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Scheme funding concerns lead to focus on critical risks as sponsors and trustees move towards a more coordinated approach to risk management, says MetLife

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Despite reports that funding has improved over the past year, continued market volatility and economic uncertainty is driving defined benefit scheme sponsors and trustees to focus more intensely on critical funding-related risks impacting their schemes, according to the MetLife Assurance 2011 UK Pension Risk Behaviour IndexSM (UK PRBI) released today. 

The study of 89 sponsors and trustees analysed how each group viewed 18 investment, liability and business risks that affect their pension schemes, and assessed how well they believed they were managing those risks.
 
The ranking of Funding Deficits as the most critical risk according to both sponsors and trustees is reflective of reactions to continued volatility within defined benefit schemes.  It demonstrates the degree to which this risk weighs on their minds and how pivotal design and implementation of investment strategies, that effectively manage contribution levels, are to pension risk management.  Fundamentally, whilst the overall funding position of schemes may be improving, on an individual scheme basis, the lack of a consistent and sufficient funding level is not inspiring confidence among either of the two groups. 
 
With Employer Covenant and Asset and Liability Mismatch as the second and third most important risks, respectively, it seems sponsors and trustees are taking a close look at how they will protect their members’ benefits moving forward by examining the employer covenant and focusing on any mismatches between the amount and timing of their scheme’s asset and liability cash flows. 

In a significant shift from the 2010 UK PRBI, scheme sponsors’ and trustees’ risk management priorities showed signs of greater alignment.  Instead of primarily focusing on the risks they are each directly responsible for, scheme sponsors and trustees appear to see nearly eye-to-eye on the importance ascribed to the 18 risks that their schemes are exposed to. The challenging economic environment of the past several years may have contributed to this.  With the spotlight on risk management, the 2011 UK PRBI found that trustees and sponsors have increased communications and reviewed their governance structure so as to better align their views on risk.  As a result, they may now have a clearer understanding of their scheme’s individual situation, paving the way for a more co-ordinated plan of action to manage scheme risk in the future.
 
Dan DeKeizer (pictured), Chief Executive Officer, MetLife Assurance Limited, says: “In the face of lingering market uncertainty and concerns over the future viability of their schemes, sponsors and trustees have started to recognise that a more integrated approach to pension risk prioritisation may be the most effective strategy for their common goal of protecting members’ benefits, in contrast to the separate and largely un-coordinated model identified in the 2010 UK PRBI  findings.
 
Whilst it’s encouraging to see sponsors and trustees increasing communications about risk prioritisation, the open question for the future is whether or not risk mitigation activity will be similarly  coordinated.  Sponsors and trustees must continue to work together and coordinate their actions to ensure the most critical risks are given the time and attention they deserve.”
 
The gap between the most important and least important risks among the 18 risks measured by the UK PRBI has widened significantly in 2011, indicating that sponsors and trustees are taking a much more selective approach to pension risk prioritisation.  The gap between the most important risks and least important risks in 2011 is 57 percentage points.  This represents a major turnaround from the inaugural UK PRBI, which measured the degree of risk differentiation  at just eight percentage points between the risk selected as most important and that selected as least important, with sponsors and trustees seemingly unwilling to set any of the risks aside as potentially unimportant.  This year’s results demonstrate that sponsors and trustees are focusing their attention on a core set of key issues which should allow clearer prioritisation of action going forward.
 
Sponsors and trustees may have a better appreciation of the importance of the top three risks facing their schemes – Funding Deficits, Employer Covenant and Asset and Liability Mismatch – by having a strong understanding of their liabilities.  Whilst volatile market conditions over the past several years have made it difficult for schemes to assess what their funded positions have been at particular points in time, sponsors and trustees have had confidence in their ability to measure their technical liabilities, thus placing them in a good position to determine what needs to be addressed to meet their ongoing benefit promises.  As in the 2010 UK PRBI, trustees and sponsors self-reported the highest level of success in managing the Measurement of Technical Liabilities/Provisions.
 
The 2011 UK PRBI found that sponsors and trustees are confident in their ability to manage risk, but highlights a gap between how well the risks deemed most important are reported as being managed.  Ideally there should be consistency between the importance that scheme sponsors and trustees ascribe to risks and how successfully they are reported as being managed. Whilst Funding Deficits is regarded as the most important risk, it is ranked 12th in reported success. Similarly, Asset and Liability Mismatch, the third most important risk is ranked 11th in reported success, and Longevity Risk, the fifth  most important risk, is ranked last overall in reported success.  
 
The overall index score for the 2011 UK PRBI is 79%, up from 78% in 2010. This essentially static result is consistent with the underlying findings that show a shift toward a smaller, more focused group of risk factors. As success lags awareness, we would not expect to see a significant increase in the Index until a consistent set of risks stabilises, providing sufficient time for focus to be reflected in success.
 
Emma Watkins, Director of Business Development, MetLife Assurance Limited says: “The results of this year’s UK PRBI are very encouraging.  Sponsors’ and trustees’ view of risk importance appear to be converging, action has been taken on increasing communication and improving governance, and both parties have confidence in their ability to manage risk overall.  However, as in the 2010 UK PRBI, the gap between the risks that sponsors and trustees deem to be most important, and the reported success they believe they have in managing them, provides insight into the challenges pension risk management presents. 
 
"Risks that are rated as high in importance but low in success in this year’s UK PRBI – Funding Deficits, Asset and Liability Mismatch and Longevity Risks – represent the areas of highest concern currently.  Improving the success measures for those risks will require focused and coordinated action on the part of both sponsors and trustees.”

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