A way through the maze the challenges of maintaining UK pension schemes

About this researchA way through the maze: The challenges of managing UK pension schemes is an Economist Intelligence Unit report that examines the risks associated with running UK pen

commissioned by

An Economist Intelligence Unit report

About this research

A way through the maze: The challenges of managing

UK pension schemes is an Economist Intelligence Unit

report that examines the risks associated with running

UK pension schemes, and explores the approaches to

governance, funding, investment, and scheme design

that companies use to manage these risks The report

was commissioned by Towers Perrin Phil Davis was the

author of the report and Rob Mitchell was the editor

The Economist Intelligence Unit bears sole

responsibility for the content of this report The

Economist Intelligence Unit’s editorial team executed

the online survey, conducted the interviews and

wrote the report The findings and views expressed

in this report do not necessarily reflect the views of

Towers Perrin

Our research for this report drew on two main

initiatives:

● We conducted a survey of 206 C-level, or board-level

executives of UK companies in late summer 2007 as

the credit crisis was emerging Respondents were

primarily chief executive officers, chief financial

officers and chief human resources directors,

although some other roles were also represented

in the sample The survey included companies, and

pension schemes, of a variety of sizes, and from a

wide range of industries

● To supplement the survey results, the Economist

Intelligence Unit also conducted a programme

of qualitative research, comprising a series of

in-depth interviews with trustees, advisers and other

participants in the pensions environment

We would like to thank the many people who helped

with this research

● The risks associated with running UK pension

schemes are becoming more severe The majority of

respondents questioned for our survey believe that the risks facing their organisation’s pension scheme have increased over the past few years The key risks, according to respondents, are regulatory changes that could affect funding, which are cited by 48%, changes

to mortality assumptions, which are cited by 47% and volatility of equities, which is cited by 40%

● Better knowledge and understanding is a key risk

management tool When asked about the aspects of

their scheme management that they are keen to improve

in the next few years, items related to “knowledge and understanding” score highly For example, improving their understanding of funding options is seen as the main priority, cited by 42% of respondents, followed

by improving their understanding of long-term trends, which is cited by 36% With new risks on the horizon, and new techniques to manage, mitigate or transfer them becoming available, keeping abreast of new trends and often complex concepts has become more pressing than ever

● Performance management remains an important

weakness When asked about their strengths and

weaknesses with regard to different aspects of scheme governance, respondents saw their strengths as the setting and monitoring of investment strategy and the managing of relations between trustees and the corporate sponsor They were also fairly confident about their ability to put in place a formal process to identify risks and monitor those risks on

an ongoing basis The main areas of weakness were seen to be performance management—of investment consultants and trustees in particular—and enhancing

trustee competencies Many companies, it seems, have difficulties in determining the metrics that apply

to their scheme, and in conducting performance management based on outcomes

● More innovative investment techniques have

yet to enter common practice Tools to optimise

investment strategy, such as liability-driven investment or the use of derivatives, are widely discussed and written about in the business press, but they remain little used among UK businesses Just 14% of respondents say that they already have liability-driven investment in place, and 17% say that they use derivatives to hedge interest rate and inflation risk Appetites to use these tools in future are relatively strong, however, with 41% intending

to apply liability-driven investment in the next three years and 39% intending to use derivatives

● The idea of transferring liabilities has its appeal,

but practical considerations are preventing

take-up Appetites for the concept of bulk annuity buy-outs

seem relatively strong, with 60% of respondents saying that they would transfer at least some of their liabilities if they could do so at a competitive price with the full support of stakeholders In reality, however, most respondents say that they would be unlikely to adopt this approach: just 19% intend to transfer liabilities to an insurance company over the next three years, and 61% say that they do not intend

to explore this option The main barriers are cited as being the reluctance of trustees to support such deals, and fears about reputational damage should the third party fail to meet its obligations A significant proportion also believes that the economic cost of buy-outs is simply too high to consider it

Executive summary

Pensions once inhabited an obscure corner of

corporate life, ignored by everyone until it was their

turn to accept the gold carriage clock and head out

the door for retirement How times have changed

Pensions talk is on the lips of employees, employers,

politicians and the thousands of advisers that service

retirement schemes A perfect storm of volatile market

conditions, stringent new rules and demographic

change has created unprecedented uncertainty over

pension provision Many employers that blithely

created final salary schemes years ago as a standard

employee benefit now wish they had been more

circumspect And employees increasingly fear that the

benefits they believed were rightfully theirs could be

snatched away

The fears are quantifiable The majority of

respondents questioned for the EIU/Towers

Perrin survey believe that the risks facing their

organisation’s pension scheme have increased over

the past few years A full two-thirds said that the

risks had increased, compared with just one in ten

who said that they had decreased Smaller schemes appear to be feeling the heat most keenly—four out

of ten schemes with assets of less than $1bn said that risks had increased “significantly”, compared with three out of ten larger schemes Arno Kitts, head of the investment council of the National Association of Pension Funds, says that the concerns of executives all centre on one issue “Obviously the key risk is that the pension fund cannot pay pensions.”

