To help you to do it, we suggested some self-reflection – ‘What is the “right” end point or long-term funding target for my scheme?’.
But while it is a simple question, the answer is less straightforward, thanks to an ever-increasing range of funding goals for pension schemes to target.
As a group of trustees, you may all agree to run the scheme on until the last member’s benefit has been paid, using a very low risk investment strategy.
Or you might want to secure all benefits with an insurance company, or even consider transferring to a consolidation vehicle.
There is no right answer. It is a complex decision, entirely specific to the circumstances of your scheme and sponsor. Our decision tree has been designed to help identify some of the key considerations when setting a funding target – and you can climb it more than once.
SETTING THE BEST COURSE FOR SUCCESS
Once you have established your desired destination, you can use the techniques we set out in Step 2 to work out a suitable timeframe to get there. These techniques will also help you determine the combination of investment return and contributions to get you there in time – and with a degree of risk you and your sponsor can withstand.
Now, in Step 3, you need to identify your key risks:
- What could knock you off track?
- What are the main things that might not go to plan?
These might include investment returns not delivering what you expected, changes in interest rates and inflation, or collateral calls when you don’t have sufficient liquid assets to generate the cash you need.
While these risks may not materialise, trustees need to be prepared to tackle them if they do, and the best way is to set boundaries based on how you would recover if they did.
For example, if your funding position worsened by 15%, what combination of investment returns, contributions and extension of your recovery plan would get you back on track? If you cannot create a reasonable solution to a 15% drop in your funding level, then consider reducing the amount of risk being taken in your portfolio to lessen the likelihood of it happening.
STRIKING THE BALANCE BETWEEN THE JOURNEY AND THE DESTINATION
If you cannot see a way to achieve your goal in your desired timeframe with a degree of risk you are comfortable taking, you may need to revisit the three distinct elements of your plan. This may feel like you are going over old ground but revisiting this process will help all stakeholders understand and agree the trade-offs needed – and should result in a far more robust plan.
A SIMPLE FRAMEWORK TO KEEP YOUR JOURNEY ON TRACK
This next step may seem simple, but we believe it is one of the most important you can make to keep you moving towards your destination. Once you have agreed your funding goal, target date and risk limits, summarise them in a clear, one-page reference document that you can use to check progress and identify where and when action needs to be taken.
By using this framework, you can clearly see the scope you have to reduce risk or shorten your time horizons if you get ahead of your plan. Equally, if you fall behind , your framework document will alert you to what needs to be done to get back on track.
We call this one-page reference document a Pension Risk Management Framework. It is a powerful tool that helps trustees stay on track and focused on key factors that will impact the scheme along the journey.
Use this to help you to take confident, consistent decisions that keep moving you towards your goal. In our next blog, we will explore what such a framework can look like, and how you can use it to frame your decisions.