Impact of Covid-19: Can the pension industry navigate optimally?

Pandemics and disasters are unpredictable as their probabilities and severity vary. In their occurrence, entities without proper risk management protocols are hugely exposed to the perils. Responses to such eventualities, both locally and at the global stage, continue to evolve. The commonality in the key mitigation factors is however adaptability and flexibility in aid of greater perspectives.

“Luck is a very thin line between survival and disaster and not many people can keep their balance on it” ~ Hunter S. Thompson.

So how do stakeholders balance survival and continuity in the midst of a crisis? How do they establish an appropriate trade-off? Pension funds play a key role in driving the economy and negative impacts of any nature on the sector may be a cause of alarm in achieving better outcomes. To demonstrate this key role, below is an excerpt of statistics as per the OECD (Organization for Economic Co-operation) June 2020 Report of pension funds relative to the size of the economy (% to GDP)

In assessing pension outcomes, Melbourne MERCER, a Global Pension Index, outlines three indices used to measure the effectiveness of pension systems: Adequacy, Sustainability and Integrity. These same principles are relevant in evaluating the impact of Covid-19 on pension funds

Adequacy

The principle of adequacy assesses the sufficiency of accumulated pension benefits in meeting the intended purpose of financial freedom at retirement. This can be estimated through the income replacement ratio (IRR). IRR refers to retirement income expressed as a percentage of an individual’s employment income when they retire.

Current changes in workforce patterns as a result of the pandemic has impacted the inflows into pension funds i.e. reduction on the rate of contributions, layoffs necessitating early access of benefits which will ultimately lead to attrition of pension assets as well as reduced investment income as a result of non-performance performance of financial instruments in the capital markets. In addition, withdrawals impact heavily on the adequacy of anticipated income at retirement as well as disrupt return on investments leading to reduced outcomes.

Trustees, who are the individuals entrusted with the responsibility of protecting pension assets have a fiduciary responsibility in honoring the pension promise. To ensure that target outcomes are achieved in the long-term, additional voluntary contributions and diversification of assets to enhance investment returns can be considered as buffers to supplement this gap once the financial situation improves.

Sustainability

The principle of sustainability is determined by the ability of a pension fund to accumulate enough assets to meet beneficiary obligations, through funding and investments. Funding relates to contributions made into the pension scheme and investments relates to the return achieved from optimizing the contributions over the long-term.

Certain temporary relief guidelines have been outlined as part of the flexibility mechanisms to employers in meeting short-term funding obligations. These relief mechanisms include:

• Deferment of contributions or contribution holidays during the period of financial distress which can later be supplemented through a remedial action plan to cover for the lost period;
• Variation of contributions as a result of reduced pay or unpaid leave;
• Temporary suspension of contributions which will be waived during the notice period;
• Closure or wind up in line with the applicable laws and regulations for entities which are unable to continue with operations;

For specific types of pension scheme i.e. defined benefits schemes, sponsors or employers need to engage professionals on asset-liability matching to ensure appropriate funding requirements are met, otherwise draft relevant remedial plans for risk mitigation.

Many employers and employees have negatively been impacted by the Covid-19 pandemic leading to financial constraints resulting into an inability to meet scheme obligations. To put this into perspective, industry statistics from the Retirement Benefits Authority estimate that within the last six months of the Covid-19 pandemic season, approximately KShs. 2.1 bn worth of contributions from employers has been suspended as they struggle to keep businesses afloat and maintain cash flows as a result of competing for financial needs within organizations.

According to industry statistics for the first half of 2020, pension funds have recorded a flat growth rate i.e. Q1 2020 registered a 4% decline in earnings while in Q2 2020 grew by 4%. Whilst the investment market remains uncertain, it is prudent for the relevant pension stakeholders to review their investment policies to adopt strategies that are aligned to the current circumstances without losing the objective of protection of member funds with a target of capital preservation. The key responsibility is to focus on the long-term goals to avoid materializing losses in the short-term.

Integrity

In this context, the principle of integrity examines the communication, operations, governance and protection of pension plans. Jim Rohn observes that effective communication is 20% what you know and 80% how you feel about what you know. Communication is very critical in times of a crisis owing to the delays and disruptions that lead to increased queries. Therefore, the adoption of a communication policy to manage expectations and address multiple stakeholders is important, as it reinforces confidence and fosters transparency clearly and consistently.

Further, in lieu of the new normal, engagement at different levels and sensitization on use of virtual communication platforms is important as well as maintaining alternative and open channels of communication for the different stakeholders i.e. members, service providers and regulators. In addition, proper security measures must be put in place to safeguard the online meeting spaces.

Given the risk based supervision adoption by the Pension Regulator (RBA), reporting must be adhered to within the outlined framework for effective monitoring of the risk health status of the schemes. Where the risk profiling reveals challenges, remedial action plans should be drawn and subjected through proper channels for support aimed at addressing the particular circumstances.

“It is not the strongest nor the most intelligent of species that survives, but the one that is most adaptable to change” ~ Charles Darwin.

Operational continuity is most susceptible during uncertain times, therefore, reasonable steps in the form of processes and procedures must be developed to reduce the disruption of services. This can easily be achieved through prioritization and investing in resourcing requirement for settlement of benefits and pension payroll. In addition, in this error of advancement in fintech, automation is key in the management of member information, communication and data management. Further, data backup and recovery on offsite facilities is important in safeguarding the schemes proprietary information.

In the advent of risk based supervision, governance has taken a center stage in the management of corporates and pension schemes have not been left behind. The onerous decision making responsibility bestowed on Scheme Trustees, especially under such times as during this pandemic where there is pressure to quickly and expeditiously deliver, must be based on factual information. Consequently, Trustees must ensure that they put in place mechanisms and processes on response to multiple possible scenarios as a result of unprecedented events. This can be achieved through:

Outlining procedures on holding meetings remotely and protocol on calling a special or extra-ordinary meeting and resourcing requirements;

• Quorum on decision making in case of exterior circumstances; and
• Delegation of authority for specific actions or activities through committees.
• Risk management must also be deliberate, especially in assessing potential issues that can arise, and how to be proactive in mitigating them.

Conclusion

In conclusion, business continuity and disaster recovery plans for pension stakeholders have now been put on the litmus test. Therefore, consistent review, appropriate monitoring and contingency planning especially on aspects with significant consequences to scheme members should be given due attention to ensure alignment to changing circumstances. Succession planning is also important in managing transition should changes happen quickly to ensure adaptability. In addition, the governing body, which is the Board of Trustees, must ensure that they procure appropriate professional indemnity against any claim which may occur as a result of unintended or un-willful professional liability.

Ruth Njuguna is the General Manager, Octagon Pension Services Limited. The views expressed in this article are her own personal views and not necessarily those of her organization