The Pensions Regulator (TPR) has issued guidance on integrated risk management. This follows on from the guidance it issued earlier this year on assessing and monitoring the employer covenant. Both sets of guidance are designed to complement and give practical advice to trustees and employers on TPR’s Code of Practice on Funding Defined Benefits. Further guidance on DB scheme investment strategy is intended to be published in 2016, and this will complete this suite of documents covering all the interlinking areas affecting scheme funding.
The aim of integrated risk management (IRM) is to enable scheme trustees to assess, prioritise and manage the employer covenant, investment and funding risks in a co-ordinated and integrated way.
The diagram below, taken from TPR’s guidance, illustrates these three areas – covenant, investment and funding, each of which interrelates with and affects each of the other areas. The DB funding code and TPR’s covenant and investment guidance (the latter still to be published) provide guidance for trustees on how to assess the risks of each of the three areas on an individual basis.
The process of integrated risk management takes the risks that are identified in each of these areas and assesses how those risks interact both bilaterally and all together. That process involves considering links, impacts and concentrations of risk across the different areas, and analysing how best to manage risk in the scheme in the light of those considerations.
TPR is clear that IRM needs to be implemented proportionately, taking into account the individual circumstances of the scheme. It also emphasises the need for scheme trustees and the sponsoring employer to engage in this process and to develop a common understanding of the risks and relationships between them. Transparency and openness by the trustees and the employer about their respective risk appetites will aid clarity of understanding and constructive negotiation and solutions.
The guidance states that trustees should consider introducing IRM wherever the scheme lies within its actuarial valuation cycle, rather than waiting until the next valuation is due.
TPR identifies some of the key benefits of IRM as being:
- Better decision making resulting from greater trustee and employer understanding of risks.
- Better working relationships between trustees and employers because of open and constructive dialogue.
- More effective risk assessment, contingency planning and monitoring arrangements resulting from an evidence-based focus on the most important risks.
- Greater efficiency due to more effective use of trustee, employer and adviser resources.
IRM involves 5 key stages:
Step 1: Initial considerations for putting an IRM framework in place
Step 2: Risk identification and the initial risk assessment
Step 3: Risk management and contingency planning
Step 4: Documenting the decisions
Step 5: Risk monitoring
TPR’s guidance sets out details of how to implement each of these stages. The guidance also contains practical examples to illustrate the concepts and advice given.
There is also an appendix setting out details of the possible risk assessment approaches that the trustees may use, including stress testing, scenario testing, scenario projections, stochastic modelling and reverse stress testing.
This guidance sets out a clear procedural framework which, if fully implemented, will ensure that trustees, the employer and advisers are dealing with scheme risks in an integrated way. TPR has emphasised this approach before and ideally trustees will already be alive to the interactions between covenant, investment and funding.
Some may consider TPR’s full approach to be something of a hammer to crack a nut. However TPR is clear that this needs to be implemented proportionately, and without a process to ensure that links are made, concentrations of risk, action triggers and other crucial issues can be missed.
For more information about TPR’s guidance on assessing and monitoring the employer covenant see our blog post here.