The Pensions Regulator’s Code of Practice 3, on funding defined benefit pension schemes, stresses the importance of having an integrated approach to setting investment and funding strategies, taking account of the strength of the sponsoring employer’s covenant. TPR has now issued practical guidance on what such an integrated approach should look like. The guidance is aimed at trustees and sponsoring employers of defined benefit schemes.
TPR notes also that it intends to publish guidance on setting investment strategy during 2016.
What is IRM?
Integrated risk management (IRM) is a method that considers together the risks that the scheme and the employer face to determine any relationships between them. These risks are those that might affect the trustees’ ability to meet their key objectives of:
- paying all members’ benefits as they fall due,
- meeting the Statutory Funding Objective and
- meeting any other funding objective the trustees have adopted.
Looking at risks in this way should help the trustees and the employer to prioritise the risks and assess their materiality. The exercise should involve an examination of the interaction between the risks and a consideration of “what if” scenarios to test the scheme’s and employer’s risk capacities. It may be helpful to quantify the risks but any such approach should be proportionate to the risk and resources available.
IRM involves also considering what should be done in the event of risks materialising. For instance, it may be necessary to put contingency plans in place to cater for the more significant risks. In addition, IRM helps to identify opportunities to reduce scheme risk.
What does IRM look like in practice?
TPR suggests a 5-step process for implementing IRM:
- Initial considerations – the guidance includes a number of example scenarios, illustrating how trustees, employers and advisers may work together on IRM.
- Assessment of the key risks, considering both impact and probability, first for each risk in isolation and then in combination, and consideration of the trustees’ and employer’s appetite for risk and capacity for taking risk. The risk analysis should include scenario analysis, looking at the scenarios in which material risks arise and how such scenarios arise, as well as their potential impact and the probability of their occurring. When looking at risks across the employer covenant and the funding and/or investment strategies, TPR suggests that trustees look for causal links, concentration of risk and significant risk themes.
- Decide plans to address the key risks – including contingency plans to deal with future material risks.
- Document the process that has been agreed – and how decisions were reached – this can be done within existing documents to contain costs.
- Implement plans as agreed and monitor the scheme risks – high-level monitoring should be carried out at least once a year, using agreed risk indicators and triggers for action.
There is an appendix which describes a number of risk assessment approaches that trustees might choose to employ.