the ViewJuly 2016

Focus points:Keeping Pace 4Keeping it real: making risk relevant 6Case Study: Action for Children 12Brexit – 21 days later 9Setting the right pace 14

To say the last few weeks have been interesting is somewhat of an understatement. The EU Referendum has no doubt led to unprecedented change and uncertainty.

Welcome

But it will be some time before any of us know the long term impact of Britain’s choice to leave the EU. If you’re concerned about the immediate practicalities or implications please speak to one of your Hymans team. However in the meantime, our Head of Capital Markets, Graeme Johnson, discusses what we can expect to see from the markets in the short-term post-Brexit environment on page 9.

Putting the impact of the referendum to one side, we still need to look ahead to what’s next for pensions.

In our previous issue we discussed how 21st century trusteeship needs to look very different to the traditional model. For too long trustees have had to rely on outdated triennial valuation information to make important and timely decisions. Added to that, lengthy and unwieldly risk registers have been the norm for managing risk. In this issue we discuss how different approaches and technology advances can make these issues a thing of the past.

From a funding and investment perspective, neither the traditional triennial valuation cycle nor using analytics based on historic data meet the needs of today’s DB pension schemes. With fleeting opportunities to de-risk, schemes tell us they want a more dynamic, precise and responsive approach to managing funding and cashflows.

With truly ‘on demand’ and up to date member data trustees can make better informed (and quicker) decisions. To find out more about a transformational approach to valuations turn to page 10.

Last year trustees told us their biggest challenge was managing risk strategically. This is understandable when you consider that trustees often manage risk via onerous

risk registers. Often it’s a tick box exercise rather than an integrated governance approach. Turn to page 6 to hear how our new risk management framework helped the trustee board at Gist, and became a core part of the schemes’ governance, encouraging a culture where risk is more than just a number.

Our case study on Page 12 demonstrates how our 3DFunding approach helped Action for Children develop a long-term strategy, helping them to focus on the right balance of contributions, timeframes and investment strategies.

In this issue we also discuss the importance of cashflow risk management. It’s an approach we’ve advocated for some time, so we were delighted to see tPR’s recent annual funding statement address this issue for the first time. On page 4 Matt Woodman discusses the approach sponsors and trustees can take to mitigate this risk.

You may also have noticed that we’ve had a makeover. We launched our new website last month and as well as a ‘facelift’ we’ve also made information easier to find, especially on the topical, current issues that will be most relevant to you. You can have a browse here - www.hymans.co.uk . I would love to hear your comments and feedback on our new look, new website, or indeed of the articles in this issue.

I’m currently in Thailand enjoying an extended summer break and I hope you manage to get some time off to relax and unwind over the summer too.

2 the View

Calum Cooper

Partner and Head of Trustee Consulting calum.cooper@hymans.co.uk0141 566 7837 @Calum_Cooper

July 2016 3

1%

2%

3%

4%

5%

6%

7%

-6% -4% -2% 0% 2% 4%

Expe

cted

retu

rn o

n as

sets

Net cashflow as a proportion of assets

Maturity vs Investment risk

‘I am playing all the right notes, but not necessarily in the right order’, a classic line from Eric Morecambe to Andre Previn (or Preview!) that I often make to my own piano teacher…

Keeping pace with the mood music

...and arguably the same can be said about the approach being taken to the management of pension schemes as they mature. In fact, the Pensions Regulator is so concerned that plans are in place to sell the right assets in the right order that they highlighted the issue in their 2016 annual funding statement.

The world has changed for DB pension schemes. In the past, where the focus of risk management was to mark to market balance sheet volatility of assets and liabilities, DGFs and LDI made a lot of sense. This was because there was no actual asset sales or ‘crystallisation events’ as contribution income was always adequate to meet benefits falling due.

In this new world, a fixated focus on the volatility of an overall portfolio of assets can miss the bigger picture. A sudden fall in the price of an individual asset you intend to sell can be very damaging. In fact, over time, this additional cashflow risk can be as big, if not bigger, than the volatility risk many schemes are currently focussed on.

