Integrated Risk
Management
A new approach to pension
scheme risk modelling
December 2015
Affordability Risk Modeller
(ARM)
ARM is an interactive tool which enables trustees and
scheme sponsors to:
The Pension Regulator’s code of practice on
funding defined benefit pension schemes
►► Gain new insight into how affordable their scheme is,
given the investment risks and employer covenant
constraints.
‘Trustees should manage funding, covenant and investment
risks in a way which takes account of how they interact with
each other.’
►► Dynamically model the impact of varying investment
and funding strategies.
‘Trustees should assess their employer’s ability to help their
scheme if risks materialise.’
►► Comply with tPR’s code of practice on funding and
guidance on Integrated Risk Management (IRM).
effectively and efficiently without causing disruption to the existing
advisers and processes in place.
The Pensions Regulator’s (tPR’s) code of practice requires defined
benefit schemes to have a funding strategy which takes into
account an integrated assessment of the employer covenant and
investment risks that a scheme is exposed to.
At EY, by combining our actuarial, investment strategy and
employer covenant expertise we have developed ARM as a
modelling framework which links together these components to
deal with the new regulatory requirements head on. The model is
easy to use and can run using high level scheme information (or
more detailed membership data as the situation requires), avoiding
the need for lots of expensive dis-jointed modelling.
The ARM approach complements the existing valuation process,
allowing trustees and sponsors to comply with tPR’s requirements
ARM enables trustees and sponsors to adopt the following
approach, which we consider is consistent with that set out in tPR’s
IRM guidance:
1. Identify risks individually and collectively to determine the
likelihood that a scheme will remain affordable — we call this
‘Affordability Confidence’ (see next page for more details).
2. Analyse how the risks can be managed and Affordability
Confidence improved through interactive modelling of
alternative funding and investment strategies.
3. Monitor the risks over time by tracking the movement in
Affordability Confidence.
Identify risks
Sponsor
covenant
risk
ARM
Investment
risk
Monitor risks
1
Funding
Funding
risk
risk
Manage risks
Integrated Risk Management
Affordability Confidence
Are you confident that your scheme will remain affordable?
We define Affordability Confidence as
the likelihood that the contributions
payable at the next valuation will
be lower than the maximum level of
affordable contributions.
►► ARM uses the concept of ‘Affordability Confidence’ to illustrate how affordable
a scheme may be for a sponsor into the future, by projecting forward the range
of possible funding positions, allowing for investment risks.
►► The current contributions and maximum affordable contributions (on both
an expected and downside business case) are compared to the possible
contribution levels needed in three years time.
Example output
£7mn pa
Current contributions
Potential contributions in three years’ time
Improved
Affordability
Confidence
Affordability
Frontier
£6mn pa
Affordability Confidence
£5mn pa
The Affordability Confidence on the current investment strategy
is 82%. That is, there is an 82% chance that contributions at
the next valuation will be less than £3.90mn (the maximum
affordable amount).
ARM can
assess the
impact on
affordability of
changing the
investment
strategy, e.g.,
increased
diversification
of assets
improves the
Affordability
Confidence
from 82% to
91%.
£4mn pa
Downside
business case
£3mn pa
£2mn pa
£1mn pa
3.9
2.6
Affordable
outcomes
Improved Affordability
Confidence due to
investment changes
£7mn pa
Current
contributions
Maximum
affordable
contributions
50%
chance
60%
chance
70%
chance
80%
chance
90%
chance
99%
chance
ARM insights
►► This forward looking analysis may provide a high degree of confidence that a scheme is affordable or, if not, may prompt a
change to the funding and investment strategy to increase Affordability Confidence.
►► ARM allows users to clearly compare investment risks alongside covenant constraints in one integrated model. This enables a
better understanding of the funding risks and facilitates more informed funding discussions between trustees and sponsors.
►► Trustees can embed Affordability Confidence into their risk register and monitor this over time to provide an early warning
system of any increase in risk. Trigger points could be set so that if Affordability Confidence falls below certain levels this would
prompt mitigating actions by the trustees and/or the sponsor.
Integrated Risk Management
2
How EY can help
If you would like to discuss how ARM can help you better
manage your pension scheme funding risks, we would be
delighted to talk with you.
Please contact your usual EY consultant or one of the
names shown below.
Iain Brown
Partner
Direct Tel: + 44 20 7951 7546
Mobile: + 44 7977 023 389
Email: [email protected]
Taylor Dewar
Partner
Direct Tel: + 44 20 7951 0580
Mobile: + 44 7920 139 378
Email: [email protected]
Tom Lukic
Partner
Direct Tel: + 44 121 535 2925
Mobile: + 44 7775 750 632
Email: [email protected]
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Sean Bottomley
Director
Direct Tel: + 44 113 298 2327
Mobile: + 44 7740 923 265
Email: [email protected]
Karina Brookes
Executive Director
Direct Tel: + 44 20 7951 1246
Mobile: + 44 7469 036336
Email: [email protected]
Fiona Taylor
Executive Director
Direct Tel: + 44 141 226 9077
Mobile: + 44 7747 632 018
Email: [email protected]
Christopher Bown
Director
Direct Tel: + 44 20 7951 3231
Mobile: + 44 7730 733 861
Email: [email protected]
Philip Wheeler
Senior Manager
Direct Tel: + 44 141 226 9557
Mobile: + 44 7786 313 701
Email: [email protected]