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Category Retirement
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Making sense of retirement fund risk

16 September 2008 Old Mutual

A lack of financial education, industry jargon and seemingly complex investment and risk products have resulted in a large number of retirement fund trustees believing that they do not have the experience or skill to manage their fund’s financial risks.

However, according to Craig Aitchison (pictured), head of Old Mutual Actuaries and Consultants, putting in place a financial risk management strategy for a retirement fund is quite an intuitive process.

“In general, a risk management strategy is the process where outcomes are identified and steps taken to ensure that the good risks are taken advantage of and bad o­nes are managed for limited impact. With retirement planning, these strategies should focus o­n addressing risks that might prevent retirement and exit benefits from meeting the members’ needs.”

Here are some effective risk management steps that Trustees can put in place:

1. Identify the nature of the risk: For example, a retirement fund may be aiming to meet members’ financial needs at retirement age and therefore structured with little emphasis o­n providing death benefits. However, if a member dies whilst still in service and has not had the opportunity to build up sufficient credit in their fund, the risk exists that the fund will pay out inadequate benefits to the member’s dependants.

2. Analyse the risk: This involves setting clear goals and objectives with a qualified consultant who will help you measure the suitability of the goal to your needs. Using the example of a deceased member, a rule of thumb is that a member’s family will require between 10 and 15 times the members annual salary o­n death.

When it comes to retirement benefits, a fund that aims to o­nly replace 50% of salary at retirement, is probably aiming too low to allow members to retire comfortably. However, at the other end of the spectrum, a wildly optimistic goal may also be unattainable.

3. Respond to the risk: This involves prioritising which of the risks present the biggest threat to the fund, looking at the likelihood of this event occurring and assessing the impact it will have o­n the fund should it materialise.

Risks with the most severe financial and reputational impacts must therefore be dealt with first. Priorities are also not static, but change and evolve as more information comes to light. Trustees therefore constantly need to review their management strategies if they feel the current measures to be inadequate.

A culture of risk awareness amongst members of the board is essential to ensure that there is regular feedback into the risk management strategy. Both the nature of the risk as well as the needs of the fund must be considered when deciding o­n the appropriate response to the risk. For example, avoiding negative investment returns by investing in cash or a 100% guaranteed investment might expose members to the risk that retirement benefits are inadequate due to consistently low returns.

Regular monitoring and management of the risks is also crucial to ensure the smooth running of a retirement fund. This is where an expert financial advisor can help Trustees to analyze risk and respond appropriately.

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