Two trustees and an adviser reveal where they see the biggest challenges in 2023, which event of 2022 has had a lasting impact on pensions, and which market dynamics we can expect to see more of. 

 

Dinesh Visavadia, director, ITS: Pensions dashboards and the Pensions Regulator’s new single code will be the main challenges for 2023. There are a lot of new regulations and work involved, and trustees will need to start the work early on. The move by standalone DC schemes to master trusts will accelerate in the coming years given the regulatory push. 

 

James Chalk, associate director, 20-20 Trustees: In my view the biggest challenge for trustees in 2023 will be in addressing new regulatory requirements. The single code of practice will compel trustees to look in the mirror to ensure that their governance processes and documentation are robust, together with the requirement to prepare an own risk assessment. Furthermore, the new funding code is (finally) expected to come into force in 2023. This will require a fundamental change in the approach that many trustees take towards triennial valuations and agreeing long-term funding targets and investment strategies with employers. 

 

Calum Cooper, partner, Hymans Robertson: Consolidation and scale has benefits and clearly there are a lot of subscale UK DB pension schemes out there, with the median DB scheme of the order of £25m. But 2022 has been a clear reminder of systemic risk and specifically the perils of single points of failure. Single points of failure are born of sameness, and sameness flows from a healthy desire to be cost efficient. So, with consolidation we’ve got a material risk of losing the benefits of diversity and the systemic resilience that comes with that. This isn’t a pensions only thing.  

Looking to life more generally, in Europe for example we’ve seen it with our reliance on gas imports from Russia – fine until the world changes. We see lack of resilience in our reliance on China and Taiwan for computer chips, which is causing some international consternation (just imagine if none were exported….).  

And closer to home we’ve seen it in pensions with a herding to leveraged LDI to manage balance sheet risk over similar time horizons. In my view, the LDI crisis of late September and early October was born of a sameness of strategy amongst the majority of DB schemes. The risk is that the learnings are applied to be resilient to this sameness, and the inherent specific systemic risk, but that the next crisis will always be different. To manage uncertainty, you need systemic diversity through multiple lenses. The regulator can help with this as overseer of the industry, but trustees and advisers have a role to play too.  

  

The challenge and the opportunity, then, is to balance the benefits of scale efficiencies (value for money) with reducing the sameness of schemes (effectively paying a premium for resilience to uncertainty). How can trustees ensure that there are no single points of failure in their strategy, operations or governance? To really understand that, you have to zoom out to look at what others are doing, and make sure you are NOT doing exactly the same. This is emotionally hard as there is comfort in the crowd. And the risk of sameness is not always visible until it’s happened. 

  

On the lens to look through, a decent start would be sameness of systems for valuing liabilities, sameness of strategy (think LDI and illiquid assets to harvest illiquidity premia), sameness of governing people (difference and diversity leads to better decisions), sameness of time horizons (2030 anyone?) and endgames or even sameness of managers of assets, leading to stressed customer service when it counts most, during a crisis. 

 

 

Visavadia: Increasing yields have brought forward the journey plans of many schemes. However, there is a lot of preparatory work involved in improving the membership data quality and working with the insurers on schemes targeting risk transfer to insurers. There could be challenges for some schemes which have surplus funding. 

 

Chalk: Undoubtedly the gilt market and liability-driven investment crisis will be remembered as the 'event' that defined 2022. But in my view the sustained increase in gilt yields over the course of the year has had a much broader and more transformative impact.  

 

Before the mini-Budget in September, yields had already increased by c.200bps since the beginning of 2022. For many schemes which had not fully hedged against rate movements, this resulted in a significant improvement in scheme funding, making buyout affordable in many cases. More schemes than ever are now approaching the insurance market or looking to do so during 2023. This is fantastic news for members whose benefits will be secured, but the resource burden on insurers and administrators in particular is not insignificant. 

 

Cooper: Long story short, the LDI crisis. It was epic, and it felt like living through a surreal film. Like ‘The big short’ but in pensions and without Brad Pitt and Ryan Gosling of course. The reverberations of it will be felt for a long time. 

  

As we know, this was the child of Trussonomics and her sidekick Kwarteng’s mini-Budget. It was not, in my view, ‘what’ was in it, more ‘how’ they went about it. Ultimately, not getting any of the numbers checked, or even getting any numbers full stop – people got a bit nervous about that. Rightly. Financial systems require confidence and trust. What happened would be like trustees estimating, gut feel, their own valuation results, and not asking their actuary for a view. Or even asking their actuary not to give a view. Just in case their answer is a bit awkward (sometimes it is).  

  

Confidence evaporated and investors in UK debt got a bit anxious. As a result, the cost of borrowing spiked, LDI tanked, and it was leveraged so returns of minus 80%+ were not uncommon – overall assets fell by about £500bn at a time when expected pension payments were rising due to inflation. That forced asset sales to shore up the losses and speculative investors spotted a systemic vulnerability in the sameness of UK DB’s asset strategy. The consequence has been material sales of liquid assets for many to shore up hedges with lower return strategies from here. Some had to reduce their hedge and are nursing losses on selling bonds after a bond crash, only to see the prices of the bonds they sold bounce back. It’s been a torrid time. 

  

The consequence will be some healthy soul searching around governance, operational resilience and strategy. The real world is unpredictable. The LDI crisis is a good reminder of ‘ludic fallacy’ (or simply that you really can’t predict the future), shaking off that sense of comfort from a feeling you can assess uncertainty with statistics alone. Because, when the world really changes, it’s typically people and politics and governance and the weird and wonderful things people do that change the game (putting natural disasters or an asteroid strike or the likes to one side). You can’t model that. And after years of rearview mirror risk management, I hope a much more forward looking and imaginative approach to thinking about risk and uncertainty will emerge. Perhaps we’ll see strategies being built through the lens of real-world scenarios like, ‘What’s the impact on member outcomes if global temperatures rise 2°C?’. Then we’ll unleash human judgment and creativity to build more resilient strategies, enhanced by guiding statistics rather than simply being led by statistics like volatility and gilts-plus returns. 

 

Visavadia: Everyone working together will be key to managing schemes well. 

 

Chalk: Risk transfer specialists will be in high demand – consultants, insurers and professional trustee firms will all be looking for talented individuals specialising in this area. 

 

Cooper: I think we’re going to see more consolidation on all fronts in the DB and DC markets. Governance, assets, advisory, professional trustees, insurance, consolidators, technology, data, you name it. That’s natural in maturing markets. But these DB and DC markets are huge with at least one years’ GDP at stake and millions of people’s later life quality on the line too. What’s key is that consolidation happens, and that it happens in a way that does not lead to vulnerability to systemic risk, whilst still delivering better value for end consumers. Success is that more money spent on pensions goes to the pensioners through a long-term lens. It’s the long-term lens and sustainability that will ensure that systemic risks (or more appropriately, uncertainty) are taken into account. Or more simply – let’s just make sure we are not scooping up nickels in the name of efficiency in front of a systemic risk bulldozer (whatever it turns out to be). Because that would be a terrible thing for pensioners. 

 

How would you answer these questions – on the challenges in 2023, most impactful event of 2022 and how the industry will change?