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Article | Pensions Briefing

How the Merchant Navy Officers’ Pension Fund transformed its funding position

Pensions Corporate Consulting|Pensions Risk Solutions|Pension Board and Trustee Consulting
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By Kim Farnum and Pieter Steyn | March 16, 2018

Like many defined benefit (DB) schemes, the Merchant Navy Officers’ Pension Fund (MNOPF) once struggled to improve its funding level. An improved approach to governance has transformed the scheme’s fortunes.

The challenge

In 2012, the scheme’s funding level hovered at just below 70% measured on a gilts basis.

Today, it is 85% funded and expects to reach full funding on a gilts basis by 2025.

The MNOPF has also taken steps to improve the security of members’ benefits, via a series of buy-in insurance transactions. Most recently, the scheme announced it has secured £490 million of members’ benefits through a deal with Legal & General in December 2017.

Figure 1. Funding level comparison vs average UK DB pension scheme

Chart showing funding level comparison vs average UK DB pension

The funding problems the MNOPF faced are extremely common among DB schemes. Yet high-quality governance, including the appointment of a delegated chief investment officer (CIO), can make all the difference, as the MNOPF example illustrates. How? Three of the stakeholders involved give their perspective on what has changed for the better.

The scheme chair’s perspective

When Rory Murphy became chair of the MNOPF’s trustee board in 2014, he was acutely aware of the challenges involved. The £3.5 billion umbrella-style pension scheme has 350 participating employers, including some of the shipping world’s biggest global names. Ensuring they are all on the same page is a huge undertaking in itself; improving the monolith scheme’s funding level in a low interest rate environment is another significant challenge.

Working with the scheme’s consultants, Willis Towers Watson, Murphy has embraced the opportunity the delegated CIO model has given him to focus on the scheme’s strategic objectives. But this doesn’t mean relinquishing the reins.

“What’s very important is that the CIO’s decision making is owned by the board,” says Murphy. “A common misunderstanding is that when using a delegated CIO model, the trustee board loses some power. Actually, the board polices and monitors every decision.”

Day-to-day, this means that the trustee board sets the investment objectives, return targets and funding level triggers, ensuring that the views of the MNOPF’s 350 employers are considered, explains Murphy.

The decision to appoint a delegated CIO has improved the scheme’s governance, says Murphy. The MNOPF no longer has an investment committee; the whole trustee board oversees the delegated CIO. Murphy explains: “All too often with pension schemes, there is a tendency for the investment committee to know what’s going on and the board to rubber stamp it. That is poor governance. We make sure the whole board is involved and knows where we are on the journey plan.” This doesn’t mean, however, that the board’s time is taken up looking at the minutiae of investment decisions; rather it has been freed up to concentrate on the achievement of the fund’s strategic objectives.

He has a clear idea of what constitutes a healthy relationship between the scheme and its advisers. “It is not the trustee board’s job to catch out the delegated CIO. We are not looking for holes in what they are doing, we are working with them to get to the end of our journey plan.”

That said, the trustee board is free to end the relationship at any point, which ensures that the delegated CIO is held to account. The MNOPF has also appointed an independent set of advisers to scrutinise Willis Towers Watson’s decision making in this area, adding an additional layer of governance.

What is a delegated CIO?

Sometimes known as a fiduciary manager, a delegated CIO makes day-to-day investment decisions on behalf of a pension scheme. The exact nature of a delegated CIO relationship will vary from scheme to scheme, but typically, the delegated CIO will be responsible for hiring and firing managers, monitoring investment performance and ultimately, delivering a scheme’s long-term strategic objectives.

By removing the daily decision-making responsibilities from a scheme, the trustee board gains the capacity to think deeply about strategy. Trustees still retain ultimate responsibility for the scheme’s fortunes and remain involved in all key decisions; they would, for instance, be consulted on whether to de-risk when a funding trigger is reached. They also hold the delegated CIO to account, meeting regularly for progress updates.

The consultant’s view

“Our job is simply the implementation of the trustee board’s strategic plan,” explains Pieter Steyn, UK head of delegated services at Willis Towers Watson. “We manage the resource-intensive activities, such as the detailed asset-allocation decision making, the portfolio management aspects and selecting, monitoring as well as de-selecting managers.”

This frees up the trustee board’s time to think about strategy, Steyn echoes. He adds: “The typical pension fund decision-making structure is sequential. The big difference with the delegated CIO model is that everything happens in parallel: liability-driven investment, manager selection, monitoring and strategic asset allocation all happens at the same time. This creates bandwidth for the board to do more. In essence, it is similar to broadband versus dial-up.”

The MNOPF benefits from economies of scale, via Willis Towers Watson. “Large investors have an advantage,” says Steyn. “They tend to pay less for the same thing. If you have a passive allocation to a fund, the large investor pays one fee and the small investor pays another. If you pay less in fees, the large investor keeps more of the return and therefore, they get to the end point faster than the small investor.”

Steyn and his team also ensure that the MNOPF is fully compliant with regulation such as the Markets in Financial Instruments Directive II regulations which came into effect in January 2018.
Additionally, the Willis Towers Watson team are in charge of monitoring the scheme’s funding triggers. “From time to time, buy-in transactions happen and there are trigger mechanisms for those,” explains Steyn.

The trustee board may work closely with Steyn’s team, but Steyn is in absolute agreement with Murphy: accountability remains the priority. Steyn’s team reports to the MNOPF quarterly. “There is no place to hide,” he says. “Because this is a commercial arrangement, our incentive is to continue to be really strong in what we do. Therefore, we continue to invest in processes and people to ensure we stay ahead of the competition.”

The actuary’s take

Senior Consulting Actuary Kim Farnum recently joined the Willis Towers Watson team responsible for the MNOPF. Her role is to advise the trustees in relation to funding and other actuarial matters, working alongside Steyn’s team.

Discussions about the December 2017 buy-in were underway before Farnum joined the team. “Once it looked like a viable deal, my role was to evaluate the funding impact it would have on the scheme. Even though it looked good on paper and offered clear risk-reduction benefits, we would have to think again if the transaction ultimately led to higher contributions being required from the employers.”

“What really impressed me about the MNOPF was that they have a very clearly laid out mission statement and set of strategic objectives,” she reports. “They are on a journey and know the steps they need to take to get to their endpoint. They are set up in such an efficient way that when opportunities such as the recent buy-in arise, they are very well prepared to evaluate them and act very quickly.”

A shift in mind-set may be in order for other trustee boards who are keen to close their funding gaps, suggests Farnum. “Trustee boards may need to start thinking and operating more like the executive boards of companies. Rather than getting caught up in details which they can delegate, the key is to retain the strategic direction and responsibility.”

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