Sustainable funding in volatile times

The improvement in both our own funding and that of the schemes we protect increases the likelihood of us meeting our current funding objective of being self-sufficient by our funding horizon, which we currently define as being 110 per cent funded at 2030.

Our Probability of Success (PoS) is the main way we measure progress towards this target. As at 31 March 2022 our PoS was 96 per cent, increasing from 95 per cent over the year. This means that in 96 per cent of the scenarios modelled we have a margin of at least 10 per cent at the funding horizon. Like any complex modelling exercise, our projections are subject to some uncertainty.

The chart shows the main drivers of the change in our PoS over the year. The increases arising due to improvements in our own funding position and to that of schemes in the universe of schemes we protect have been offset by changes we made to the long-term risk model (LTRM) and the assumptions used.

Upgrading the LTRM was a planned activity over the first two years of the strategic plan and has enabled us to improve the modelling of the risks we face. We have also enhanced some of our modelling assumptions too, this combined with a more pessimistic economic outlook are the main reasons for change here.

Our ultimate funding goal is to have enough money to enable us to pay all our members, both current and future, their compensation when it falls due. Our selfsufficiency objective, which we published in 2010, has guided our approach to investment and setting levies and ultimately helped us build our financial strength and grow our reserves.

As demonstrated by this year’s results, we now stand in a strong financial position, with exceptional investment performance in recent years having accelerated progress on our funding journey.

In our 2019-22 Strategic Plan we committed to reviewing our Funding Strategy at the end of that three-year period. Over the past year and more, we have been considering afresh the risks we face and how our approach needs to evolve in the future.

We still face risks, notably from underfunding within the population of schemes we protect and future insolvencies triggering claims on the PPF. However, we believe these risks have reduced over time, and our healthy reserves now provide us with a good level of protection.

We are now in the final stages of the review and will be in a position to share the outcome following completion of our stakeholder engagement programme. Assuming our funding position remains robust over the next three-year period, our expectation remains that we will look to reduce how much levy we collect in keeping with our long-stated intention.

As usual, we will formally consult on our proposals for levy in the autumn of 2022.

The investment portfolio has performed strongly against our rolling five-year target. Over the last five years, the total Fund has delivered an annualised contribution of Cash + 2.73 per cent versus an annualised target of Cash + 1.50 per cent. Non-LDI assets alone delivered an annualised contribution of Cash + 4.76 per cent.

Over the same period, the investment team contributed on average £270 million
per annum (around 90bps per year), over and above the return of the Strategic
Asset Allocation (SAA) benchmark. The main contributors to total alpha over that period were outperformance in the Public Equity, Private Equity, Timberland and Farmland and Infrastructure portfolios and also the asset allocation positioning relative to the SAA.

In the last year the portfolio contributed Cash + 4.28 per cent, with every non-LDI asset class delivering positive returns. The investment team added £610 million (150bps) of outperformance over the SAA benchmark over the same period. The main contributors to alpha were outperformance in the Private Equity, Infrastructure, Alternative Credit and Real Estate portfolios. Asset allocation positioning also contributed strongly, as we actively managed the asset allocation through the year while maintaining an overweight position to private markets relative to public assets.

Following a successful insourcing programme and systems upgrade, most of our investments are now managed in-house, giving us greater control over our assets.

Over the years we’ve evolved our investment approach by hiring experienced investment professionals with excellent track records, improving knowledge and experience within the team, and we’ve improved the diversity represented within the function.

We now have the right balance between internally and externally managed investments. Externally, all of our managers are given tangible mandates to perform against. Importantly, all investment activities are fully supported by an investment operations team and integrated risk management within the investment function.

During the last Strategic Plan period we finalised the insourcing programme. More recently, we implemented a new performance measurement and attribution system, which allows us to monitor and analyse both our internal and external manager positions in real time. We are now able to analyse and understand our investment performance at a very granular level. By using this detailed portfolio information in our decisionmaking, we are able to improve investment outcomes.

We’ve continued to develop and embed a market-leading approach to responsible investment, which has significantly advanced our strategic response to climate change. We are actively engaging with our external managers to better align their investment strategies with our ESG objectives and to improve the quality and depth of their ESG reporting. There will be many other developments and challenges in this area over the next Strategic Plan period, including exploring more opportunities for sustainable investment in asset classes such and forestry and infrastructure as well as understanding our own environmental impact outside the investment portfolio.

The funding of the schemes we protect and their sponsors’ risk of insolvency remain the biggest risk we face. While the risk exposure is not within our control, understanding it allows us to plan and prepare for its impact on us.

Although we expected the pandemic to result in a number of insolvencies, this hasn’t yet come to pass. The uncertainty around if and when claims will materialise, linked to whether or not government support for business would be extended, has been challenging.

However, we stand ready to absorb such claims. We continually monitor the risk created by market volatility, and model the number and size of claims we might expect.

We compile and analyse data on the schemes we protect and publish this information annually in The Purple Book, a key product of our RMF. The data gives us an in-depth understanding of how the universe of schemes we protect is changing.

Understanding these trends helps us paint a realistic picture of how this landscape might look in the future and helps us to model the level of claims we may need to absorb in years to come. This, when combined with information relating to our membership, helps inform decisions on our future levy and investment strategy.

Over the past year, we’ve carried out further work to leverage the benefits of our upgraded LTRM software and make our risk modelling more realistic. The new platform has allowed us to conduct additional model runs, alongside a comprehensive review of our risk assumptions. This work has in turn fed into our funding strategy review.

In line with one of our 2021/22 Business Plan objectives, we’re continuing to enhance the LTRM and have retendered for our Economic Scenario Modeller, which will feed into this. We’re now in the process of implementing this model, which will be a key focus for the start of the next financial year.