The challenges of Self-Sufficiency

The self-sufficiency approach regarding pensions occurs when pension schemes reach a certain threshold in relation to assets that enables them to feasibly sustain themselves solely by investing such assets. In doing so, they rely less on funding from sponsors.

However, there are certain obstacles that need to be overcome for pension schemes to be successfully self-sufficient. We look at the main self-sufficiency challenges that are often experienced within the pensions industry.

Limiting Risks

Limiting risks involves balancing pension scheme assets, to ensure that they are invested in a way which minimises risks to the pension scheme’s investment portfolio. This is particularly pertinent for those aiming for self-sufficiency, particularly as we approach cash negative scenarios as they will be trying to establish ‘what are the most effective investments for capitalising on income needs?’ and ‘how can we maximise investment gains?’

By focusing on these objective questions, pension schemes can mitigate some degree of risk and concentrate on achieving adequate returns that promote self-sufficiency. Once self-sufficient, a pension scheme is usually 100% funded based on its own investment choices, so underperformance within an asset category has minimal impact on their sponsor.

De-risking Strategies for Investments

Certain changes to de-risking strategies can be controlled or taken into account by trustees and sponsors more so than others. Monitoring market conditions and the performance breakdown across the assets your pension scheme invests in, will enable you to make appropriate changes to your risk strategy.

Trigger-based de-risking strategy is centred around this concept and remains a long-standing, popular approach to determining how to adapt to changes that affect your asset classes. If applying this method as part of your asset strategy, you will need to establish well-defined rules to determine when changes are needed based on actions (triggers) within the financial market. The setting of such triggers is increasingly part of investment consultant guidance and is also incorporated into a Fiduciary Managers mandate.

Recovery Plans

It’s also important to decide on a plan of action regarding the amount of time that’s needed in order to reach self-sufficiency. This is known as the recovery period. If adequate time is not allowed to obtain the required level of self-sufficiency, then you increase the likelihood of pension scheme assets being invested in asset classes which are more volatile and therefore carry larger risks. The length of the recovery period is coming under increasing scrutiny by the Pension Regulator and features in the new consultation so is likely to form a major part of many a valuation discussion.

A longer recovery period can result in higher returns being expected within a market whose long-term future is by its very nature unpredictable and therefore higher risk.

Finding the balance between short-term investments that will gain value and long-term investments that carry greater risk, but also greater potential reward has always been tricky. The integrated risk-management approach has started to incorporate the impact of the employer covenant strength and modelling tools are developing that can assess risk in terms of both exposure to the Scheme investments and corresponding impact on employer business plans. Trustees and employers now need to factor in the most recent consultation and what this may mean to valuations.

Cashflow Considerations

Cashflow is becoming a primary consideration due to a combination of maturing membership, the reduction in ongoing contributions and the increasing tendency of transfers to access DC flexibilities. This can all become a significant challenge to self-sufficiency, and we are seeing increasing developments in the way in which some of the more innovative consultancies are placing cash requirements at the heart of their investment strategy advice.

Pi Partnership provides specialist independent consulting to employers, occupational pension schemes and Boards of trustees. We are one of the leading providers of independent scheme secretaries and provide professional trustee services to a wide range of pension schemes. Over the last 20 years we’ve worked with clients ranging from FTSE100 companies to small charitable organisations. For more information about the services we can offer your business contact us today.