Integrated risk management: TPR’s guidance

Introduction

Integrated Risk Management (IRM) is the focus of TPR’s latest guidance. Published on 8 December 2015, it sits alongside the code on funding defined benefits, which applies to schemes with effective valuation dates from 29 July 2014 onwards (Great Britain) or from 29 July 2015 (Northern Ireland).

The concepts outlined in the guidance are not new, but are designed to provide practical help to trustees on what a proportionate and integrated approach to risk management might look like, and to explain how they could go about putting one in place.

In this Alert

• Key points
• What is integrated risk management?
• Step 1: Initial considerations for putting an IRM framework in place
• Step 2: Risk identification and initial risk assessment
• Step 3: Risk management and contingency planning
• Step 4: Documenting the IRM framework and decisions reached
• Step 5: Risk monitoring
• Actions for trustees

 Key points

• The IRM guidance is aimed at trustees and employers of workplace DB schemes.
• TPR splits the IRM process into five key steps. These may overlap, be done in parallel, or be undertaken more than once.
• There is no one set formula for IRM. Trustees should adopt a proportionate approach that is appropriate to the size and circumstances of their scheme.
• IRM should not be seen as a one-off exercise, with TPR emphasising that trustees (and employers) should consider repeating risk assessments at regular intervals.

What is integrated risk management?

The DB funding code provides a principles-based framework for complying with the statutory funding objective set out in the Pensions Act 2004.  IRM is a risk management tool which is designed to help manage the risks associated with scheme funding.

With good governance at its heart, IRM means more than just understanding the risks to a scheme.  It should help decisions over what can be done should risks materialise, and what contingency plans may need to be in place.  It also helps inform trustees’ approach to monitoring these risks.  Unsurprisingly, therefore, an essential component of IRM is that there should be an open and constructive dialogue between the trustees and the employer.

Each of TPR’s five key IRM steps is supplemented by practical examples which illustrate how they are intended to work in practice.  The guidance also sets out a range of approaches to risk assessment which trustees might find useful, covering stress testing, scenario testing, scenario projections, stochastic modelling and reverse stress testing.

Step 1: Initial considerations for putting an IRM framework in place

Although IRM will be particularly pertinent for trustees who are conducting an actuarial valuation, it should be seen as an ongoing process.  Trustees should therefore consider introducing an IRM framework wherever the scheme lies within its actuarial valuation cycle.

Trustees are responsible for ensuring that their scheme’s IRM approach is “appropriate and effective”. They should consider who will be involved in the process, how they will engage with the employer, and how the scheme’s advisers should work together.

In multi-employer schemes where the employers are part of the same group, TPR states that “it is beneficial for the IRM framework if the employers have an agreed risk capacity and risk appetite”.  It envisages that the principal employer (or other nominated employer) will then engage with the trustees on behalf of all of them.

The approach will need to be slightly different for non-associated multi-employer schemes.  This is because there will be employers of different sizes and their businesses may be focused on different industry sectors.  Nonetheless, with the aim of ensuring a smooth IRM approach in such schemes, TPR suggests that the employers should nominate representatives who will then agree a collective risk capacity and risk appetite.

Although putting an IRM framework in place will require an initial investment of time and resources, as TPR notes, this should be repaid as the framework is used over time by current and future trustees.

Step 2: Risk identification and initial risk assessment

The scheme’s current position and current risks should be used as the platform for risk assessment, both of which should, in turn, reflect the funding and investment strategies already in place.

Before taking decisions that will affect a scheme’s funding, trustees will also need to understand the employer covenant through advice and analysis.  This will help trustees to know the range of material risks and drivers affecting their scheme.  The idea is that an IRM framework will then enable trustees to take this analysis a step further, so as to have a clearer picture of how risks identified as significant for each of the three fundamental DB risks individually (funding, investment and covenant) impact on the other two, as well as how they ultimately affect the scheme and the employer.

Although TPR considers the order in which these three risks are considered as less important than ensuring that IRM is performed, in its view, assessing the employer covenant is the best starting point.

Step 3: Risk management and contingency planning

Identifying risks is not a one-off exercise.  TPR envisages that trustees and employers will together develop their IRM approach by:

• Applying risk management strategies straight away. For example, if having assessed the current position they conclude that the scheme is outside their (or the employer’s) risk appetite, trustees should work out ways to strengthen the employer covenant or modify the funding and investment strategies to bring them into line with the relevant risk appetite.
• Developing contingency plans for dealing with material risks as they arise in future. Contingency plans will involve a shared understanding of the actions to take if risk appetites are exceeded in the future. This is seen as essential to allowing swift action to be taken and for reducing / managing the level of risk if this happens.  Keeping track of material risks in this way “can also mean that the trustees and employer do not miss valuable opportunities to lock in improvements”.

Any agreed triggers for action should be both practical and realistic so that, in the event of one occurring, both the employer and trustees remain committed.

Step 4: Documenting the IRM framework and decisions reached

TPR envisages that trustees will distil its IRM approach into a series of key points, in order to retain a clear overview of what is important and why.

However, trustees should not spend a disproportionate amount of time and resources on documenting the agreed IRM framework, and existing documents should be drawn upon wherever possible.  By way of example, monitoring and contingency plans might be contained within the scheme recovery plan.

Step 5: Risk monitoring

As TPR explains, monitoring material risks, together with appropriate contingency planning, will allow trustees to respond quickly and effectively should risks emerge.  One way of doing this is to use a “financial risk dashboard” to monitor key measures, such as risk parameters and performance indicators, for material risks.

How often risks are monitored will depend both on the materiality of the risks and on scheme resources.  However, where risk levels approach agreed risk appetites, monitoring should likewise be increased.

As with all steps in the IRM process, trustees should be able to make use of information that is already available when monitoring risks.  For example, in terms of covenant monitoring, this may be based on information which is produced in the employer’s regular accounts.

Actions for trustees

• Act now.  Trustees should speak to the employer and liaise with their advisers about putting an appropriate IRM framework in place, “having ascertained the potential costs and established from their adviser what outputs the testing or modelling being offered will provide (including its limitations)”.
• Make use of existing resources.  Well governed schemes will already have strategies in place for monitoring funding and investment, as well as the employer covenant, and trustees should utilise existing documentation where available to help produce their IRM framework.
• Maintain a proportionate approach.  TPR helpfully sets out some questions for trustees to consider here. These include whether the individual risks faced by the scheme are large in terms of their likelihood and impact, whether they are complex, and whether trustees “need to conduct sophisticated modelling in order to understand risks”.

If you wish to discuss any of the issues raised with us, please speak to your usual Sackers’ contact.