The poor financial state of some pension schemes is clear to see About 6% of company schemes surveyed had liabilities amounting to more than half of the company’s market capitalisation, while four in ten said that liabilities were over 20% of the market capitalisation That represents a serious risk to the financial health of the scheme sponsor Given that the majority of the schemes in the survey have assets of more than £500m, the effect on the overall economy

is not insignificant, either

Mr Kitts outlines the shock that many companies have suffered in recent years “If you are a

manufacturing company, you have realised that there

is a large investment animal associated with your

The risk environment

Increased significantly Increased slightly

No change Decreased slightly Decreased significantly

32 32 26 8 2

Over the past three years, how do you think the risks associated

with managing your organisation’s pension scheme have

changed?

(% respondents)

Source: Economist Intelligence Unit survey, 2008.

Between 1% and 10% of market capitalisation Between 11% and 20% of market capitalisation Between 21% and 30% of market capitalisation Between 31% and 40% of market capitalisation Between 41% and 50% of market capitalisation 50% of market capitalisation or more

What is the size of your organisation’s liabilities in relation to its market capitalisation? Please choose the option that you think

most accurately reflects your scheme

(% respondents)

32 29 25 6

3 6

Source: Economist Intelligence Unit survey, 2008.

business that can have a significant effect on it,” he says This is leading companies to examine, perhaps for the first time, the risks posed by their pension schemes and how to manage those risks “The biggest driver of change,” says Mr Kitts, “is when the financial director asks ‘Why is there this big, volatile number in

my accounts and what can I do about it?’.”

According to respondents, the most significant overall risk to their organisation from their pension scheme is regulatory changes to funding, which are cited by 48% of respondents This is hardly surprising—regulation has stopped employers taking surpluses out of pension schemes to reinvest

in the business This means that any contributions, including extraordinary contributions, are unlikely ever to be available to the sponsor again

At the same time, changes in accounting rules have forced assets held as long-term investments

to be valued at prevailing market prices As a result, at times of market stress, pension schemes appear hopelessly underfunded and a large one-off contribution may be required from the sponsor The likelihood of this happening is not remote: four in ten

respondents said that special employer contributions would be necessary over the next three years

The risks posed by improving mortality assumptions are cited by 47% of respondents The main worry is simply that people are living longer, so are a bigger drain on the pension fund’s resources Over the past

22 years, the expected average lifetime has risen by 2.7 years, or 3.5%, from 77.7 years to 80.4 years, according to the Credit Suisse longevity index Women’s life expectancy is higher than that of men and has increased from 80.9 years to 82.7 years over the same period

Moreover, people living longer is only part of the problem The more taxing issue is predicting the rate of increase of longevity Steven Haasz, managing director, wholesale, at Prudential, sums

up the scale of the difficulties “The risk of olds living just a year longer is huge It adds about 3% to a scheme’s liabilities, which may negate any aggressive investment strategy that has been put in place to increase returns.” The Holy Grail is to develop products that hedge out mortality risk—and several investment banks are working on it—but as yet such a financial instrument does not exist

75-year-The volatility of equities was cited as the third greatest risk for retirement schemes, cited by 40% of respondents Although many schemes have reduced their dependence on equities following the 2000-

03 market downturn, an astonishing one in ten still have an equities allocation of 80% or higher in their portfolios Even the most financially secure of companies, with a predominantly youthful workforce and few pensioners, would struggle to justify such an overwhelming dependence on the riskiest and most volatile asset class

In general, it is apparent that survey respondents are most worried about the risks over which they have least control After all, companies can do little about regulatory changes except to lobby against harmful decisions And there is, as yet, no solution for managing longevity risk (or, indeed, a way to account

Regulatory changes affecting pension funding Changes to mortality assumptions Volatility of equities

Volatility of future inflation expectations Potential future accounting changes Reductions in expected future investment earnings due to changes in asset strategy Increasing deficits

Volatility of long-term bond yields Restrictions on desired corporate activity arising from regulatory changes

Which of the following do you consider to be the most significant risks to your organisation from your pension scheme?

