The Invensys Pension Scheme (“IPS”) provides benefits to over 75,000 members. IPS is a very mature scheme; indeed, pensioners and deferreds represent 66% and 33% of the membership respectively, with active members accounting for less than 1%. The size of IPS’s assets and technical provisions (between £4 billion and £5 billion) has also historically been large relative to its sponsor, Invensys plc. Unsurprisingly, risk management has therefore long been at the centre of IPS’s trustee directors’ minds.
In 2011, the trustees decided to implement PFaroe to strengthen their ability to manage investment risk. PFaroe is used by IPS’s Executive Office and has become a pillar of the investment and risk management process.
The business case
Previously, the investment and risk management decisions were based on information and analysis provided, with varying degrees of regularity, by investment and actuarial advisers, asset managers and banks.
The business case for adopting PFaroe therefore hinged on providing the scheme with a tool to perform its own bespoke analysis, which would drive a better understanding of the risk exposure and, as such, facilitate the investment decision-making process. By bringing this analysis in-house, it was also expected that there would be some cost benefit.
“The business case was built on a desire to better quantify the market and actuarial risks arising from the scheme’s assets and liabilities, with the expectation that this would enable us to be more confident making certain investment decisions,” says Thomas Mercier, CIO at IPS. “What is more, by having a tool that put the information at our fingertips, we felt that we’d be more proactive and dynamic in the management of our risk exposures.”
Driving a better understanding of investment and actuarial risks was particularly pertinent to IPS given the complexity of its benefit structure. While there is only one scheme, this incorporates a number of different benefit types. In particular, this results in a complex exposure to changes in inflation; while some scheme members’ pensions are adjusted in line with RPI, others are pegged to CPI, and there are a number of different caps and floors in place.
Clearly, this makes it difficult for IPS to model the scheme’s exposure to inflation, and how it may change under different market scenarios. And without accurate measurement, management of this risk could not be optimized. IPS therefore sought an analytics system that would allow them to better understand this risk, and subsequently test different potential solutions for managing it.
Mercier adds: “Once we had ascertained that we needed such a system, we naturally looked towards third-party providers, given that we did not have the required skills or resources to develop and support it in-house. And, in this respect, RiskFirst stood out above the rest.”
Given the nature of the scheme’s benefit structure, implementation of PFaroe was complex but, nonetheless, completed on time (within three months) and without major set-backs. What is more, over that period RiskFirst worked with IPS to enhance and extend functionality to meet the needs of the scheme. Using PFaroe resulted in a number of clear benefits, justifying the original business case.
1. Better understanding of risk underpinning investment strategy
PFaroe has enabled IPS to take more control of the scheme’s risk measurement, reducing reliance on investment and actuarial advisers, asset managers and banks.
Mercier explains: “Using PFaroe has made the risks that the scheme is facing far more observable. While PFaroe allows us to quickly obtain a broad view of the risks, a key advantage is that it also allows us to delve much deeper. We use data sourced from PFaroe and its functionalities to stress-test assets and liabilities or project funding levels under various market scenarios. This allows us to move forward in the decision-making process with more confidence.”
This has helped IPS develop the framework within which it can make investment decisions. Mercier adds: “PFaroe allows us to answer two key questions: are we comfortable with the overall level of risk; and, are we happy with how this risk is distributed across market factors, such as interest rates, equity and credit. I can then better report back to the trustees and make recommendations to adjust our investment strategy.”
2. An ability to structure and test solutions to managing risk
PFaroe has also proved critical in helping IPS structure solutions to manage these risks. Notably, IPS has been able to better manage its inflation exposure to capture the impact of caps or floors on the scheme’s evolving sensitivity to changes in inflation. This was a key project for the trustees – and one that could not have been completed effectively without PFaroe.
Mercier adds: “Not only are we making more informed decisions, we can also make these more quickly. For instance, we have a view on the exposure amount we want to have to certain market factors under various market conditions, which we track using inputs with PFaroe. If the market shifts, we are better prepared to make the decision to adjust or keep our exposure.”
3. An integrated picture, for all
Given IPS’s focus on monitoring the risk in its asset portfolio, it is crucial to the scheme that PFaroe provides an integrated picture of the risks across both sides of the balance sheet.
It is also useful as a shared source of information: IPS’s actuary uses PFaroe as a liability valuation tool, and the scheme’s investment consultant uses some of the analytical output, especially concerning risk. By providing consolidated and consistent scheme-specific information in one place, it is therefore often used as the focal point for meetings with advisers.
4. The importance of service
IPS’s has seen significant benefits in the Software as a Service (SaaS) model, leveraging RiskFirst’s support and dedication to continuously developing the product to ensure that it suits client needs.
“I’ve been impressed over the years by RiskFirst’s willingness and ability to evolve, continuously incorporating new and useful functionality into PFaroe,” says Mercier. “Their technical proficiency, combined with their client-friendly approach, has made them a reliable technology partner for IPS.”