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Repairing the Pension Deficit using an Integrated Funding and Investment Risk Management Framework

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  • 1. Private & Confidential The-Pensions-Net-Work 20 June 2013Robert GardnerFounder and Co-CEORedington LtdRepairing the Pension Deficit using anIntegrated Funding and Investment RiskManagement Framework1
  • 2. Private & Confidential The-Pensions-Net-Work 20 June 2013 2We live in uncertain times...
  • 3. Private & Confidential The-Pensions-Net-Work 20 June 2013 3People are living longer
  • 4. Private & Confidential The-Pensions-Net-Work 20 June 2013The economic outlook remains uncertain4
  • 5. Private & Confidential The-Pensions-Net-Work 20 June 2013 5Pension schemes remain under pressure
  • 6. Private & Confidential The-Pensions-Net-Work 20 June 2013Crisis to recovery: a bumpy ride so far ...620-Year Nominal Gilt Yields 20-Year Breakeven InflationCredit Spreads Equity Markets2.02.53.03.54.04.5May 2008 May 2009 May 2010 May 2011 May 2012 May 2013%2.02.53.03.54.04.55.05.5May2008May2009May2010May2011May2012May2013%20406080100120May2008May2009May2010May2011May2012May2013Rebasedat100asofMay2008FTSE 100 MSCI World MSCI Emerging Markets050100150200250300350400May2008May2009May2010May2011May2012May2013Bps
  • 7. Private & Confidential The-Pensions-Net-Work 20 June 2013But deficits have grown7Buy-Out DeficitBuy-Out Funding RatioAggregate of PPF eligible schemesMarch 201260%Down 7.0%GBP 675.8bnAggregate of PPF eligible schemesMarch 2012Up £208.8bn
  • 8. Private & Confidential The-Pensions-Net-Work 20 June 2013 81. Transfer to membersChange benefitformat, e.g. ETVs, EarlyRetirement2. Transfer to externalentityBuy-In/Buy-out3. Self SufficiencyA 7-Step Plan to FullFundingChoosing the End Game
  • 9. Private & Confidential The-Pensions-Net-Work 20 June 2013 9Preparing for the End GameVUCA
  • 10. Private & Confidential The-Pensions-Net-Work 20 June 2013 10VolatilityUncertaintyComplexityAmbiguityVisionUnderstandingClarityAgilityQE JapanCPAC and RPIEconomy, Politics,ProductsWho, what, when,why?Repair DeficitEducationS.M.A.R.TCalls to actionPreparing for the End GameVUCA
  • 11. Private & Confidential The-Pensions-Net-Work 20 June 2013 11Preparing for the End GameThe Seven Steps to Full Funding
  • 12. Private & Confidential The-Pensions-Net-Work 20 June 2013 12Step 1 Description• A strategic Pension Risk Management Framework sets out fundingobjectives, risk budget and other constraints such as liquidity and collateralrequirements• A Flight Plan charts each plan’s path to full funding and generates requiredreturns that are used to set investment strategyClear Goals and Objectives
  • 13. Private & Confidential The-Pensions-Net-Work 20 June 2013 13The Flight PlanMap path to fullfundingFocus investmentstrategy decisionsIdentify bestopportunities
  • 14. Private & Confidential The-Pensions-Net-Work 20 June 2013Pension Risk Management Framework1414Objective Measurement (Assumed) Performance Indicators Performance (31 March 2013) RAGFunding ObjectivesPrimary Funding Objective:To become fully funded on a TechnicalProvisions (Gilts +100bps) basis by 2023.Expected Returns > Required ReturnsRequired Return:Expected Return:Difference:Gilts +140bpsGilts +125bps-15bpsSecondary Funding Objective:To build up a sufficient buffer to withstand anadverse demographic shock and still return tofull funding by 2023.Expected Returns > Required Returns to returnto full funding by 2023 (following an adversedemographic shock)Required Return:Expected Return:Difference:Gilts +175bpsGilts +125bps-50bpsInvestment StrategyActual Returns should exceed ExpectedReturns (implying outperformance).Actual Returns > Expected ReturnsActual