Please select up to three

(% respondents)

48 47 40 36 26

25 21 20 17

Source: Economist Intelligence Unit survey, 2008.

for a pharmaceutical company making a crucial

breakthrough to prevent strokes)

The other principal risk, stock market volatility,

is more manageable, through the use of derivatives

for example But while technical solutions are

available, the result can be imperfect Using fewer

equities might, for instance, have the unintended

consequence of reducing the likelihood of the fund

meeting very long-term liabilities, since shares are

generally considered a good hedge against inflation

Risks associated with pension schemes can impact

on a variety of corporate performance measures

Among respondents to our survey, 43% say that the balance sheet is the most widely affected measure, followed by 25% for cash flow, 21% for earnings per share and 11% for credit rating

When asked how effective they thought a number

of strategies were at reducing the risk associated with their schemes, the answers varied depending on the corporate measure selected While governance changes were seen as the most effective technique across the board, respondents who selected balance sheet as the most affected measure tended to favour benefit design changes and liability-driven investment—two approaches that can favourably impact the balance sheet Respondents who were most concerned about cash flow had little time for bulk annuity buy-outs, perhaps a reflection of the high costs associated with these transactions

Conversely, respondents who chose credit rating as the measure most affected by pension risks tended

to be more adventurous and be most likely to favour derivatives and bulk annuity buy-outs

So pension schemes are becoming aware of many

of the risks they face but do not necessarily have the tools to mitigate them They are in the midst of a perfect storm and are urgently seeking perfect advice

to navigate their way through it

Balance sheet Cash flow Earnings (per share) Credit rating

43 25 21 11

Which of the following corporate performance measures is most

affected by risks associated with your pension scheme?

Please select one

(% respondents)

Source: Economist Intelligence Unit survey, 2008.

Amid the gloom there are, though, beacons of hope

A surprising finding in the survey is that governance changes to improve decision-making are seen as the most effective measure to reduce the negative impact

of pension scheme risks This rates more highly than all other putative measures including benefit design changes and the use of derivatives Why does this represent hope? Because governance is one of the few solutions that can be applied without great expense being incurred

Chris Close, partner at Sackers, a specialist pensions law firm, says that, in the past, many trustee boards failed to realise they were pivotal parts of the pensions machine “Governance is really important Let’s not forget that some of the larger schemes are as big as major corporations,” he says

The Pensions Regulator, created in 2004, insists that

an amateur approach is no longer acceptable and laid down governance guidelines earlier this year It recommended that pension scheme trustees should focus on seven key points:

1 Trustee knowledge and understanding

2 Conflicts of interest

3 The employer’s covenant

4 Monitoring professional advisers

5 Keeping accurate records

6 Offering adequate defined contribution investment choices

7 Ensuring proper procedures are followed

Six out of ten respondents said that they are good

at setting and implementing processes to identify risk And a large majority of 67% said they are good

at setting and monitoring investment strategy Clive Gilchrist, managing director of Bestrustees,

an independent trustee firm, says that investment strategy involves considerably more than appointing

a set of investment managers “Setting investment strategy means following the actuarial valuation, conducting an asset-liability exercise and selecting the investments in light of the covenant and risk.”

He adds that it is good practice to assess each manager’s performance every quarter and interview them at least once a year, so long as this does not lead

to short-term decision-making “Organising a beauty parade based on a single quarter’s performance is not advisable.”

While monitoring investment returns is a tried and tested process, just 51% of respondents said they are good at measuring their own performance and that

of their consultants Many ideas are being trialled

to develop consultant and trustee benchmarks, although standardised objective criteria have yet

to be established across the industry Bestrustees, for one, is working on pilot schemes with several pension funds to enable trustees to measure their own effectiveness On the simplest measure, the trustees are invited to rank their colleagues on two issues: how often they turn up at meetings and how much they pay attention Mr Gilchrist says that these questions are more important than may appear at first sight

Scheme governance

“You do not need to be Einstein to be a trustee and

you do not have to generate lots of ideas But you do

need to listen and react with common sense to advice

offered,” he says

Administrators, too, should be monitored Poor

administration has let down a number of pension

schemes, says Mr Close “If record-keeping is poor,

benefits can be over- or under-stated and this can

harm the employer’s finances in the first case and

reputation in the second.”

