 www.sackers.com
Ian Cormican
Sacker & Partners LLP
6...
Draft Code – Funding Defined Benefits
Principal
Driver for
consultation
…to minimise
any adverse
impact on the
sustainable...
© Sacker & Partners LLP 2014
Consultation Document
Defined Benefit Regulatory
Strategy
Defined Benefit Funding Policy
Draf...
© Sacker & Partners LLP 2014
5
www.sackers.com
Principles
based
Scheme -
specific
Flexible
Moving away
from fixed
triggers
© Sacker & Partners LLP 2014
6
www.sackers.com
Is it same old,
same old?
No. Possibly a
profound sea-change
Balanced
Fundi...
© Sacker & Partners LLP 2014
7
www.sackers.com
Risk Management is at heart of it
Financial Management Plan?
Contingency
pl...
Covenant
Regulator’s key factors
Outlook / plans for
sustainable growth
Sector outlook
/ position of
employerr
Profitabili...
Covenant Gradings
Gradings
1.Strong
Very strong trading,
cash generation and
asset position relative
to size of scheme / d...
Key
change
How realistic is that?
Trustees are now expected
to understand and assess
employer’s business plans
Not just ba...
© Sacker & Partners LLP 2014
Balanced Funding Outcome?
Expresses a level
of contributions
they think should
be payable by ...
Notional value of
assets such that no
further deficit
reduction
contributions
required
Compare with actual
contributions t...
© Sacker & Partners LLP 2014
13
www.sackers.com
RISK BAR - INDICATORS
How much scheme falls short of BFO
Reliance on
inves...
© Sacker & Partners LLP 2014
Risk
Bar for
Intervention
Shortfall compared to the BFO
indicator
Size of the scheme’s liabil...
© Sacker & Partners LLP 2014
15
www.sackers.com
Spring 2014
Annual
Funding
Statement
Completing
valuations
now – bear
in m...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
Balancing Risk, Return and Contributions
John Towner, Redingt...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
600
650
700
750
800
850
900
950
1,000
in£Millions
Liabilities...
Teach-in Balancing Risk, Return and Contributions 6 May 2014 21
How much should you pull each lever?
An Integrated Framewo...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
How do you agree on the right journey plan?
Scenario 1 Scenar...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
Case study – how does it all work in practice?
23
Case Study
...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
Integrated funding and investment in action
24
Sponsor Adviso...
Teach-in Balancing Risk, Return and Contributions 6 May 2014
Austin Friars House, 2-6 Austin Friars,
London EC2N 2HD
Telep...
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Balancing Risk, Return and Contributions Redington teach-in - 6 may 2014

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Balancing Risk, Return and Contributions Redington teach-in - 6 may 2014

  1. 1. Teach-in Balancing Risk, Return and Contributions 6 May 2014 Balancing Risk, Return and Contributions 1
  2. 2. Balancing Risk, Return and Contributions © Sacker & Partners LLP 2014 www.sackers.com Ian Cormican Sacker & Partners LLP 6 May 2014
  3. 3. Draft Code – Funding Defined Benefits Principal Driver for consultation …to minimise any adverse impact on the sustainable growth of an employer New statutory objective – Pensions Bill © Sacker & Partners LLP 2014 3 www.sackers.com
  4. 4. © Sacker & Partners LLP 2014 Consultation Document Defined Benefit Regulatory Strategy Defined Benefit Funding Policy Draft Code of Practice Consultation closed on 7 February 4 www.sackers.com Text DB Funding
  5. 5. © Sacker & Partners LLP 2014 5 www.sackers.com Principles based Scheme - specific Flexible Moving away from fixed triggers
  6. 6. © Sacker & Partners LLP 2014 6 www.sackers.com Is it same old, same old? No. Possibly a profound sea-change Balanced Funding Outcome (BFO) Risk - bar New approach to covenant - Segmentation Focus on investment
  7. 7. © Sacker & Partners LLP 2014 7 www.sackers.com Risk Management is at heart of it Financial Management Plan? Contingency planning Covenant risk Funding risk Investment risk Governance
  8. 8. Covenant Regulator’s key factors Outlook / plans for sustainable growth Sector outlook / position of employerr Profitability / trends Generation cash / application Debt level / servicing Balance sheet vs deficit Reinvestment Balance sheet strength Dividend policy © Sacker & Partners LLP 2014 8 www.sackers.com