Return:Expected Return:Difference:Gilts + xxxbpsGilts + xxxbpsxxxbpsRisk BudgetPrimary Risk ObjectivesThe investment strategy should not risk thedeficit worsening by [10%] of liabilities over a 1-year period (including longevity risk).VaR95 < 10% of liabilities VaR95: 7.8%Secondary Risk ObjectivesThe investment strategy should not risk annualcontributions increasing by more than £10mp.a. over a 1-year period (including longevity)CaR95 < £10mVaR95: £8.2mHedging StrategyNominal/Inflation hedge ratio should bemaintained within +/- [5]% of the funding ratio.Funding Ratio (Ongoing Basis) 106%Nominal Hedge Ratio (Ongoing Basis) 90%Inflation Hedge Ratio (Ongoing Basis) 90%LiquidityMaintain sufficient eligible collateral to meetpotential margin calls on derivative positionsand cover one-year’s worth of benefit paymentsTotal available liquid assets £[xxx]mOne-Year Collateral Requirement + One-YearCash Flow£[xxx]mStatus Metric is at or above target Metric is within [10%] of target Metric is more than [10%] away
  • 15. Private & Confidential The-Pensions-Net-Work 20 June 2013Funding Objectives15 Relative importance of contributions vs. returns in funding the deficitdepends on the funding and risk objectives set out in PRMFTime
  • 16. Private & Confidential The-Pensions-Net-Work 20 June 2013 Schemes face demographic, operational, insolvency and investment risks‘Reduce deficits and improve member security by designing, developing anddelivering investment strategies that manage risk effectively and generateoutperformance’ Question: What is the risk in a 1-in-20 downside scenario?Risk Objectives16Risk: Trustee Perspective Risk: Sponsor Perspective Deficit Value (VaR) Required Contributions (CaR) Funding Ratio (FRaR) Required Return on Assets (RRaR)
  • 17. Private & Confidential The-Pensions-Net-Work 20 June 2013Sponsor Covenant Load Estimate the sponsor Covenant Load by combining cash contributions withthe value of the sponsor’s implicit support of the scheme’s investment risk A PRMF which integrates funding considerations will explicitly consider thecovenant load and the risk of contributions increasing in a downsidescenario17SponsorCovenantLoadCashContributionsover HorizonInvestmentReturn overHorizonCaR overHorizon
  • 18. Private & Confidential The-Pensions-Net-Work 20 June 2013Integrating Funding and Investment Risk1818Time HorizonContributionsRiskContributionsTime HorizonRequiredReturnsRiskRequiredReturnsTimeHorizonContributions
  • 19. Private & Confidential The-Pensions-Net-Work 20 June 2013Integrating Funding and Investment Risk1919
  • 20. Private & Confidential The-Pensions-Net-Work 20 June 2013Implementing an Integrated PRMFCase Study: The journey of a small scheme (a)20
  • 21. Private & Confidential The-Pensions-Net-Work 20 June 2013Scheme 2008 2013 CommentsClear Funding Objectives   Pension Risk Management FrameworkRisk Budget   Reduced VaR from 30% to 15%Monitoring   Missed Buy-Out opportunity in 2008Allocation to Equities 90% 0% Dynamic asset allocationHedge Ratio 5% 90% Funding Level immunised to rates & inflationRecap:- What is the end game?- What is the most efficient investment strategy for meeting theinvestment and funding objectives?- How will the investment strategy be implemented?- How will the investment strategy be adjusted over time?Case Study: The journey of a small scheme (b)21
  • 22. Private & Confidential The-Pensions-Net-Work 20 June 201313-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.ukContactsRobert GardnerFounder and Co-CEODirect Line: 0207 250 3416robert.gardner@redington.co.ukLinkedIn: http://linkd.in/134mv6HTwitter: https://twitter.com/robertjgardner22
  • 23. Private & Confidential The-Pensions-Net-Work 20 June 2013Get To Know Us Better With Our Publications23