Aon Hewitt Retirement and Investment. Trigger Strategies. Staying on track. Risk. Reinsurance. Human Resources.

Transcription

1 Aon Hewitt Retirement and Investment Trigger Strategies Staying on track Risk. Reinsurance. Human Resources.

2 Trigger Strategies What is a trigger strategy and why is it important? Recent political and economic changes have led to volatile investment markets and the outlook for markets remains uncertain. Therefore it is essential for trustees to ensure they remain on track to meet their scheme s objectives in both the near and longer term. One approach to help stay on track is a trigger strategy: a set of pre-determined courses of action based on events that are usually linked to improvements in the scheme s funding position. The strategy is usually set with a de-risking focus in mind. An effective trigger strategy helps trustees set a clear path towards achieving their objectives for the scheme. Call to action For those trustees with trigger strategies already in place, we believe recent market movements are sufficiently material to warrant a review of the existing strategy. In particular, trigger strategies should be reviewed with reference to: their relevance to current market conditions the scheme s current funding level (particularly on the long term funding measure) any developments that mean the existing strategy could be redesigned to be more effective Similarly, we believe that trustees of schemes without trigger strategies in place should consider putting one in place now. In our view, planning how to react to changing market conditions will give your scheme better outcomes. This paper considers: how trigger strategies can help trustees reach their long term scheme funding target different types of trigger strategies that could be employed key factors to consider in setting a trigger strategy Types of trigger strategy Our view is that the default approach to setting triggers should be a funding level approach. Funding level triggers aim to increase the likelihood of reaching a long term target level of funding. They do this by locking-in positive experience (e.g. strong investment returns) quickly, before those gains are lost to unfavourable experience. Typically, the strategy comprises a set of pre-agreed strategic allocations, which are implemented as the funding level reaches pre-agreed levels. For example, a scheme may have in place a trigger strategy such that when the funding level increases to 80% on the long-term funding basis, 10% of the equity allocation is moved into liability driven investment assets to help lock in the gains. An alternative would be time-based triggers, where the de-risking strategies would be implemented at fixed dates. Some schemes may decide to include time based underpins where they are concerned about reducing risk over a given time period, perhaps due to concerns over the sponsor covenant, or the scheme maturing relatively quickly. However, whilst this is a simpler approach compared to funding level triggers, it ignores the impact of market movements and is therefore not our preferred approach. In our view, planning how to react to changing market conditions will give your scheme better outcomes Aon Hewitt Trigger Strategies 2

3 Yield triggers Some schemes also use yield triggers, which are typically associated with increasing the level of interest rate or inflation protection a scheme has in place when conditions impove. For instance, as yields rise, the cost of buying interest rate protection becomes cheaper. Similar to funding level triggers, the strategy would typically comprise a set of pre-agreed yields, which, when reached, would mean the level of interest rate and inflation protection is increased to pre-agreed levels. By setting yield triggers, trustees can ensure their scheme is able to increase the level of interest rate and inflation protection when pricing is favourable. A key challenge is that market views and conditions may change over time, so any yield triggers should be regularly reviewed. Designing a trigger strategy A fundamental pre-requisite for an effective trigger strategy is to have a clear objective agreed between the trustees and the sponsor. The objective should be set with direct reference to the long term funding target and should specify: the scheme s liability measure (in most cases we would recommend a self-sufficiency or a buy-out basis) timescales to achieve full funding (or a margin above) on the target liability measure. This should consider the amount of contributions the sponsor is willing to commit the target asset allocation to support the scheme s funding objective once full funding is achieved Progress against this plan should be monitored regularly. Key considerations Once the long term objective is agreed, the following elements of the trigger strategy then need to be considered: Area of consideration Type of trigger strategy Timing of triggers Sizing and spacing of triggers Governance structure Deficit contributions Points to consider We suggest a funding level approach, perhaps coupled with a time based element, which is set with reference to the sponsor covenant and the scheme s maturity. There is a need to strike a careful balance between de-risking earlier, whereby the expected time to meet the objective could be increased, and de-risking later, which would mean more risk is left on the table for longer. It is important to space the triggers appropriately and ensure a sensible amount of assets are being transitioned on each trigger. Setting triggers too close together will result in spurious accuracy and unnecessary work. We suggest trigger monitoring and strategy reviews are delegated to a trustee subgroup with the help of advisors. Deficit contributions should be factored in when setting the trigger strategy, although it may be the case a best estimate assumption is required, as future contributions cannot be guaranteed with certainty. Ongoing monitoring To remain effective, the trigger strategy should be regularly reviewed. There is a danger that poorly designed triggers, albeit with well-intentioned actions associated with them, can result in anchoring and less chance of the long term target being reached. It is critical that trustees regularly monitor the fundamental aspects and drivers of the strategy, whilst retaining flexibility on the actions required when they are needed. Aon Hewitt Trigger Strategies 3