There are other issues that are often mistaken as

meaningless detail but that are, in fact, critical to

governance Take the size of trustee boards: large

boards of 15-plus trustees are considered inefficient

because there is often too much discussion and

insufficient analysis and decision-making Equally,

boards of just three or four are fallible They need

to be large enough to delegate time-intensive

issues, such as investment, to specialist committees

Bestrustees believes that the average trustee board

should number five to 12, rising to between nine and

12 for larger schemes

The managing of relations between the trustees and corporate sponsor is another important governance area and one in which many schemes believed they performed well The good performance may be linked to the formalisation of the relationship, following pressure from the Pensions Regulator “In the past,” says Mr Gilchrist, “discussions took place around a table Now they are more often conducted in writing so there is an audit trail that could be shown to the regulator.”

Procedures to resolve disputes over funding or scheme strategy have also been formalised The regulator is now able to act as a referee, although

it has not empowered itself to pass judgment This

is a recognition that both parties must reach a compromise that they are happy with if they are to continue to work for the good of scheme members

“It is all about partnership—nobody forces a company

1 Very successfully 2 3 4 5 Not at all successfully

How successfully do you think your organisation manages the following aspects of scheme governance?

Please rate on a scale of 1 to 5, where 1=Very successfully and 5=Not at all successfully

(% respondents)

Managing relations between trustees and the corporate sponsor

Setting and monitoring investment strategy

Managing administrative aspects of scheme management

Putting in place a formal process to identify risks

Monitoring risks on a regular basis

Speed of decision making and execution

Manager selection

Measuring performance of asset managers

Enhancing trustee competencies

Measuring performance of investment consultants

Measuring performance of trustee board

Source: Economist Intelligence Unit survey, 2008.

to set up a pension scheme,” says Mr Gilchrist “It is there because the company believes that attracting and retaining people is important.”

At the same time, without distance between the trustee board and scheme sponsor, conflicts

of interest can arise For example, companies may use the same advisers as their trustees, and may be unaware that this is the case Mr Gilchrist says that conflicts of interest are becoming less common “It was usual for the financial director to be a trustee, but much less so now The FD may attend meetings but it should be on the explicit understanding that it is in a company capacity.”

The issue of knowledge and understanding has risen to the fore in the wake of the Myners Report

in 2001 and this is underscored by the survey

When asked about the aspects of their scheme management they were keen to improve, aspects

of “understanding” scored highly Improving understanding of funding options, in particular,

is seen as a priority, cited by 42% of respondents, followed by improving understanding of long-term trends, cited by 36% As might be expected, there is

a gulf between the knowledge base in small schemes compared with larger ones For instance, just 14%

of large schemes (those with £1bn-plus assets) said that they needed to improve their mastery of asset allocation in the next year, while 32% of smaller schemes said that this was a critical learning point.Trustees are well advised to take training seriously The regulator’s Trustee Knowledge and Understanding regime is free and voluntary, and there are compelling reasons to undergo minimum levels of training Where problems arise in funds, the regulator has intimated that it would take a dim view of cases where basic knowledge levels were low and little attempt had been made to raise them

Low levels of knowledge are the main reason why many in the industry wonder whether the whole model of lay trustees running pension schemes should be overhauled Should, for example, pensions be run by professionals? After all, Myners recommended that employers paid trustees for their work Surprisingly, Mr Gilchrist, a professional trustee, believes any changes could be harmful

“Being paid would not change anything for most trustees They do the job because they want to do it,” he says Lay trustees have much to offer, he believes “They are not investment experts, lawyers or actuaries, but they know the company and its ethos, and they know the scheme and its members It would

be a great loss if things changed.”

Understanding of funding options (eg, use of contingent assets) Understanding impact of long-term trends (eg, changes to longevity) Asset allocation

Response to regulatory change Performance management of fund managers Understanding of investment trends Management of interest rate and inflation risk Relationships with members

Relationships with external advisers (eg, investment consultants and asset managers) Speed of reaction to changes in capital markets

Source: Economist Intelligence Unit survey, 2008.

