As a speaker at this month’s Risk Management Conference in Muskoka (August 24 – 26), Calvin Jordan, CEO of NSAHO Pension Plan in Nova Scotia, will be sharing his views on leverage and how it can help pension funds increase expected returns. In advance of the conference, we asked him to answer our three questions on risk management after the financial crisis.
CIR: When it comes to risk, what are some key learning’s from the crisis, are pension funds looking at risk now versus pre 2008?
CJ: My guess is that, for most pension plans, the important lesson from 2008 was just a reinforcement of one very basic idea: it’s a bad idea to take risk that exceeds what your stakeholders can tolerate. We seem to need an occasional crisis to remind us of how important the basics are.
CIR: Has the 2008 financial crisis changed pension risk management for good?
CJ: Yes, but in some comparatively small ways. No doubt many pension plans will take harder looks at things like currency hedging, prime-broker exposure, caps to be applied to illiquid exposures, market exposure hiding in market neutral funds, etc. However in my opinion, the really big risk management issue of our time is for pension plans to more fully embrace liability-driven investment (LDI) strategies. This change was already occurring, and 2008 just sped up the pace of change.
CIR: How will the continued economic turmoil impact pension funds in the coming years? What risks will they create?
CJ: It seems like a good bet that many defined benefit pension plans will struggle with large solvency deficits for the next several years. Some pension plans will increase contributions but for many, contributions are already too high for this to be a practical option. Where it hasn’t already been done, plan designs and funding policies will change and shift more risk to members. Benefits will be made less generous, with ancillaries such as indexing being the easiest targets.
Medium-sized and larger pension plans will more fully adopt LDI strategies. And too much energy will be spent resisting minimum funding rules in the hope that the next bull market will make these other actions unnecessary.
The big risk is what happens if there is another market crisis before a pension plan fully recovers from 2008. Plans that are taking more risk than they can prudently tolerate need to de-risk. Benefits that can’t be afforded need to be reduced. These aren’t easy decisions but there really is no prudent alternative.
When funded ratios become dangerously low, some will feel that they have no choice but to maintain risk at pre-crises levels, even if this risk is no longer prudently tolerable. If you apply this thinking to casino play you lose your house. When contributions have been increased to their practical maximum and surpluses have disappeared, your risk tolerance has unquestionably decreased. Investment and benefit policies that aren’t adjusted accordingly may risk the viability of the pension plan – or worse.