repairing the pension deficit using an integrated funding and investment risk management framework
TRANSCRIPT
Private & Confidential The-Pensions-Net-Work 20 June 2013
Robert Gardner
Founder and Co-CEO
Redington Ltd
Repairing the Pension Deficit using an
Integrated Funding and Investment Risk
Management Framework
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We live in uncertain times...
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People are living longer
Private & Confidential The-Pensions-Net-Work 20 June 2013
The economic outlook remains uncertain
4
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Pension schemes remain under pressure
Private & Confidential The-Pensions-Net-Work 20 June 2013
Crisis to recovery: a bumpy ride so far ...
6
20-Year Nominal Gilt Yields 20-Year Breakeven Inflation
Credit Spreads Equity Markets
2.0
2.5
3.0
3.5
4.0
4.5
May 2008 May 2009 May 2010 May 2011 May 2012 May 2013
%
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
May 2008
May 2009
May 2010
May 2011
May 2012
May 2013
%
20
40
60
80
100
120
May 2008
May 2009
May 2010
May 2011
May 2012
May 2013
Reb
as
ed
at
10
0 a
s o
f M
ay 2
00
8
FTSE 100 MSCI World MSCI Emerging Markets
0
50
100
150
200
250
300
350
400
May 2008
May 2009
May 2010
May 2011
May 2012
May 2013
Bp
s
Private & Confidential The-Pensions-Net-Work 20 June 2013
But deficits have grown
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Buy-Out Deficit
Buy-Out Funding Ratio
Aggregate of PPF eligible schemes
March 2012
60%
Down 7.0%
GBP 675.8bn
Aggregate of PPF eligible schemes
March 2012
Up £208.8bn
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1. Transfer to members
Change benefit format, e.g. ETVs, Early
Retirement
2. Transfer to external entity
Buy-In/Buy-out
3. Self Sufficiency
A 7-Step Plan to Full Funding
Choosing the End Game
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Preparing for the End GameVUCA
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Volatility
Uncertainty
Complexity
Ambiguity
Vision
Understanding
Clarity
Agility
QE Japan
CPAC and RPI
Economy, Politics, Products
Who, what, when, why?
Repair Deficit
Education
S.M.A.R.T
Calls to action
Preparing for the End GameVUCA
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Preparing for the End GameThe Seven Steps to Full Funding
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Step 1 Description
• A strategic Pension Risk Management Framework sets out funding
objectives, risk budget and other constraints such as liquidity and collateral
requirements
• A Flight Plan charts each plan’s path to full funding and generates required
returns that are used to set investment strategy
Clear Goals and Objectives
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The Flight Plan
Map path to full funding
Focus investment strategy decisions
Identify best opportunities
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Pension Risk Management Framework
1414
Objective Measurement (Assumed) Performance Indicators Performance (31 March 2013) RAG
Funding Objectives
Primary Funding Objective:
To become fully funded on a Technical
Provisions (Gilts +100bps) basis by 2023.
Expected Returns > Required Returns
Required Return:
Expected Return:
Difference:
Gilts +140bps
Gilts +125bps
-15bps
Secondary Funding Objective:
To build up a sufficient buffer to withstand an
adverse demographic shock and still return to
full funding by 2023.
Expected Returns > Required Returns to return
to full funding by 2023 (following an adverse
demographic shock)
Required Return:
Expected Return:
Difference:
Gilts +175bps
Gilts +125bps
-50bps
Investment StrategyActual Returns should exceed Expected
Returns (implying outperformance).Actual Returns > Expected Returns
Actual Return:
Expected Return:
Difference:
Gilts + xxxbps
Gilts + xxxbps
xxxbps
Risk Budget
Primary Risk Objectives
The investment strategy should not risk the
deficit worsening by [10%] of liabilities over a 1-
year period (including longevity risk).
VaR95 < 10% of liabilities VaR95: 7.8%
Secondary Risk Objectives
The investment strategy should not risk annual
contributions increasing by more than £10m
p.a. over a 1-year period (including longevity)
CaR95 < £10mVaR95: £8.2m
Hedging StrategyNominal/Inflation hedge ratio should be
maintained within +/- [5]% of the funding ratio.
Funding Ratio (Ongoing Basis) 106%
Nominal Hedge Ratio (Ongoing Basis) 90%
Inflation Hedge Ratio (Ongoing Basis) 90%
Liquidity
Maintain sufficient eligible collateral to meet
potential margin calls on derivative positions
and cover one-year’s worth of benefit payments
Total available liquid assets £[xxx]m
One-Year Collateral Requirement + One-Year
Cash Flow £[xxx]m
Status Metric is at or above target Metric is within [10%] of target Metric is more than [10%] away
Private & Confidential The-Pensions-Net-Work 20 June 2013
Funding Objectives
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Relative importance of contributions vs. returns in funding the deficit
depends on the funding and risk objectives set out in PRMF
Time
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Schemes face demographic, operational, insolvency and investment risks
‘Reduce deficits and improve member security by designing, developing and
delivering investment strategies that manage risk effectively and generate
outperformance’
Question: What is the risk in a 1-in-20 downside scenario?
Risk Objectives
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Risk: Trustee Perspective Risk: Sponsor Perspective
Deficit Value (VaR)
Required Contributions (CaR) Funding Ratio (FRaR)
Required Return on Assets (RRaR)
Private & Confidential The-Pensions-Net-Work 20 June 2013
Sponsor Covenant Load
Estimate the sponsor Covenant Load by combining cash contributions with
the value of the sponsor’s implicit support of the scheme’s investment risk
A PRMF which integrates funding considerations will explicitly consider the
covenant load and the risk of contributions increasing in a downside
scenario
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Sponsor Covenant
Load
Cash Contributions over Horizon
Investment Return over
Horizon
CaR over Horizon
Private & Confidential The-Pensions-Net-Work 20 June 2013
Integrating Funding and Investment Risk
1818
Time HorizonC
on
trib
uti
on
s
Risk
Co
ntr
ibu
tio
ns
Time Horizon
Req
uir
ed
Retu
rns
Risk
Req
uir
ed
Retu
rns
Time
Horizon
Co
ntr
ibu
tio
ns
Private & Confidential The-Pensions-Net-Work 20 June 2013
Integrating Funding and Investment Risk
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Implementing an Integrated PRMFCase Study: The journey of a small scheme (a)
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Private & Confidential The-Pensions-Net-Work 20 June 2013
Scheme 2008 2013 Comments
Clear Funding Objectives Pension Risk Management Framework
Risk Budget Reduced VaR from 30% to 15%
Monitoring Missed Buy-Out opportunity in 2008
Allocation to Equities 90% 0% Dynamic asset allocation
Hedge Ratio 5% 90% Funding Level immunised to rates & inflation
Recap:
- What is the end game?
- What is the most efficient investment strategy for meeting the
investment 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)
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Private & Confidential The-Pensions-Net-Work 20 June 2013
13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk
Contacts
Robert GardnerFounder and Co-CEODirect Line: 0207 250 [email protected]
LinkedIn: http://linkd.in/134mv6HTwitter: https://twitter.com/robertjgardner
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Private & Confidential The-Pensions-Net-Work 20 June 2013
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