16 November 2018
A ‘practical guide’ for pensions actuaries is helping members advising UK DB pension schemes to help their clients manage Resource & Environment (“R&E”) risks.
If you were to pick a random pension scheme trustee and asked them what kept them awake at night (assuming it’s not a young child), their response would probably not feature the term “resource and environment”. They might talk about the ongoing support of their sponsoring employer or people living longer or prolonged periods of low economic growth giving poor asset returns. But just because our random trustee hasn’t mentioned “R&E” doesn’t mean they are not, or should not be, mindful of it.
Trustees spend lots of time managing the individual risks that may derail their scheme’s progress. It is, of course, hugely valuable doing so, to keep the scheme financially healthy. In a sense, though, it’s just like dealing with the symptoms. But what if there was (to extend the medical analogy) a root cause that could hugely affect all the patient’s symptoms?
R&E is one such fundamental issue that could manifest itself in a variety of different ways for a pension scheme. And in a real “step change” way, rather than some of the more cyclical impacts we’re all more used to dealing with.
If you’re reading this blog, you probably live in a world that seems very far removed from the natural environment. You’re probably far more used to dealing with things like inflation, interest rates, value at risk and life expectancy than earth, water, air and fire. The two sets appear at first glance to be completely unconnected but a brief pause for thought reveals the connection: the natural environment and use of its resources ultimately affects all those who live in it, both directly and via the systems we have created such as the economy. Looked at in this way, it’s easy to see that resource and environment issues can affect:
- Life expectancy- we know, for example, that temperature and levels of air pollution affect mortality rates. Availability of healthy versus unhealthy foods does the same;
- Rates of economic growth and levels of inflation- as the supply of resources needed to construct more complex goods and consumables changes, this then has implications for interest rates that can be used to try and control growth and inflation;
- Company performance- measures to tackle climate change, for example, brings opportunities for companies that can generate clean energy or help us to use energy more efficiently, but can also lead to business failure for those companies that are locked into heavy use of fossil fuels.
So whilst our trustee didn’t mention R&E issues, all the things he or she is concerned about could be (and indeed almost certainly will, over time, be) impacted by them. Therefore, as actuaries, if we talk about R&E issues in the language of symptoms, we’re likely to find some very receptive clients.
Indeed, this was partly the aim of the IFoA’s working party entitled “R&E issues: implications for pensions actuaries”. Their remit was to develop a practical guide, using the symptoms-based language introduced above and focussing on the key areas of mortality assumptions, financial assumptions and sponsor covenant. Additionally, and importantly, the guide is intended to be practical, so as well as noting symptoms it also suggests some appropriate medicines. That is, it sets out some practical steps that could reasonably be taken by pensions actuaries now and attempts to bring them to life through a practical example using the familiar “integrated risk management” framework.
The practical guide
The guide itself is a 10-page summary of key points and actions. It is complemented by three in-depth reports covering mortality assumptions, financial assumptions and covenant assessments.
The in-depth reports give summaries and analyses of research that has been conducted that might be helpful to pension schemes. For example, the recently published financial assumptions report looks at investigations into the impact of climate change on investment markets and evaluates how useful these investigations may be to pension schemes. Whilst deliberately being heavier on the theory than the shorter-form guide, the in-depth reports retain a practical focus and conclude with lists of action points to assist users.
The combined work gives pensions actuaries the language, the background and the practical orientation on how they might help their clients to actively consider and manage R&E risks. So the next time you ask a random trustee what’s keeping them up at night, their response won’t be “resource and environment”. But hopefully that’s because they can now sleep more comfortably in the knowledge that their actuary has read the guide and is helping them manage these risks appropriately. As we look towards the future, we expect that industry thinking on this topic will evolve significantly, not to mention the emergence of climate experience and societal responses. The actuary’s work in respect of R&E risks is therefore far from complete and the IFoA’s Resource and Environment Board will be monitoring and responding to developments to equip actuaries in dealing with these issues going forwards.
Read the guide and complementary reports