The scale of the cashflow issue is highlighted in the following chart, which plots the target asset return of every FTSE 350 company with a DB pension plan against their cashflow position (net contribution excess or deficit after benefit payments as a percentage of assets).

Net cashflow p.a. as % assets

Relationship between cashflows and asset returns

Increasing risk

Increasing asset sales (increasing risk)

Expected distribution

Expe

cted

retu

rn p

.a.

4 the View

There are a number of sensible approaches trustees and sponsors can take to mitigate this risk whilst maintaining higher target returns, funding plans and balance sheet risk management whilst also ensuring their schemes are cashflow resilient

Matt WoodmanSenior Investment Consultant matt.woodman@hymans.co.uk0207 082 6144

Higher target returns in this chart correlate, in the vast majority of cases, with a higher allocation to risky assets such as equities, DGFs and property. The key here is that the price of these assets at the point of any sale is uncertain.

Broadly, you should expect the distribution of schemes to sit around the orange line, which would be consistent with investing in assets with more certainty in their realisation value as a scheme matures and needs to sell assets at a value to meet benefits. However, that is not the case and the distribution is quite random.

Schemes with negative cashflow, who also target higher returns, run a real risk of being a forced seller of these risky assets just after a market fall. This crystallises the funding position, negating a potential recovery and running a real risk that schemes will require more contributions from sponsors.

However this needn’t be the case. There are a number of sensible approaches trustees and sponsors can take to mitigate this risk whilst maintaining higher target returns, funding plans and balance sheet risk management at the same time ensuring their schemes are cashflow resilient.

Is your scheme in need of a cashflow health check?Our health check will help you assess how much of an issue cashflow negativity is for your scheme, what your current and potential short-term cashflow needs are, as well as the disruptors which will impact your future needs.

The results help you consider potential solutions and take appropriate actions for your scheme. If you’d be interested in this for your scheme please get in touch.

July 2016 5

We all deal with risk in our lives. From crossing the road to climbing mountains, risk assessment and control is important to achieve our goals safely. Yet in the pensions’ world, risk management can often feel like an onerous task and one which isn’t always joined up with what you’re trying to achieve.

Keeping it real: making risk relevant

Trustees told us last year that their biggest challenge is to manage risk strategically1. The traditional risk register is often a lengthy and detailed document that lacks focus. It can feel too difficult and time consuming to engage with all these risks during a trustee meeting. Risk registers often sit gathering dust and require an investment of time when they’re looked at, which makes managing risk feel more onerous than it needs to be. Trustee boards can be forgiven for, on occasion, putting off this work.

And yet risk and reward should be deeply rooted where trustees focus their efforts and in all decisions. Doing so makes it real and relevant. We decided to do something about this. We developed a framework that brings risk to life and embeds risk management into the day to day operation of schemes in an engaging and relevant way.

1Set

objectives

2Identify and categorise

risk

4Prioritise

risks

5Manage/ Mitigate (action)

6Report & Monitor

1Hymans Robertson Trustee Barometer 2015

3Analyse/

quantify risks

6 the View

To bring this to life, here’s how we helped Gist Limited Pension Scheme get risk firmly on their agenda

About Gist Limited

Gist is a UK, European and global end-to-end supply chain company with a long history, spanning over 100 years. Gist specialise in managing supply chains for perishable and chilled products. Their 3000+ customers cover a wide range of commercial and industrial sectors.

The challengeThe trustees were looking to find a better way to manage and monitor their scheme risks. Previous discussions on the risk register in board meetings were cumbersome and repetitive and didn’t drive definitive actions.

Our solutionUsing our risk management framework we held an interactive workshop with the trustee board to understand what they were trying to achieve, identify the events that could knock them off course and to agree an approach to implement risk management as a core part of the Scheme’s governance.

