PFaroe provides FTSE-100 company Babcock International Group plc. and the trustees of its four defined benefit pension schemes with a trusted, central source of accurate and timely information. Crucially, this has transformed the debate between sponsor, trustees and consultants from an age-old one around the validity of the numbers, to a more constructive one focusing on finding solutions to the issue of the day.

Such consensus has been crucial to Babcock employing a unified trigger-based de-risking strategy, which has accelerated its schemes’ progress towards the end-game.

Responding to change

Historically, Babcock’s schemes were governed by separate trustee boards which worked independently, and followed separate investment strategies. This structure was recognised as inefficient and a hindrance to timely decision-making – less than ideal for schemes with aggregate pension liabilities exceeding £2.8bn.

Changes were afoot. Babcock made the first step by proposing a more streamlined governance structure, with one team of investment advisers and an investment

Whilst accepted by the trustees, it was clear that the success of this structure would be reliant on the provision of accurate and reliable information from a single source. Babcock turned to PFaroe.

By providing both sponsor and trustees with the same transparent, consistent and, crucially for Babcock, accurate information, PFaroe has put all parties on the same page when it comes to understanding the issues at hand. The result is a proactive, risk-based strategy.

Timely and accurate information

Babcock has long been an advocate of trigger-based de-risking strategies – enabling its schemes to alter asset allocations and affordably reduce risk positions when markets are favourable. Yet, whilst using funding-level triggers has intuitive appeal, the operational requirements around implementation can be substantial.

Babcock’s schemes have since implemented two sets of trigger mechanisms – heavily reliant on PFaroe’s ability to provide liability measures on a variety of bases and ‘Value at Risk’ measures that inform trustees of the levels of risk they are taking (relative to agreed risk budgets). The first trigger monitors funding levels and prompts de-risking – moving each scheme to a new flight path each time its funding level increases by a prescribed amount. And within its hedging portfolio, Babcock has a second set of market-based triggers that aim to gradually reduce interest rate and inflation risk, as opportunities arise over time.

Clearly, timely and accurate information has been crucial. If Babcock was to examine its funding position only once a month – or worse, once a quarter – opportunities to alter investment strategies or to de-risk could be missed.

Similarly, the provision of approximated valuations based on roll-forward approaches could result in missed opportunities: (i) overstating funding levels could result in trigger points being artificially breached early, which could lead to action being taken at inappropriate times, and (ii) understating funding levels could result in opportunities being missed all together. And since funding levels are likely be worse in volatile or falling markets, the greater the ‘error’ in liability estimates, the greater the potential impact on future funding levels.