Improved governance needed to reduce pension scheme risks

Ethical MarketsSRI/ESG News

For immediate release: Monday, February 25th 2008. Improved governance needed to reduce pension scheme risks, Economist Intelligence Unit report finds

The risk environment for UK pension schemes is becoming more severe,
thanks to a combination of regulatory uncertainty, changes to life
expectancy, the volatility of financial markets and rising inflation,
according to a new survey of 200 board-level executives of UK companies.
Overall, 64% of respondents said that they thought the risks associated
with running their scheme had become more severe over the past three
years.

Asked about a range of techniques that could be used to reduce pension
scheme risks, respondents thought that changes to governance to improve
decision-making and control of pension issues would be most effective.

More innovative approaches, such as liability-driven investment and bulk
annuity buy-outs, were thought to be less effective and, to date, have
not been widely used. For example, just 14% of respondents say that they
already have liability-driven investment in place, although 41% expect
to use the technique in the next three years.

In the right circumstances, companies would consider using bulk annuity
buy-outs (whereby companies transfer some or all of their liabilities to
a life insurance company or capital markets player). If they could do so
at a competitive price with the full support of stakeholders, 60% of
respondents said that they would transfer at least some of their
liabilities. However, those conditions are not generally met, and as a
result most respondents said that they would be unlikely to adopt this
approach in practise: just 19% intended to transfer liabilities to an
insurance company over the next three years, and 61% said that they do
not intend to explore this option.

These findings form part of A Way through the maze: the challenges of
managing UK pensions schemes, a newly-released Economist Intelligence
Unit survey and report, commissioned by Towers Perrin. As UK pension
schemes continue to face an uncertain future, the report examines the
various techniques that companies can use to manage the risks associated
with their scheme in terms of governance, funding, investment and scheme
structure.

“There is widespread agreement that the risks associated with running
UK pension schemes are becoming more severe,” says Rob Mitchell,
editor of the report, “but there remains hesitation to adopt some of
the more innovative approaches to managing these risks, such as
liability-driven investment and bulk annuity buy-outs. In general,
respondents believe that changes to governance processes are the most
effective way of reducing pension scheme risks.”

Mark Duke, head of pensions at Towers Perrin said: “Many companies
know they’ve got a big pensions problem. But it’s technically
complex, often challenging to define a solution and sometimes near
impossible to get all the stakeholders to take the necessary decisions.
We agree with the survey respondents. Effective decision making has to
be underpinned by good governance. The people who do this best are the
ones who get to the right answers first and stop their problems getting
bigger.”

Other key findings of the report include:

? Better knowledge and understanding is a key risk management tool.
When asked about the aspects of their scheme management that they are
keen to improve in the next few years, items related to “knowledge and
understanding” score highly. For example, improving their
understanding of funding options is seen as the main priority, cited by
42% of respondents, followed by improving their understanding of
long-term trends, which is cited by 36%. With new risks on the horizon,
and new techniques to manage, mitigate or transfer them becoming
available, keeping abreast of new trends and often complex concepts has
become more challenging than ever.

? Performance management remains an important weakness. When asked
about their strengths and weaknesses with regard to different aspects of
scheme governance, respondents saw their strengths as the setting and
monitoring of investment strategy and the managing of relations between
trustees and the corporate sponsor. They were also fairly confident
about their ability to put in place a formal process to identify risks
and monitor those risks on an ongoing basis. The main areas of weakness
were seen to be performance management-of investment consultants and
trustees in particular-and enhancing trustee competencies. Many
companies, it seems, have difficulties in determining the metrics that
apply to their scheme, and in conducting performance management based on
outcomes.

A Way through the maze: the challenges of managing UK pensions schemes
is available free to download at:
www.eiu.com/sponsor/towersperrin/waythroughthemaze/