We recommended that the identified risks were compared to each other by displaying them on a heat map, rather than using a detailed approach to quantify the magnitude of a risk, as shown below. A more visual approach enabled the trustees to see the relative importance of their risks and obtain an overview of all their risks at a glance.

The trustees and in-house pension team had strong controls in place to mitigate risks, although not all of them were fully understood or appreciated. Our approach is to ensure that all items scheduled on the trustees’ business plan are a control for a risk (otherwise why do it?) and similarly all controls should appear on the business plan. Agenda items and meeting papers for Trustee meetings now also reference the risk that they relate to. For example, a valuation presentation would be linked to the relevant funding risks.

To make the best use of time in trustee meetings, we proposed that risks and the actions to manage the risks are monitored, and changes are reported in a quarterly one-page report.

July 2016 7

Results and benefits • Having reviewed all their risks, including identifying a couple of new ones, and putting action plans in place for

mitigating them, the Trustees fully understand and feel in control of managing their risk.• Risk management is now an engaging topic that is accessible for all Trustees, resulting in stronger scheme

governance. • Trustees are able to make better use of their time in meetings, and can also focus their preparation on mitigating

their biggest risks.• Risk management is now functionally embedded in the culture of this Trustee board and actions are now related

directly to risk mitigation, helping the Trustees to achieve their goals.

We were grappling with the process of how best to manage scheme risks in order to better protect the interests of our members. This engaging workshop provided real insight and a different perspective into the approach we take to risk and how best to tackle it. The ongoing reporting has helped us to embed a culture of risk management into our business - tactically and strategically. Risk management is no longer the dry subject it once was and we’re finding we achieve more in less time.

Neville Shiggins, Trustee of Gist Ltd Pension Scheme

Emma Clare Actuary and Head of Trustee Support emma.clare@hymans.co.uk0207 082 6242

Interested in testing our new app?We’re committed to helping Trustees bring risk to life. By investing in technology we plan to enable Trustees to put their long paper risk registers in the bottom of the drawer, permanently. Our new tool will facilitate risk workshops and instantly produce a consensus view from individual input (giving all Trustees an equal share of voice). It will also make monitoring and reporting much more streamlined. We’re looking for a few Trustee boards to help us test this app and provide us with feedback. Spaces are limited but if you are interested, please do get in touch emma.clare@hymans.co.uk.

8 the View

The reverberations of the UK’s vote to leave the EU may be felt for many years, but even a few weeks have allowed financial markets to take stock.

Brexit – 21 days later

Economic forecasts now reflect the near-unanimous view that Brexit would have short term economic costs. For 2017, the consensus now expects minimal UK growth, forecasts for the Eurozone have been substantially reduced, but the impact expected elsewhere is modest.

Nevertheless, the fall in government bond yields and future interest rate expectations has extended beyond Europe. The crystallisation of one economic risk has perhaps resensitised investors to others, such as Eurozone implosion and a Chinese hard landing.

Mark Carney has told us to expect a cut to UK interest rates over the summer. (The MPC has just decided that doesn’t mean July.) Financial markets concur and protecting against interest rate risk is as expensive as it has ever been. Clients should not necessarily rush to increase protection levels, but the latest events emphasise the importance of having a long-term hedging plan in place and being as flexible as possible in implementation.

Equity markets have recovered rapidly from a downward lurch. Two weeks after the vote, global indices in local

currency terms were only a little below 2016’s high. All else being equal, lower risk-free returns might support higher equity valuations. Of course, the logical consequence of lower risk-free returns is that all else – future growth prospects in particular – is not equal.

Sterling has been the biggest casualty of the referendum vote and provides a stark example of the tension between short and long-term considerations. Unhedged UK equity investors have done well: a total return of 12% to global indices. Hedged investors face big cash calls to cover currency losses. What to do now? Momentum is a powerful influence in foreign exchanges and might argue for unwinding hedges. There is, however, an alternative long-term case for more hedging – some valuation measures suggest sterling is as cheap against the dollar as it has been for a generation.

