Author: Frank Oldham
Okay….so, as I often wonder, maybe I should, in fact, have been a pilot instead of an actuary!
Anyway, it has always fascinated me that commercial aircraft manage not only to find the runway after many hours of flight, but (thankfully) more often than not secure a safe and soft landing; even in poor weather and sometimes virtually zero visibility.
The one exception to this in my own experience was a flight in a small 8-seater to an island off the North American coast, many years ago in very poor visibility. Not for the first time in my flying experiences, the fog and cloud layer hung low, at about 1,000 feet, above which you could only see a grey-white mass. On this occasion we could see through the cockpit and in front of the speeding aircraft – and there was absolutely no visibility of the approaching runway whatsoever. Whether the pilot should have in fact landed (or turned back to New York) on this occasion remains a moot point, though clearly, we did land safely, otherwise I would not be writing this piece, but the landing was, to say the least, extremely scary and there were several white and slightly ill-looking faces in the aircraft – including the pilot! Reflecting after the event, the real difference for this particular flight was, of course, technology. The smaller 8-seater did not have the same systems for a “blind” flight as today’s modern, commercial jet-liners. There is a lesson there for us all…
One thing that is also apparent during a long intercontinental flight is that activity in the cockpit rises at the time of decent (as you might expect), and continues to remain raised during the final approach, with ever more regular – and finer – adjustments to the aircraft’s direction, height, pitch and speed as the massive body of the aircraft is carefully lined up for that perfect landing.
So, as it happens, I turned my career attention to pensions, training as an actuary and more recently helping pension plans manage, and in most cases reduce, pension risk. But there remains an interesting analogy in respect of journey planning for pension plans.
Over the last decade or so, most plans have already started their long descent to an ultimate strategic and preferred goal (or landing), namely to reduce and eliminate most risks, be it to a position of hibernation or self-sufficiency, or to ready themselves for a complete risk transfer to a third-party insurer. During this phase to reduce altitude (from “cruising” – albeit an erratic form of cruising for most), plans have been focusing on managing and reducing investment risk, in particular, ensuring the assets behave a little more like the liabilities. Moreover, reducing volatility has become more important than extra return.
Funding levels increased materially in the first three quarters of 2018. In the US, the number of plans funded at 95% or above on an accounting basis has increased from 20% to almost 40%, so we have a substantial number of plans ready to commence their descent carefully towards their target destination. Indeed, we are seeing an increasing number – particularly in the UK – with a substantial portion of their liabilities now matched and with interest and (in the UK) inflation rates near to fully hedged (at least as a proportion of the assets).
As plans get closer to their intended destination and as they line up for their (hopefully) final approach, emphasis needs to turn more towards addressing the liability risks. In the same way that blustery weather can take an aircraft off course and require almost continual re-adjustment of that final trajectory, plans need to track their liabilities as closely as they track their assets and ensure they have a fully integrated picture of their flight path.
Over recent years, member options – including lump sum cash outs in the US, plus transfer payments and pension increase exchange exercises in the UK – have added to pre-existing uncertainties relating to the liabilities (lump sum payments at retirement, changes in longevity expectations and so on). By way of example, over the 12 months to the end of March 2018, more than £14bn has been transferred out of UK DB plans by members as part of the current pensions freedom options. Moreover, it is not untypical for transfer payments to represent between 5% and 10% of non-vested/non-pensioner liabilities for individual plans. This can have a significant impact on cash flow planning and liability outcomes – the amounts are unpredictable and individual payments are often $/£ millions in size.
Added to continually changing expectations around life expectancy, at a time when more plans are moving to cash flow-driven investing as part of their final approach towards hibernation/self-sufficiency or buy-out – and the challenge of keeping on track for that safe landing is more acute than ever. Continually changing liabilities and short-term cash flow demands can provide severe and unpredictable turbulence and strong side winds on that final approach to the runway.
Making use of the best technology to regularly track not only your assets, but also your liabilities in detail – and, most importantly, the interaction between the two – is essential if you don’t want to lose control at critical moments. This is where tools such as PFaroe, which is leading the way in both the UK and US markets, have a key role to play in helping trustees and plan sponsors navigate this phase of their journey. In particular, the detailed liability modelling, combined with comprehensive asset functionality and forward-looking scenario analysis to examine future cash flows, is critical to keeping that runway in sight.
I have long been a fan of PFaroe, combining intuitive user interfaces with accurate mapping of both sides of the pension balance sheet, quick response times, and sophisticated modelling capabilities to map out the most efficient course, even during turbulent markets. And it doesn’t stop there. Continuing development of the PFaroe platform has now brought integrated access to Club Vita mortality data in the UK – allowing you to model your liabilities using mortality data relevant to your plan – plus, sophisticated lump sum modelling in the US, helping to ensure you land in the right place!
For those plans seeking a buy-out or some form of risk transfer as their goal, this technology is just as relevant as for those following a course to hibernation/self-sufficiency. As a risk transfer comes in sight, this can be akin to a steep or forced landing on a short runway. Navigation can be even more critical, since a small misjudgement can mean an aborted landing and wasted resources, as the opportunity to transfer risk at the right price is missed.
The plans that will most successfully navigate their course, either to buy-out or to hibernation, will take advantage of the tools available, such as PFaroe, to ensure they remain on course – and to lock in to attractive pricing for risk transfer at the right time (letting the autopilot of fully integrated technology ensure a soft landing even in the most challenging of circumstances).
So, if you are already on the de-risking descent, and now need to focus not just on your assets but a closer interaction with variation in your liabilities and more active cash flow management, make sure you have the right tools to navigate this critical part of the journey.
Fasten your seatbelts and have a safe flight!