How we designed a comprehensive contingency planning framework addressing covenant, funding and investment risks, inspired by LCP Sonar.
From casual to meticulous:
planning to succeed
13 November 2018
Mary Spencer, a partner in our investment team, and Fran Bailey, the leading consultant in our rapidly expanding covenant advisory team, work together in our Pension Scheme Risk Management group. Together, they're going to discuss how LCP Sonar can help you implement a truly integrated approach to managing your pension scheme risk.
When I’m planning a journey, such as a trip abroad, I don’t often ask myself “what are the risks?” and I certainly don’t come up with a risk management plan. However, I suppose subconsciously I do plan in such a way that I’m confident I’ll reach my destination – I arrive at the airport early enough that I don’t miss my flight and usually I’ve also planned my travel to the airport ahead of time. But it’s probably fair to say that my approach to managing my journey risks is a little casual.
But you would expect the flight itself to be meticulously planned, and you would expect risk to be at the forefront of this: the pilot well-trained, safety checks completed, and experts lined up to guide the plane at each stage of its journey to ensure that nothing goes wrong. Flying is a highly controlled exercise, potentially because the many passengers on board each plane are relying on the pilot and their support team to get them to their destination safely.
Somewhat like a pension scheme, where the members rely on trustees and their advisers to ensure their benefits are paid. And because of this reliance, pensions are also a highly regulated area – and regulation dictates that we must think about and manage the risks faced by a pension scheme. But theory aside, what does that mean in practice? I’ve often seen pension scheme trustees unsure of how to approach risk management, an area where it’s all too easy to be bombarded with an array of detailed figures that don’t aid decision making.
As a covenant adviser, I think it’s also fair to say that consideration of covenant risk hasn’t always got as much trustee governance time as other risks. But it’s extremely important that covenant’s interaction with other risks is fully interrogated, and it’s critical that this risk is monitored on a regular basis. With this in mind, we’ve worked together this year to develop LCP Sonar.
LCP Sonar plots how a scheme stacks up on a range of pension scheme risk measures, covering the key areas of covenant, funding and investment. We wanted to develop a tool that opened an engaging conversation about risk and gave some clear pointers on actions that may be taken to effectively manage a range of different risks. We launched LCP Sonar at our Annual Pensions Conference in September and have already used it with a number of our clients.
Importantly, we wanted to enable trustees to prioritise the risks on which they focus. LCP Sonar allows trustees to view their risks against those of their peer group, so that they can better manage their governance time by focussing on the risks that look more likely to throw them off course as their scheme progresses along its journey plan.
The right approach to risk management for each pension scheme will be very different, because the differing circumstances and covenant support available will lead to different long-term objectives and interaction of risks. But in my view, it is essential that objectives are identified right at the start – how can you identify what might throw you off course if you don’t know where you’re trying to get to (and when)? Once everyone is clear on the objective they are working towards, a focussed risk management plan can be developed, and you can monitor the risk metrics that will help you make decisions. You can also react more quickly to changing conditions, as you can agree up front the actions you will take in different scenarios.
However, best practice risk management requires input from sponsors as well as trustees. For example, a robust approach to integrating covenant risk requires collaborative engagement. Having an open dialogue with your sponsoring employer’s management, and ensuring relevant financial information is shared, means that covenant strength can be monitored. As a result, the impact of any changes in covenant strength on the journey plan of a scheme can be managed jointly, and appropriate actions can be taken to mitigate or benefit from these changes. This is particularly critical when the risks in the scheme itself could threaten the future viability of the sponsor, or for helping trustees to understand the potential future impact of external events such as “Brexit”.
By using this approach we’ve already had success in developing effective risk management plans that support a long-term journey, taking your risk approach from “casual” to “meticulous”. In the coming months we’ll share some case studies and insights from our clients to demonstrate how our risk management approach can add value in practice.
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Spotlight on all risks
LCP Sonar, our risk profiling tool, benchmarks your scheme against other pension schemes, covering covenant, funding and investment risks. You can quickly see how your scheme’s risk profile compares to others and think about the key risks for you.Discover more