OREANDA-NEWS. Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE:AON), has said that the Pensions Regulator's (tPR) annual defined benefit funding statement 2015, released today, shows a strong continuation of existing themes.  The statement reaffirms that tPR expects schemes to have an integrated approach to managing risks, understanding their big risks such as their level of hedging, and understanding what might have changed since their last scheme valuation. This might include changes to their investment strategy, changes to their employer covenant or changes to member behavior, such as a growth in DB to DC transfers in order to gain access to Freedom & Choice. 

Lynda Whitney, partner, Aon Hewitt, said:
"The Regulator has separately highlighted schemes which still have capacity to take additional risk and those that only have limited capacity.  tPR has recognised that some schemes have capacity because they have taken more prudent approaches in the past or because their employer covenant has improved.  Consequently, these schemes are better placed to deal with higher deficits in 2015.  But all schemes can consider possible adjustments to assumptions, length of Recovery Plan, level of deficit contributions that can be supported without impacting the employer's sustainable growth plans, and the impact of additional security from contingent assets.

"While formal valuations are only every three years, it is vital to have good monitoring and risk analysis tools that operate between valuations. Although in my opinion schemes should not cherry pick a date, but stick to a consistent policy on whether or how they take post-valuation experience into account.  tPR is recognising this with a focus on considering the experience after valuation - which has been particularly bumpy this year.  We have worked with over 280 schemes using our Risk Analyzer tool which can undertake that monitoring as well as reviewing many other factors."

Duncan Lamont, principal consultant in Aon Hewitt’s Global Asset Allocation team said:
“We wholeheartedly agree with many of the points raised in the tPR’s statement. For many pension schemes, hedging ratios remain at low levels and I am not surprised to see tPR saying that the position of schemes with valuations this year depends significantly on how much they hedged interest rate and inflation risk.

“Our analysis suggests that interest rates will rise by more than is priced into the yield curve.  This is an argument for some element of under-hedging but it is not a justification for hedge ratios as low as the 20% level of many schemes. For all but those schemes which are already highly hedged, we believe that the decision on whether to hedge or not should largely be driven by risk considerations rather than on views on the likely direction of interest rates.”

Duncan Lamont continued:
“The focus should be on right-sizing risks as opposed to having the interest rate ’bet’ dominate funding level progression. Furthermore, after the recent rise in yields, the gap between how far we expect yields to rise and what is priced into the bond market has narrowed considerably. For pension schemes which have been waiting for a better opportunity to raise their hedge ratios, now is the time to act.

“We also strongly agree with the tPR’s drive to encourage greater contingency planning. Markets have been expecting central banks to raise interest rates every year for the past five years - and every year it has failed to happen. It would not take much of a downturn in growth or in inflation for rate expectations to get pushed back further. tPR is right to draw attention to the importance of understanding the implications if the anticipated increase fails to happen.

“Our clients are increasingly drawn to our deterministic scenario analysis to help them quantify these risks. In this, a range of alternative economic scenarios are formulated - these cover positive, negative and topical potential futures and allow pension schemes to model how their funding level would progress.  This answers ‘what if?’ type questions, and our clients have found it to be a valuable, intuitive approach.”

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Aon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services.