  9. 9. Covenant Gradings Gradings 1.Strong Very strong trading, cash generation and asset position relative to size of scheme / deficit. Low risk. 4. Weak Concerns over potential insolvency or where scheme is so large that without fundamental change to the strength of the employer it is unlikely ever to be able to adequately support the scheme 2. Tending to strong Good trading, cash generation and asset position relative to size of scheme / deficit. Medium risk. 3. Tending to weak Concerns over employer strength relative to the size / deficit and/or signs of significant decline, weak profitability or balance sheet concerns / vulnerable for economic cycle. No immediate insolvency but longer terms concerns. © Sacker & Partners LLP 2014 9 www.sackers.com
  10. 10. Key change How realistic is that? Trustees are now expected to understand and assess employer’s business plans Not just backward looking / performance but prospects as well © Sacker & Partners LLP 2014 10 www.sackers.com
  11. 11. © Sacker & Partners LLP 2014 Balanced Funding Outcome? Expresses a level of contributions they think should be payable by a company within that segment Reviewed annually But say it is not a minimum level of funding 11 www.sackers.com
  12. 12. Notional value of assets such that no further deficit reduction contributions required Compare with actual contributions to see if it meets expectations BFO – How do they go about assessing it? Calculated on an “objective liability” basis (not scheme specific) Compare to actual assets / determine the notional annual rate to repair deficit © Sacker & Partners LLP 2014 12 www.sackers.com
  13. 13. © Sacker & Partners LLP 2014 13 www.sackers.com RISK BAR - INDICATORS How much scheme falls short of BFO Reliance on investment outperformance in Recovery Plan Quality of Governance Weakening of covenant eg dividendsPPF deficit Avoidance issues Reductions in deficit contributions Issues raised by tPR in previous valuations / previous interaction Back-end loadings Mortality Investment strategy risk
  14. 14. © Sacker & Partners LLP 2014 Risk Bar for Intervention Shortfall compared to the BFO indicator Size of the scheme’s liabilities Impact of the interventions / value tPR can add Overall tPR resources 14 www.sackers.com
  15. 15. © Sacker & Partners LLP 2014 15 www.sackers.com Spring 2014 Annual Funding Statement Completing valuations now – bear in mind Pro-active investigations with 25 schemes applying these principles Transitional BFO Indicator for September 2013 – 2014 valuations Risk Bar for September 2012 - 2013 valuations
  16. 16. Teach-in Balancing Risk, Return and Contributions 6 May 2014 Balancing Risk, Return and Contributions John Towner, Redington 16
  17. 17. Teach-in Balancing Risk, Return and Contributions 6 May 2014 600 650 700 750 800 850 900 950 1,000 in£Millions Liabilities Assets Stable Funding? 17 What is your funding objective? Full funding and Scheme can transition into terminal portfolio Self Sufficiency? Gilts/Swaps? Buy-out? …….. And how long will it take to get there? Technical Provisions?
  18. 18. Teach-in Balancing Risk, Return and Contributions 6 May 2014 600 650 700 750 800 850 900 950 1,000 in£Millions Liabilities Assets 18 What levers can you pull to reach your goal? One Lever is Time Time 2029 Contributions £10.0m p.a. Required Rate of Return Gilts + 1.20% Time 2024 Contributions £10.0m p.a. Required Rate of Return Gilts + 1.61% 10-Year Recovery Plan 600 650 700 750 800 850 900 950 1,000 in£Millions Liabilities Assets 15-Year Recovery Plan
  19. 19. Teach-in Balancing Risk, Return and Contributions 6 May 2014 600 650 700 750 800 850 900 950 1,000 in£Millions Liabilities Assets 600 650 700 750 800 850 900 950 1,000 in£Millions Liabilities Assets 19 What levers can you pull to reach your goal? Another Level is Contributions from the Sponsor Time 2024 Contributions £10.0m p.a. Required Rate of Return Gilts + 1.61% Base Model Time 2024 Contributions £12.0m p.a. Required Rate of Return Gilts + 1.44% Higher Contributions
  20. 20. Teach-in Balancing Risk, Return and Contributions 6 May 2014 600 650 700 750 800 850 900 950 1,000 in£Millions Liabilities Assets 20 What levers can you pull to reach your goal? The Final Lever is Investment Return Time 2024 Contributions £10.0m p.a. Required Rate of Return Gilts + 1.61% Base Model 600 650 700 750 800 850 900 950 1,000 in£Millions Liabilities Assets Time 2024 Contributions £7.1m p.a. Required Rate of Return Gilts + 1.91% Higher Investment Returns