Whatever your view, the appropriate reaction is not a reflex rejection of the current currency hedging policy but a review of its long-term rationale. And, even for an event as seismic as Brexit, that advice holds good for all aspects of your investment strategy.

Graeme Johnston Head of Capital Markets graeme.johnston@hymans.co.uk0141 566 7998

Economic forecasts now reflect the near-unanimous view that Brexit would have short term economic costs. For 2017, the consensus now expects minimal UK growth, forecasts for the Eurozone have been substantially reduced, but the impact expected elsewhere is modest.

July 2016 9

With today’s fleeting opportunities, trustees are telling us they want a much more dynamic, precise and responsive approach to managing pension scheme risks. That’s what our new on demand valuations offer; a ground-breaking approach to risk management with all funding analytics based on accurate, bang up to date member data at no extra cost to our clients.

On Demand Valuations

The scale and pace of change in recent years has felt unprecedented. For example, last year’s Freedom and Choice offers DB members new levels of freedom over their retirement decisions; and a secondary annuity market is just around the corner. Many of your members’ benefits will most likely be fully settled earlier. If your data is not kept up to date by reflecting these settlements as they happen, then cashflow forecasts, funding information and risk analytics will quickly become inaccurate.

New levels of freedom for members over retirement decisions increase cashflow uncertainty with the likelihood that significant numbers of members’ benefits will be fully settled earlier. Currently funding and risk analytics tools are typically based on ‘as at’ member data from the last triennial valuation. If valuation data doesn’t reflect these settlements as they happen then cashflow forecasts will be off the mark and important decision-making over funding, investment and de-risking will be flawed.

As an example, approximations typically made in traditional funding updates, coupled with the impact of member data changes (which as noted will become increasingly material as “Freedom and Choice” gathers momentum) commonly results in “valuation drift. Looking forward, we believe this might lead to over-estimating liabilities by as much as 6% (2% p.a.) over a valuation cycle. i.e. ±£6m, per £100m of liabilities. If not addressed, your on-going decision making and management of the scheme will be inhibited; either lacking the confidence to make important funding and investment decisions or, worse, will do so based on flawed funding and risk data.

potential ‘valuation drift’ p.a.

potential ‘valuation drift’ over triennial

cycle

per £100m of liabilities

The cost of over or underestimating based on the traditional approach can be significant.

What might this mean for your scheme?

2% 6% £6m

Based on Hymans Robertson market analysis April 2016

10 the View

We’re delighted to be able to provide our clients with updated liability, cashflow and risk information, based on up to date member data “on demand”. As a matter of course, every quarter, we will run full member by member liability calculations to ensure funding and risk information is fully up to date and will do so at no extra cost to our clients.

This approach will give our clients the updated information they need to optimise the management of their pension scheme risks.

Investment and funding strategy discussions can take place at any time, safely in the knowledge of the scheme’s true funding position and the impact different decisions will have. You’ll no longer experience the planning blight that so often occurs in waiting for the formal valuation.

You can monitor (and act on) de-risking triggers without the risk of mismeasuring the scheme’s liabilites. You’ll no longer take action, fearing that more accurate analysis will subsequently show it to be inappropriate.

LDI portfolios can be updated regularly to ensure there is no drift away from the scheme’s actual liability exposures. You’ll no longer have to worry that your liability protection is out of date.

You’ll be able to assess the impact of a buy-in or member option exercises quickly, on a member by member basis.

From an investment strategy perspective, it will help ensure that assets selected to back your cashflow needs, (e.g. protection or income assets) are more appropriate, effective and efficient – helping avoid forced asset sales and saving transaction costs].

When it comes to the triennial valuation process and other funding requirements (s75 debts; bulk transfer values, s179 valuations) there will be no need to wait for the results. The weeks (and even months) of down time will be removed. Discussions can begin immediately (and even in advance), minimising the distraction of if and how to allow for changes since the valuation date.