Investment is an imprecise art and few, even among

the world’s best investors, end up with a masterpiece

Failure inevitably occurs and each occurrence instils

fear and disillusionment in the minds of investors

For this reason, investment styles come and go with

predictable regularity As recently as the early 2000s,

the majority of pension schemes employed a balanced

approach, uniformly allocating 60% of assets to

equities and the remainder to bonds The sharp stock

market downturn of 2000-03 inevitably threw many

of those portfolios into disarray and, today, the old

balanced approach is rarely seen

But whether a high allocation to equities is

desirable is less important than whether there is a

coherent approach to investment It is clear that, in

the past, many pension funds thought little about

what their investments were supposed to achieve

“The mindset of pension funds was focused on assets

alone rather than assets relative to liabilities,” says

Iain Lindsay, a senior portfolio manager at Goldman

Sachs Asset Management This resulted in a mismatch

of predominantly equities on the asset side, yet like liabilities “The strategy worked well in the 1990s, but then they came unstuck,” he adds

bond-Scarred by this experience, many pension funds realised that asking their investment managers to beat an index or a rival manager had no bearing on the fund’s ability to pay pensions This long-overdue realisation has dramatically changed the nature of institutional investment In terms of asset allocation, the biggest shifts over the next three years are likely

to be increased use of private equity and a reduced allocation to equities Over one-fifth of respondents said that they expected to have a greater allocation

to private equity in three years’ time, while more than one-quarter expected to have a smaller allocation

to equities Only 17% said they would have greater exposure to equities

Barings Asset Management says that exposure to equities depends often on the financial health of the

Investment strategy

Greater allocation No change Smaller allocation Not applicable

In the next three years, what changes do you expect to your asset allocation? If you do not use a particular asset class and have no

intention of doing so in the next three years, please select “Not applicable”

Hedge fund (specialist trading approaches)

Hedge fund (long/short equity style)

pension fund “I see a mixed picture,” says Jonathan Cunningham, head of international sales at BAM

“Some schemes are looking to add risk, investing

in less efficient emerging markets where there are longer-term opportunities for alpha Others use multi-asset funds to try to take risk or volatility out of the portfolio.”

Indeed, multi-asset funds are sweeping all before them at the moment, sucking in assets at a breathtaking rate Their rise stems from many pension schemes’ realisation that they threw the baby out with the bath water when they ditched the balanced approach They are now increasingly adopting a

“new balanced” approach and employing multi-asset funds to implement it The main differences between old balanced and new balanced is that the modern version uses a bespoke benchmark that relates to the liabilities, employs dynamic (rather than static) asset allocation and uses best-of-breed funds run by many firms rather than a single, monolithic balanced manager

Financial innovation is also playing a part in the changed landscape “Multi-asset funds now have more tools at their disposal,” says Mr Cunningham “They

can allocate to hedge funds, property, structured notes and even products that provide returns from falling markets.” BAM’s Dynamic Allocation Fund, for instance, has a 23% allocation to international equities, 40% to UK equities, 20% to funds of hedge funds, 12% to property and 5% in cash These allocations are adjusted depending on economic conditions

Another popular investment approach that has gained prominence in the post-2003 era is popularly known as “core-satellite” This is based on the belief that most investment performance comes from market “beta” and that active managers should be used opportunistically only So, a large weighting is made to passive index-tracking strategies and a small

“satellite” portion is reserved for active management, such as hedge funds

But some schemes have come to believe that all existing investing styles are flawed An increasing number is trying to remove investment benchmarks from the equation altogether A large minority of respondents (43%) thought that liability-driven investment (LDI) is the best way of reducing the negative impact of pension scheme risk on the

1 Very successful 2 3 4 5 Not at all successful Don’t know

How successful do you think the following strategies are at reducing the negative impact of pension scheme risks on your chosen measure? Please rate 1 to 5 where 1 is very successful and 5 is not at all successful

(% respondents) Benefit design changes Liability-driven investment Governance changes to improve decision making and control of pension issues Use of derivatives or structured products to manage interest rate and/or inflation risks Use of derivatives or structured products to manage equity risks

Bulk annuity buy-outs Use of contingent assets, guarantees and other credit support tools Alternative assets, such as private equity and hedge funds

Source: Economist Intelligence Unit survey, 2008.

company’s finances This is perhaps a surprisingly

high figure given that the term “LDI” has been in

common currency for less than five years

LDI aims to match liabilities with bond-like returns

that hedge out the effect of inflation and interest

rates This is often done using a swap, since cash

bonds and futures are too exposed to the vagaries of

the market and do not have sufficiently long duration

to match the very long-term liabilities of pension

funds

To some extent, LDI has been driven by

mark-to-market accounting rules, which mean that a drop in

value of a pension scheme’s assets imparts a nasty hit

to the balance sheet of the sponsor Equities, among

the most volatile assets, are therefore less desirable

While they reduce a deficit in the good times, a

short-term market blip negatively impacts a company’s finances Paul Bourdon, head of European pension solutions at Credit Suisse, puts it this way: “If you have 70% equities, over 20 years there is likely to be a premium But, over five years, there could be swing of plus or minus 40%.”