  21. 21. Teach-in Balancing Risk, Return and Contributions 6 May 2014 21 How much should you pull each lever? An Integrated Framework to Assess Impact on Total Covenant Load Scenario A: Highly dependent on asset returns Scenario B: Increased sponsor costs Scenario C: Win-win impact of de-risking Contributions Investment Risk / Returns Current Funding and Target Date The Trade-Offs of Different Policy Levers A B C
  22. 22. Teach-in Balancing Risk, Return and Contributions 6 May 2014 How do you agree on the right journey plan? Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Liability valuation Full funding Date Contributions Hedge Ratio Required rate of return 2.40% 2.04% 2.04% 1.50% 1.07% Return Seeking assets 81% 66% 66% 45% 28% UK Credit 6% 10% 10% 16% 21% Liability Matching 14% 24% 24% 39% 52% Cash 0% 0% 0% 0% 0% Total VaR 29.54% 24.51% 19.51% 26.89% 16.90% 1 Yr Assets Cash Generation £45 £39 £39 £30 £22 1 Year Cash Contributions £12 £20 £20 £20 £28 1 YR Contributions at Risk £83 £49 £41 £43 £27 £140.3 £108.3 £99.5 £92.8 £77.1Total Potential Cash Requirement 0 20 40 60 80 100 120 140 160 180 1 2 3 4 5 COVENANTLOAD, £millions 1 YR Contributions at Risk 1 YR Cash Contributions 1 YR Assets Cash Generation 22 An interactive tool for Trustee and Sponsor collaboration: Adjust variable to find optimal solution
  23. 23. Teach-in Balancing Risk, Return and Contributions 6 May 2014 Case study – how does it all work in practice? 23 Case Study Situation The Trustee board of a multi-billion pound UK defined benefit pension scheme wanted to increase the level of interest rate and inflation hedging within its scheme. Problem Every time the Trustees discussed their plans with the corporate sponsor, all the sponsor heard was "unaffordable, low rates, expensive, locking in deficit" and pushed back. Implication A dysfunctional stalemate in which nothing got done and governance budget was spent with no result. Need An integrated investment and funding framework with a resulting dynamic de-risking plan that provides the clarity needed to discuss and agree de-risking, as well as weighs Trustee risk management objectives against sponsor affordability concerns.
  24. 24. Teach-in Balancing Risk, Return and Contributions 6 May 2014 Integrated funding and investment in action 24 Sponsor Advisor Trustee Sponsor Clear consensus on long-term funding objective Collaboration Trustee Sponsor Sponsor AdvisorTrustee Advisor Working in Isolation Trustee Advisor Stakeholder Preferred Approach Consequence Trustees Lower Risk Higher costs Sponsor Lower Contributions Higher returns required leading to higher risk and potentially higher contributions
  25. 25. Teach-in Balancing Risk, Return and Contributions 6 May 2014 Austin Friars House, 2-6 Austin Friars, London EC2N 2HD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk Contacts & Disclaimer John Towner Director│Investment Consulting Tel: 0203 326 7143 Email: john.towner@redington.co.uk 25 Disclaimer For professional investors only. Not suitable for private customers. The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or other reference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf. Unless otherwise stated, any pricing information in this message is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs. Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence . Please note, the accurate calculation of the liability profile used as the basis for implementing any capital markets transactions is the sole responsibility of the Trustees' actuarial advisors. Redington Ltd will estimate the liabilities if required but will not be held responsible for any loss or damage howsoever sustained as a result of inaccuracies in that estimation. Additionally, the client recognizes that Redington Ltd does not owe any party a duty of care in this respect. Redington Ltd are investment consultants regulated by the Financial Conduct Authority. We do not advise on all implications of the transactions described herein. This information is for discussion purposes and prior to undertaking any trade, you should also discuss with your professional tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect of tax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate. ©Redington Limited 2014. All rights reserved. No reproduction, copy, transmission or translation in whole or in part of this presentation may be made without permission. Application for permission should be made to Redington Limited at the address below. Redington Limited (6660006) is registered in England and Wales. Registered office: Austin Friars House, 2-6 Austin Friars, London EC2N 2HD
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