The risks they take with our money

Pensions: Stephanie Hawthorne reports on trustees' new duties

Risk is one of the most critical issues to be confronted in relation to both investment and pension planning. It is a worrying conundrum for investors and trustees alike. So, how is a trustee to cope with balancing risk and the need to safeguard pension assets for members? And how can pension scheme members know what trustees are doing on their behalf?

Statistics only tell one side of the story. One hundred pounds invested in equities in December 1918 with all income reinvested was worth pounds 710,556 in December 1996, according to BZW, the investment house. The equivalent figures for gilts and cash were pounds 8,917 and pounds 6,101 respectively. Yet equities are considered far more risky investments, and the penalties for making a mistake are huge.

Investment managers are, anyway, like race horses - they need guidelines. Otherwise, they may be tempted to go for more speculative investments than trustees would like. Alternatively, if they are wrongly informed about the pension scheme, they may be overly conservative.

To answer these dilemmas, the new Pensions Act requires trustees to draw up and maintain a written statement of investment principles (SIP). It should contain details on how trustees choose investments, on the types of investment held and the balance between them.

It should provide guidelines on the preferred approach to risk, likely return and the realisation of investments, and the need for diversification, and how the fund will comply with the minimum funding requirement (MFR).

The SIP should also be available for members to see on request and be quoted in the annual report. Certainly, it should be more accessible than the "chairman's bottom drawer". Failure to have an SIP in place may now result in trustees being disqualified by the pensions watchdog, Opra, and fines may be imposed.

Nick Fitzpatrick, a partner at actuaries Bacon & Woodrow, says: "Cumbersome and bureaucratic they [SIPs] may be, but even in the best run funds, trustees have been forced to look carefully at some neglected corners of their portfolios and management arrangements."

Philip Christison of Towers Perrin welcomes the new proposals: "Much pension fund investment to date has been subject to uncertain objectives and follow-my-leader style decisions; making investment decisions for the wrong or poorly defined reasons is obviously a bad idea."

Trustees also have to state their policy on complying with the minimum funding requirement (MFR) introduced by the Pensions Act to give members greater security. MFR aims to ensure that, whatever happens to the employer, salary-related schemes have enough money in them to meet the pension rights of the members. If the pension scheme is wound up, there should be enough assets for pension payments to continue and to provide all younger members with a cash value of their pension rights.

If the money in the scheme is less than this minimum level, the employer will need to put in more money. The time limit for restoring schemes' fund levels to at least 90 per cent and 100 per cent of the MFR is one year and five years respectively.

The MFR itself is a compromise. Keith Ternent, of actuaries Buck Consultants, says: "Purists may object to such a standard on the grounds it does not absolutely guarantee the required benefits on a winding up. But it is a standard, where none has existed before."

One problem is that some funds may switch from more volatile, but better performing equities to poorer, but more predictable, investments. A typical pension fund's current holding of gilts under the new proposals might increase from 10 to 13 per cent of assets.

So far, the stock market has hardly quivered at the news. But mature funds, that is those with many pensioners or employees nearing retirement or with many people being made redundant, will have to invest heavily in gilts or other matching assets. These proposals could require employers to invest an extra pounds 300m to pounds 400m a year in UK pension funds until the MFR is fully in place between 2002 and 2007.

Even so, for most well-run pension schemes MFR will be a question of nuance and good practice. But pensioners will eventually have more protection at a reasonable price.

Stephanie Hawthorne is the editor of `Pensions World'