How to manage pension risk in a volatile environment

MetLife Assurance’s director 
of business development Emma Watkins reveals the pressing issues concerning pension scheme sponsors and trustees.

Traditional defined benefit (DB) pension schemes are being closed to new members and future accrual, and defined contribution (DC) schemes are growing in number as employers seek to control the volatility of their costs. However, there are still an estimated £1trn of private sector DB liabilities which will need to be managed for many decades.

Continued economic volatility and an ever-changing regulatory environment have sharpened DB pension scheme sponsors’ and trustees’ focus on the significant risks facing their schemes today. Determining how best to manage these risks is critical and it is therefore no surprise these factors weigh on the minds of trustees and sponsors alike.

MetLife Assurance’s 2011 UK Pension Risk Behaviour Index (2011 PRBI) identified the top three risks among sponsors and trustees as: funding deficits; employer covenant; and asset and liability mismatch.

Funding deficits

The focus on funding deficits reflects sponsors’ and trustees’ reactions to continued volatility within their schemes and just how pivotal managing funding deficits is to pension risk management.

In the 2011 PRBI, funding deficits moved up in importance to first place from fifth place last year, with the number of times it was selected as important increasing from 27% in 2010 to 58% this year. While funding status may be improving, the volatility of funding ratios, which can change from day to day and year to year, is playing a major role in how sponsors and trustees view the risk attached to funding deficits.

Employer covenant

Employer covenant risk – defined as the assessment of the sponsor’s willingness and ability to fund the scheme – was ranked second in importance among sponsors and trustees. This risk was also ranked second in 2010, but the number of times it was selected as important by respondents jumped from 28% in 2010 to 49% in 2011, indicating that sponsors and trustees are paying more attention to this risk.

Trustees, in particular, need to be confident that an employer can meet its obligations to scheme members over the long-term and especially during times of economic volatility.

Asset and liability mismatch

As for asset and liability mismatch, this risk factor was ranked sixth last year, increasing from a selection rate of 26% in 2010 to a selection rate of 48% in 2011.

This significant change indicates that both sponsors and trustees are concerned about their scheme’s ability to meet long-term liabilities, which extend far into the future. They are also interested in taking steps to change their investment strategy, if necessary with a view to de-risking.