We’ve developed our ‘on demand’ approach to demonstrate our commitment to doing what is right for our clients; to enhance both the quality of information they receive and to help them do their jobs better. Through on demand valuations schemes can make better decisions and achieve more certainty over the future. To find out how your scheme can benefit from this ground-breaking new approach, please give me a call or speak to a member of your Hymans Robertson team.

Richard ShackletonPartner and Scheme Actuary richard.shackleton@hymans.co.uk0207 082 6263

We’re delighted to be able to provide our clients with updated liability, cashflow and risk information, based on up to date member data “on demand”.

July 2016 11

How do you decide on the right balance of contributions, timeframe and investment strategy? These are all questions that trustees have been facing for some time, but recent advances in thinking and technology have meant that supporting analytics are much more readily available.

Case StudyAction for Children’s clear purpose kept their pension fund on track

Action for Children were quick to embrace these advances and started looking at funding using a 3D Funding approach (considering funding, investment and covenant together) back in 2009.

However, finding the right solution in 2009 was not without challenges, as the financial landscape had changed dramatically over the three years since the previous valuation. This meant that a quick fix solution wasn’t readily apparent. The benefit of the 3D Funding approach was that a longer term strategy could be developed, reflecting the current situation, but focused on when members’ benefits would be due for payment and so delivering the funding needed by that point.

Working with their Charity sponsor, the Trustee recognised that simply increasing contributions wasn’t an option. Instead together they agreed on a plan of:

1. changing benefits (including closing the Fund to future accrual in 2010);

2. establishing a plan for investment de-risking; as well as,

3. putting contingency plans in place for any weakening of the covenant.

These principles were set out in a ‘Memorandum of Understanding’ which both parties were able to sign up to. Not only did this clearly set out their common purpose, it gave a framework for exchange of information and monitoring. The plan, over the next twenty years, was to get to a position where further funding from the Charity wasn’t required, and the Fund could be defensively invested.

Having implemented the strategy, it has not just been a case of resting on their laurels – for example the Trustee has continued to proactively monitor developments and at each valuation reconsiders whether the Fund is on track and whether any changes to the strategy are required. Even though we have continued to see turbulent financial times, the changes that have been made, including the improvement of the Trustee’s governance framework, meant that the Fund has stayed resilient, and is still on track to achieve the target.

The Trustee has agreed a series of triggers in relation to the investment strategy, and actively monitors market conditions and funding levels using 3D Analytics to ensure that they act at an opportune moment.

12 the View

The target itself has also been the subject of regular review. At the most recent valuation the Trustee refreshed this. Whilst it was agreed that the end date was still appropriate, the target was re-expressed in investable terms, as a return above gilt yields. This meant that the target could be consistently monitored with other parts of the strategy, for example the use of LDI.

As the target becomes ever closer, the Trustee has also looked to better define the level of risk being run, recognising that as well as investment risks, other areas such as longevity risk and tracking errors are now becoming increasingly important. Working together with the investment advisors, this has led to a risk budget being defined, a framework against which all the risks can be monitored together.

This risk budget approach has also meant that the Trustee has changed the way it looks at the various asset classes. Previously it drew a hard distinction between return-seeking assets and matching assets (gilts and corporate bonds). It now assesses the variability of each asset class against the pension liabilities and, within the overall risk budget, places its money where the risk reward ratio is optimal. This has led to disinvestment from a large corporate bond portfolio, as the rewards on offer appeared not to merit the risks involved.

It has also been important for both the Trustee and the Charity to benchmark the strategy against the wider market. Whilst this information is available for many through the FTSE350 analysis , as a Charity, this kind of comparison is often more difficult and we developed our ‘DB pension funding in the charitable sector’ analysis for this purpose. This is based on the information disclosed in annual reports, so considers the positions on accounting bases to allow for consistent comparisons. This shows that many other Charities are in a very similar position to Action for Children in the challenges that they face, but the actions taken by Action for Children over the past few years have served to put them ahead of the curve.

