Why aren’t we turning the light on?
As an industry we are risk-focussed. We have to be. We exist in order to deliver on members’ pensions promises, which means we have to manage the risks that might stop us doing that. So you’d imagine we’d have our torchlights out, searching for those things that go bump in the night, ready to knock them on the head or swiftly bypass them. But we don’t. The lights are still off.
It’s because we have a funny relationship with ‘risk’. On the one hand, we are entirely comfortable with it. After all, we now live in world of integrated risk management. Trustees and employers understand the relationship between risk and reward when it comes to investments. They need to make the assets work. Time and money is spent on measuring investment risk and structuring an efficient portfolio. Similarly, and against that backdrop, employer covenants are assessed and funding discussions take place. Risks and likelihoods are juggled and, generally, people land somewhere sensible. So what risks are we still shying away from?
We rightly spend a lot of time talking about the asset side of things. However, the value in that is diminished if we don’t properly understand the liabilities. If we don’t know what benefits the scheme must pay, then other discussions are more theoretical than we thought. More fundamentally, trustees don’t know the extent to which they are meeting their core legal duty: to pay members their benefits when due. This means we also don’t know if a scheme is carrying a risk of overpaying or underpaying benefits. So it’s here where a lack of understanding is leaving many schemes on the back foot. Yet the thought of taking a closer look can leave trustees and employers fearing what they may find in the dark.
The way to work out the scheme’s liabilities is to look at the scheme’s legal documents, including any sets of rules applicable to different members, and work out what should be paid and when. Then check with the administrator if that is what has been paid. It sounds obvious, right? At times it can be tricky. The interpretation of certain rules can leave us applying cold compresses to our heads. There’s also no getting around the fact that there is cost associated with it. Nevertheless, there are very valuable long-term gains at stake.
At a fundamental level, it enables trustees to understand the extent to which they are complying with their core legal duties. The law doesn’t require trustees to be perfect. They may find that they can’t be certain that benefits for a group of members have been paid correctly, because two interpretations of the rules are possible. And they may decide not to take any action, and instead run that risk. There are ways to structure trustee protections to provide cover. On the other hand, trustees may discover they’ve been overpaying members and the scheme’s funding position is better than thought.
Danger lies in unconscious risks. So why do we still run them? If we are honest, very few of us have shone a light on this area. It stirs up fears of criticism; partly driven by burdensome regulation and partly by a reluctance to have the conversation. It’s keeping us in the dark.
Now is the perfect time for us to shine a light on scheme liabilities, without blame. We are seeing a much-welcomed focus by The Pensions Regulator on data and the unquestionable value of good administration. They are vital to member outcomes. Yet by themselves, without understanding what members are due, they are a blunt instrument. At worst, they compound underlying problems.
In a buoyant buyout market, with pensions dashboards around the corner and an increasing desire to engage members, it’s never been so important to turn the lights on, learn from mistakes and not point fingers.
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. Arc Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.