Weathering the storm: How the Scottish Hydro-Electric Pension Scheme has embraced risk management
10 Feb 2012 - Estimated reading time: 2 minutes
SSE plc (formerly known as Scottish and Southern Energy plc) is one of the largest energy providers in the UK and they are one of our longest-standing clients.
Managing risk is key to SSE's success. The trustees of their two defined benefit pension schemes know a thing about risk as well: one of the trustees is an engineer who fixes "live" overhead lines!
This article focuses on one of their schemes, the Scottish Hydro-Electric Pension Scheme. It has weathered the financial and demographic storm better than most, though the job is far from finished. Falling gilt yields, equity, credit and sovereign market uncertainty, and increasing life expectancy mean that significant challenges still lie ahead. But, without the steps the trustees have taken it would be a much more difficult task, especially in these times of market stress.
The process began in earnest in 2003 when the trustees undertook a formal review of strategy, laying the foundations for the current funding and risk management plan. The degree of sophistication has increased over time, but the trustees have clear objectives, accurate measurement, a strategy for achieving these objectives, and a process for monitoring progress against the objectives and taking action.
Objective setting: this key task was set in 2003 and has stood the test of time. A clear set of objectives has been agreed: target funding level, time period to achieve this target and tolerance to risk. The consensus between all trustees and buy-in from SSE has been a huge advantage. For SSE, the aim was to reduce risk in a measured and well managed way for the benefit of members, shareholders and customers.
Measurement: the estimation of future benefit payments has become increasingly important as investment risk has been reduced. Accuracy has been improved by using the best available information, including longevity insights from Club Vita.
Contribution and investment strategy: every three years a strategy review determines the "optimal" balance between contributions and investment risk, based on refreshed liabilities measured using full membership data.
Risk management, mitigation and monitoring: a governance framework has been established to understand the different types of risk the scheme faces (equity, interest rate, inflation, longevity etc.) and the steps that can be taken to reduce these risks when opportunities arise. Initially, funding level triggers were set and monitored quarterly. This has evolved to monitoring a suite of triggers, including swap versus gilt spreads and the cost of inflation protection. Monitoring is also much more sophisticated, using daily funding updates based on full interest rate and inflation yield curves.
You could think of it in terms of setting off on a long voyage. You agree your destination (the objectives) and take action along the way as you are blown off course or other vessels or icebergs get in your way (the review of strategy and recalibrating based on market conditions). The destination of the Titanic was known, but the monitoring along the way was inadequate - you need both to succeed.
How they have benefited from risk management
Looking back over the last eight years, the funding strategy has delivered significant benefits to all parties - to the trustees and scheme members in terms of increased benefit security and to shareholders and customers in terms of controlling contribution requirements. This is testament to the steps taken to date to manage risk.