4 Conclusion We believe that schemes with existing trigger strategies should review them now and schemes without a trigger strategy should consider putting one in place. A fundamental pre-requisite for an effective trigger strategy is to have a clear plan of what trustees and sponsors are trying to achieve with direct reference to the long term funding objective. Our recommendation is that a trigger strategy should be set with some reference to the scheme s funding level. Contacts Craig Campbell Associate Consultant +44 (0) craig.campbell.3@aonhewitt.com Akash Purohit Associate Consultant +44 (0) akash.purohit.2@aonhewitt.com Trigger strategies should be reviewed regularly with reference to current market conditions, progress made against the long-term funding journey and whether the strategy could be redesigned to be more effective. There are a number of important design and implementation considerations for trustees to consider in setting an effective trigger strategy. Care should be taken to design an appropriate strategy tailored to the scheme s circumstances. A pragmatic approach may be required. About Aon Hewitt Aon Hewitt empowers organisations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organisational and personal performance and growth, navigate risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is a global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit: aonhewitt.com Follow Aon on Twitter: twitter.com/aon_plc Sign up for News Alerts: Aon Hewitt Trigger Strategies 4

5 About Aon Aon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 72,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit: This document and any enclosures or attachments are prepared on the understanding that it is solely for the benefit of the addressee(s). Unless we provide express prior written consent, no part of this document should be reproduced, distributed or communicated to anyone else and, in providing this document, we do not accept or assume any responsibility for any other purpose or to anyone other than the addressee(s) of this document. Notwithstanding the level of skill and care used in conducting due diligence into any organisation that is the subject of a rating in this document, it is not always possible to detect the negligence, fraud, or other misconduct of the organisation being assessed or any weaknesses in that organisation s systems and controls or operations. This document and any due diligence conducted is based upon information available to us at the date of this document and takes no account of subsequent developments. In preparing this document we may have relied upon data supplied to us by third parties (including those that are the subject of due diligence) and therefore no warranty or guarantee of accuracy or completeness is provided. We cannot be held accountable for any error, omission or misrepresentation of any data provided to us by third parties (including those that are the subject of due diligence). This document is not intended by us to form a basis of any decision by any third party to do or omit to do anything. Any opinions or assumptions in this document have been derived by us through a blend of economic theory, historical analysis and/or other sources. Any opinion or assumption may contain elements of subjective judgement and are not intended to imply, nor should be interpreted as conveying, any form of guarantee or assurance by us of any future performance. Views are derived from our research process and it should be noted in particular that we can not research legal, regulatory, administrative or accounting procedures and accordingly make no warranty and accept no responsibility for consequences arising from relying on this document in this regard. Calculations may be derived from our proprietary models in use at that time. Models may be based on historical analysis of data and other methodologies and we may have incorporated their subjective judgement to complement such data as is available. It should be noted that models may change over time and they should not be relied upon to capture future uncertainty or events. Aon Hewitt Limited is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales. Registered No: Registered Office: The Aon Centre The Leadenhall Building 122 Leadenhall Street London EC3V 4AN Copyright 2017 Aon plc aon.com Risk. Reinsurance. Human Resources.