Independent Trustee Services: Win the defined benefit end game - Chris Martin

As the pace at which defined benefit pension schemes close escalates, preparation for the end game of self-sufficiency and risk transfer is becoming a priority for private sector companies. Independent Trustee Services' managing director Chris Martin discusses the strategies available for companies facing costly pension liabilities, and the broader impact of the transition to defined contribution schemes.

Could you please introduce your company?

Chris Martin: Independent Trustee Services Limited (ITS) is a professional corporate pensions trustee company, which I co-founded in 1991. We're based in central London, and have 25 staff working on professional pension trusteeship across a wide range of schemes and locations.

I began my career in pensions administration, moved on to become a director of an actuarial consultancy, then founded ITS. I've spent the last 22 years leading ITS, specialising in some of its more challenging cases, particularly those that focus on corporate restructuring to address defined benefit (DB) pension scheme deficits.

How significant a problem have DB pension schemes become?

It depends on a company's individual circumstances. But looking at the broader trends, the older industries with mature DB schemes often have extremely large deficits relative to the underlying value of the business - these shortfalls have had an increasing effect on the ability of these companies to continue trading. This impact has become particularly acute over the last few years.

"Older industries with mature defined benefit schemes often have extremely large deficits relative to the underlying value of the business."

Some, such as the Scottish textile company Dawson International, have gone into insolvency because they couldn't meet their pension liabilities. Others may have stopped paying dividends to shareholders because they have to fund their pension scheme deficit first; clearly, this has a detrimental effect on their ability to attract new investment and funding. Overall, DB pension schemes can have a massive and potentially terminal impact on corporate life.

How have corporate attitudes changed towards DB pensions?

There's been a complete change of mindset towards DB pensions in the private sector in recent years. Generally, employers no longer regard them as a standard employee benefit; rather, they're seen as an expensive and volatile legacy debt that has to be managed as efficiently as possible. Not only can the scale of the deficit threaten the viability of the company, but the factors that determine the size of that deficit, and how and when it needs to be funded are often outside the company's control.

"The first thing companies and trustee boards need to ensure is that they have a clear shared objective: what they want to achieve, how quickly and the risks they're willing to take."

This has led to the many DB scheme sponsors and trustees focusing on planning for the end game: getting to funding self-sufficiency or full risk transfer. This can take anything from five to 25 years, and there are different approaches to get there.

The critical point is that however far off or unachievable it may seem, trustees and sponsor should have a clear set of shared objectives, and a plan of how to put these into play. The one certainty is that no DB pension scheme will get to the end game (or at least the one it wants) without this investment in planning and management.

What choices do companies face in playing the DB end game?

The first thing companies and trustee boards need to ensure is that they have a clear shared objective: what they want to achieve, how quickly and - often the most difficult decision to make - the risks they're willing to take.

Once the objectives have been set, it's vital that companies and trustees have the right governance structure to deliver the end-game solution. It's no good, for example, having a sophisticated de-risking strategy - perhaps selling equities and buying bonds when certain funding level triggers have been met - if the trustees only meet to do business three times a year. Clearly, the corporate and trustee boards each have the relevant expertise to set and implement these strategies.

For some trustee boards, managing a DB scheme towards an end-game plan can feel like a 24/7 role. At this point, the professional corporate trustee (such as ITS) with the infrastructure, experience and expertise can have a key role to play.

Doesn't it help to have at least some lay trustees involved?

Certainly. We act as sole trustees on around a third of our schemes, and one thing you inevitably miss is a sense of connection with the members - the history and surrounding culture. The other advantage of having lay trustees involved is that they may understand certain aspects of their own company better than we can. As the performance of the business is clearly linked to the funding of the DB scheme, this understanding can be helpful.

"A generation that can't afford to stop working may present all sorts of employment, motivation and reward challenges."

The best solution is to have a combination of lay trustees and a corporate professional trustee. The professional can help set and drive the business of the trustee board in a way that helps it deliver its objectives, yet retain that close connection to the members and the company that lay trustees bring.

What are the most significant consequences of the shift from DB to DC pension schemes?

While the private sector is largely switching to DC schemes, public sector pensions are still typically DB schemes. This risks creating a two-tiered pensioner population: those who enjoy the certainty of DB, and the rest, who carry the investment and mortality risks associated with DC pensions. It's also creating problems within the private sector. Companies can find themselves funding DB deficits for former employees, while the current generation of workers rely on DC. Current management and employees are often working to fund a legacy benefit from which they won't gain.

The big shift has really been in who carries the risk. With DB, the company picks up the tab if investments don't perform or members live longer than expected. But in DC, the member takes the investment and mortality risk, and the company doesn't have to pay any more, it only has to make its fixed contribution. The member has to pay in more themselves or take a lower pension.

Are private sector workers aware of the risk they're taking on?

There's a worrying lack of engagement with the risks that DC pension schemes bring, and that's partly the result of a lack of focused education in this area. Historically, private sector workers didn't really have to make too many choices. They were employed until they were 65, then someone presented them with the guaranteed pension they had been expecting. Now that they have to make decisions throughout their working lives about how much they save, they need to be much better informed and educated to do so. As an industry, we all have to take some role in this.

" We are starting to see significantly improved communications and online modelling tools that focus on holistic workplace savings, but there is more to do."

As it stands, people haven't fully grasped the situation. The full impact hasn't been felt so far, as we've yet to experience a generation of retirees relying exclusively on DC pensions. But when the current workers in their 20s and 30s stop working, it threatens to be a major issue, not only for the individuals themselves, but also for their employers. A generation that can't afford to stop working may present all sorts of employment, motivation and reward challenges.

What sort of solutions are in place?

Legislation now requires auto-enrolment of employees into a minimum contribution DC plan, although members have the choice of opting out. That's a very good starting point, but there is plenty more to do. We are starting to see some of this with significantly improved communications and online modelling tools that focus on holistic workplace savings.

How effective will these measures be?

The momentum behind them is certainly building; however, it's not yet strong enough. Private sector employees need to understand that they must do more than pay minimum contributions, and start making plans and decisions for themselves.

People need to start planning for the future effectively. That means thinking about what they want to get out of a pension scheme, rather than how much they're putting in. If this doesn't happen, we'll soon have people stumbling into retirement or needing to stay in the workplace when neither they nor their employer want them to be there.

Chris Martin is managing director of Independent Trustee Services.
A whole generation of retirees may end up with a far smaller pension nest egg than they expected.