Pensions risks surge up the board agenda
The latest data from the Employer Survey conducted by Aon Consulting, the leading global human capital consulting firm’s, show that final salary pensions have surged to second place in the list of corporate risks, now ranking behind only the market environment as the biggest risk facing employers. With just under a half (48 per cent) of businesses saying they do not derisk their pension schemes regularly, Aon is urging employers to adopt a more proactive stance to risk management.
The survey showed that more than four out of ten employers consider pensions to be a “very high” or “high” risk, a significant rise since the last time the poll was conducted (2008), when only a quarter said pensions were a key business risk and the issue ranked eighth in the list of threats.
In the eyes of employers, final salary pension schemes are now clearly considered one of the highest risks. Asked to select a risk weighting for 12 different business risks, respondents said pensions ranked above regulatory threats, reputational damage, failure to attract or retain staff, business interruption and other options.
Based on the responses, Aon calculated an average risk score, with one a “very low risk” and five a “very high risk.” On that basis, the top five business risks are as follows:
|
Rank (2008) |
Business risk |
Average score |
Proportion of respondents judging risk “very high” or “high” |
|
1 (1) |
Market environment |
3.50 |
52% |
|
2 (8) |
Pension scheme |
3.22 |
41% |
|
3 (5) |
Regulatory/legislative change |
3.00 |
24% |
|
4 = (6) |
Failure to attract or retain staff |
2.76 |
20% |
|
4 = (4) |
Damage to reputation |
2.56 |
22% |
Derisking options
A typical UK final salary scheme has elements of risk deriving from a number of sources, including investment exposure, interest rates, inflation and mortality. If a company wishes to reduce the level of risk in its scheme’s liabilities, the main options include:
|
Risk |
Description |
Ways of reducing the risk |
|
|
1 |
Investment |
The main risk to DB scheme funding |
·Set a clear funding target ·Use fiduciary management tools to establish ‘trigger points’ that lock in investment gains ·Diversify away from equities into other growth assets or invest in diversified growth funds |
|
2 |
Interest rates |
The scheme’s exposure to underlying interest rates that reflects the timing of asset cashflows and expected future timing of benefit payments |
·Invest in ‘liability driven investment’ vehicles which usually include using derivatives to transform the nature of the scheme’s assets to more closely match the specific duration of benefit payments to members |
|
3 |
Inflation |
The scheme is exposed to expectations of future inflation when the value of scheme liabilities is linked to inflation but the scheme assets are not |
·Invest in inflation linked securities or use derivatives to generate inflation linked returns |
|
4 |
Mortality |
By its nature the scheme is exposed to changes in the opinion on how long members will live for |
·Markets in longevity swaps are beginning to open up although questions regarding the appropriate price to pay for these contracts, liquidity and also the availability of counterparties for contracts below £50m are all questionable |
Commenting on the findings, Marcus Hurd, head of corporate solutions at Aon Consulting’s global office, said, “It’s no wonder pensions are deemed such a big risk today. The financial meltdown of late 2008 and early 2009 catalysed a massive swelling of final salary deficits which has not showed real signs of recovery. All the time, pensions have been sucking up liquidity, the scarcest commodity of all in the recession.
“While it’s encouraging that employers have woken up to the scale of risk posed by their final salary schemes, the findings underline that there is plenty more they can do to take a proactive approach to mitigating risk.
“A first step for all schemes is to assess the magnitude of risk deriving from investments and other exposures, like interest rates, inflation and mortality. The solutions exist, but companies and trustees are still failing to take them as efficiently as they might due to the time, effort, expertise and management structures required to consider a whole range of complicated issues.
“By analysing the risks, trustees are able to understand fully the risks that sponsoring employers underwrite in relation to their pension schemes and equally employers can then understand the full range of solutions available to reduce the impact of the pension scheme on their business.”