“Having helped us agree a clear and common purpose with our sponsor, by employing Hymans Robertson’s 3D approach to funding our Fund is much more resilient to risk. By looking at contributions, investment and covenant in the round, we’ve explored strategies we’d not have otherwise considered, letting us pick the route best suited for our needs, and most likely to help us meet our goal. As a result, we feel our Fund’s destiny is much more firmly in our hands – we’re on track to become fully funded by 2029. Additionally, the monitoring we have in place through 3DAnalytics, means we can respond to events that otherwise would have knocked us off course, and stay on track.”

Christopher Daws, Chair of Trustees, Action for Children

Victoria Rolfe Actuary victoria.rolfe@hymans.co.uk0207 082 6269

Action for Children is a UK children’s charity committed to helping vulnerable and neglected children and young people, and their families, throughout the UK.

July 2016 13

Aesop’s fable of the tortoise and the hare is a familiar cautionary tale. The hare sets off on its race at speed, but then loses sight of its purpose and stops for a snooze in the sun, only awakening in time to see the slow and steady tortoise crossing the finish line. Do pensions scheme trustees risk making similar mistakes?

Setting the right pace

We advocate that trustees focus on Purpose (clear objectives), Precision (using up-to-date data) and Pace (taking no more risk than required) in order to achieve a more resilient pension scheme. So, how do you make sure you’re not taking more risk than required?

Evidence over the last 15 years indicates that most DB pension schemes continue to take too much investment risk. Perhaps it’s in the hope of taking a lower level of risk later on, or perhaps simply because that’s the way it’s always been. The ‘Typical’ chart below shows just that – an approach which takes a lot of risk now with a gradual reduction over the medium term. For many schemes, this approach has resulted in the funding level at best standing still, despite meaningful cash injections from the sponsor.

Typical

Contributions Risk

Con

trib

utio

n to

jour

ney

Time Get the job done fast (maybe!)

Balanced

Contributions Risk

Con

trib

utio

n to

jour

ney

Time

Hedge your bets

Lower for longer

Contributions Risk

Con

trib

utio

n to

jour

ney

Time

Avoid any nasty surprises

Managed

Contributions Risk

Con

trib

utio

n to

jour

ney

TimeTake advantage of opportunities

14 the View

Our approach is underpinned by 3D funding. We consider covenant, contributions and investment together. This ensures that you take joined-up decisions, focused on getting to your target over an appropriate period of time, with an appropriate level of contributions and, crucially, a well understood level of risk.

Our approach is underpinned by 3D funding. We consider covenant, contributions and investment together. This ensures that you take joined-up decisions, focused on getting to your target over an appropriate period of time, with an appropriate level of contributions and, crucially, a well understood level of risk. The charts over illustrate a range of alternative approaches that could be adopted with differing risk profiles.

For many schemes, we find that a lower level of investment risk, but for a (potentially) longer period of time - as shown in the ’Lower for Longer’ chart - is preferable for all stakeholders. Better still, combining this with an approach which allows risk to be taken opportunistically - the ‘Managed’ chart – results in the most efficient allocation of risk.

The steady pace and resoluteness of purpose delivered by our fully integrated, risk-based approach, will result in smoother progress towards your long term goals (and ultimately you winning the race!).

If you would like to chat about how this approach can help your scheme, please get in touch.

David MortonHead of DB Investment

david.morton @hymans.co.uk

July 2016 15

This communication has been compiled by Hymans Robertson LLP based upon our understanding of the state of affairs at the time of publication. It is not a definitive analysis of the subjects covered, nor is it specific to the circumstances of any person, scheme or organisation. It is not advice, and should not be considered a substitute for advice specific to individual circumstances. Where the subject matter involves legal issues you may wish to take legal advice. Hymans Robertson LLP accepts no liability for errors or omissions or reliance upon any statement or opinion.

Hymans Robertson LLP (registered in England and Wales - One London Wall, London EC2Y 5EA - OC310282) is authorised and regulated by the Financial Conduct Authority and licensed by the Institute and Faculty of Actuaries for a range of investment business activities. A member of Abelica Global.

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