The buzz phrase for those involved in DB pension management is “Integrated Risk Management” or IRM – if you want to sound familiar with these things. The phrase is a good one as it focuses trustee’s minds on what really matters, paying the pensions. If he investment, benefit and funding strategies are all lined up , then the chances of managing the scheme to eventual solvency are a lot higher than if there’s no such plan.
But my worry when I hear actuaries and investment consultants talking about IRM is that they think of it as an organisation’s pension strategy. It isn’t – IRM only addresses the risks of a funded scheme collapsing under its liabilities and of it dragging its sponsor with it. This is only half the risk, the other half of the risk is that those working for the company and not benefiting from the promise- are forgotten about.
Put another way, considering risk only from the perspectives of the employer and trustee is to neglect the risks being left to the staff no longer benefiting from the promise.
The changing pension contract
The contract between employer -government and employee has – for generations – been about risk sharing. Beveridge brought in a system that allowed everyone the comfort of knowing the State would provide a basic level of support to relieve poverty. Beyond that employers could choose to what extent they wanted to raise expectations to their staff that retirement (if they worked with the employer) could be a better place. This contract was in turn based on risk being shared with the employer (both in terms of contributions and in terms of outcomes). The recent move away from risk sharing and toward risk polarisation has meant that those with a promise take no risk and those without a promise have no share in the employer’s covenant other than a defined contribution.
This shift was supposed to be eased by the financial empowerment of staff to do it for themselves. There were many theories about how staff were going to get savvy. They included the explosion in the numbers of financial advisers in the 80s and 90s, the arrival of easier to understand “stakeholder pensions”, the improved standards arising from the Retail Distribution and most recently the auto=enrolment project. None of these initiatives has yet managed the risk transfer that followed the closure of private sector defined benefit schemes.
“Integrated” should mean just that
In my view, an employer or a trustee board must be mndful of not just those in the scheme, but those staff excluded from the scheme. I exclude from this statement multi-employer master trusts and GPPs which have no link with the employer covenant other than to ensure that contributions are being collected according to the given schedule.
For Defined Benefit schemes to properly call themselves “integrated” in their risk management, staff should properly be satisfied about what “integrated” means.
I am going beyond the limited remit of defined benefit consultancy and suggesting that a company is only integrated in its pension strategy when it can explain it to all staff in a single room without chagrin. I use that word as I am writing from France – the French have a much better vocabulary for shame and embarrassment than we do!
Very few trustees of a defined benefit scheme have concern for what goes on outside the scheme and most employers sponsoring defined benefits are beginning to regard the scheme as a toxic legacy of previous management. In short, neither employers or trustees are operating pension strategies that are integrated.
Total and deferred pay
For a more integrated approach to emerge, we need to get staff understanding both the concepts of total and deferred pay. Those who are in defined benefit schemes have higher expectations of deferred pay and those in defined contributions should have higher expectations of current total pay- precisely because they are not receiving the same promise of deferred pay.
For larger employers, establish a reward strategy that fairly balances these concepts of deferred and total pay should not be too hard. It would necessarily mean that those accruing defined benefits would receive less immediate compensation and those outside the promise would receive more. This is particularly pertinent to the public sector where the suspicion is that there is no integration between total and deferred pay so that employees in defined benefit schemes have compensation benchmarked against those in the private sector getting little or no deferred pay.
To use the language of risk rather than reward. Why should those who are managing their own retirement risks accept that his or her employer running an IRM, unless it can be proved that the risk that he or she is taking on, is being properly rewarded?
Conditional benefits or conditional pay?
We look as if we are about to look again at the idea of “conditional pension benefits”, with the “conditional” being about the employer’s capacity to pay the pension. Perhaps we should be looking at this , not by questioning the benefit promise, but the salary basis against which the promise has been made.
The only way that employers can properly claim to have agreed an integrated pension strategy with the trustees is to include total reward in the equation.