Thus swaps, once little understood by most pension funds, are now firmly on the radar Survey respondents revealed that derivatives to hedge inflation and interest rate risk are becoming popular—

17% of respondents use them now and 39% intend to use them in future

Whereas early LDI adopters tended to buy swaps to try to match all their liabilities, this has become less common While more mature schemes may seek to match their remaining liabilities, newer schemes often

In 2003, a reversal of fortunes on the high

street coupled with a very public private

equity approach prompted UK retailer WH

Smith to take a serious look at its pension

strategy With earnings down and despite

the failure of a debt-laden buyout approach

in early 2004, the board suddenly became

extremely uncomfortable about the deficit

in its defined benefit scheme, then running

at about £152m

In addition, 60% of the pension funds’

assets were invested in equities and 40%

were in bonds If the market took a turn

for the worse, the deficit might balloon

even further, putting cash flow at risk and

threatening to scupper the shareholder

dividend.

“It was pretty clear that we had to de-risk

the pension scheme pretty significantly,”

recalls Alan Stewart, WH Smith’s group

finance director.

The board took a series of measures, including two one-off contributions totalling £170m, and a transfer of pension assets from equities and bonds to a far less volatile liability-driven investment (LDI) scheme

The company made its first contribution

of £120m into the scheme in 2004 and, around the same time, began to look at ways

to escape the ups and downs of markets

It eventually settled on an LDI approach

“It was pretty clear from a relatively early stage that an LDI solution was one that fit our needs, but it took a lot of modelling to determine the optimum position,” says Mr Stewart.

At the end of September 2005, the company moved 94% of its pension assets into a large, liquid cash fund, hedging against inflation and interest rate rises with derivatives “There really is no risk in the

major cash portion, that 94% of our assets,” says Mr Stewart Six percent (about £50m) was invested in equity options The total portfolio is expected to return just above the expected liabilities

Pension liabilities are far more predictable now, too In April 2007, the company capped its service accrual for 2,500 current employees who are still part

of the defined benefit scheme, which was closed to new members 11 years ago (most employees are part of the company’s defined contribution plan) In effect this means the risk to the company has gone down, because

it is easier to predict the expected cash flow needed to cover payments for the 18,000 past and present employees currently covered by the closed plan

The result has been dramatic—today the deficit is down to £42m and falling, and the board feels confident that the LDI approach has the company’s £635m in assets sufficiently hedged against a bear market

“In truth I don’t think I could have asked for

a better outcome in terms of what we sought from our strategy,” says Mr Stewart.

CASE STUDY

Liability-driven investment at WH Smith:

Easing up on equities drives down pension risk

wish to test the water and match just a part of them

“Schemes typically implement partial LDI solutions to begin,” says Mr Lindsay “They look to get comfortable with the LDI strategy before deciding whether to extend the match to a greater proportion of the liabilities.” Hedging interest rate and inflation risk with swaps typically consumes 60% of the scheme’s assets, leaving 40% free to invest in “alpha-seeking”

strategies that can offset longevity risk and, in the best-case scenario, produce a surplus for the fund

Nevertheless, LDI remains a relatively unloved strategy—just 14% of respondents said that they already use it, although 41% intend to apply it in the next three years “LDI is talked about a lot more than it is actually implemented,” says Mr Lindsay

The resistance is often behavioural—trustees find it hard to conceive of foregoing any windfall that comes from rising interest rates or falling inflation “In many conversations with trustees they are concerned about being locked in to the LDI strategy at the wrong point

a balance and there is no obvious right or wrong.”For others, the issue is more black and white Raj Mody, a partner and actuary at the pensions practice

of PricewaterhouseCoopers, believes that LDI can

be a crude, unreliable and expensive approach

He advocates a proprietary strategy that he calls

“covenant-driven investment”, whereby companies regard their pension schemes as fully-fledged subsidiaries Decisions about the pension fund are

no longer taken in isolation but in relation to other business activities Mr Mody believes that for some sponsors this approach negates the need to hedge out inflation and interest rate exposure “If inflation goes

up, you may have the opportunity to pass the costs onto your customers This provides a natural hedge for the pension fund rather than buying expensive inflation instruments The same applies when interest rates fall—yes, your pension deficit tends to rise, but lower rates are good for the company as a whole because it can borrow money more cheaply.”