The Pensions Regulator’s (TPR) guidance on integrated risk management (IRM) requires trustees of defined benefit (DB) pension schemes to adopt an integrated approach to the consideration of:
the strength of employer covenant
different funding options.
In practice, many different approaches are used to achieve integration, but it can be difficult to visualise how each of these elements fit with each other and how they might move individually and collectively in different scenarios.
A particular challenge faced by trustees and sponsors is how the employer covenant can best be represented and considered in those discussions.
As covenant advisors, we consider both the sponsor’s legal obligations to fund the scheme and their financial capacity to do so. We usually consider financial capacity principally through the lens of free cash flow available to support scheme funding, whether from trading, other sources or even recoveries on insolvency.
But understanding free cash flow and other metrics of financial strength, while highly important, may not answer other key questions in integrated funding and IRM discussions. For example the importance (and likelihood) of potential corporate longevity – particularly given the long time periods over which a scheme may be reliant on the sponsor covenant, and possible time horizons over which off-plan performance in different investment strategies might be repaired.
How realistic is it to assume that a sponsor business may continue for 5, 10, 15 or even 50 years, given disruptive technologies, market shifts, M&A or the impact of other social or economic factors such as climate change? Many businesses only plan or forecast a year ahead. Some track five-year plans. Listed companies may have projections provided by equity analysts.
Another challenge in IRM discussions is visualising the impact of different economic or financial scenarios and how the three variables of IRM move individually and in combination.
So, as trustees consider their progress towards long-term funding targets, seeking to understand sponsor financial capacity and longevity in different scenarios is vital – finding the right balance between contributions and investment returns over sensible time horizons, particularly when sponsoring employers may be keen to pay out substantial dividends.
What can you do? Book a demonstration.
To support our clients with the challenge of visualising how views of sponsor covenant fit with the other variables of scheme funding, we have developed IRM gateway. Building on our traditional covenant advice, IRM gateway allows trustees and sponsors to see the key elements and dynamics of integrated funding 'on screen' and understand how they might move together in different economic and other scenarios.