After the damage of the global financial crisis, funds should be submitting themselves for voluntary financial health checks to diagnose vulnerabilities and pinpoint risks, asset consulting firm Mercer says. Darren Wickham (pictured), principal in Mercer’s retirement, risk and finance business, said risk profiles would increase as the population ages and members begin to draw-down.
But, there was no need to “reinvent the wheel” in designing more robust risk management tools, Wickham said.
Financial condition tools already existed for general, health and life insurers to identify dormant risk areas, and these could readily be used to assess funds’ financial health or sickness.
Wickham said funds must assess four areas: financial strength, fund sustainability, risk, and stress.
First, financial strength assessment at balance date included reserves, liquidity, and strength of service providers.
Second, fund sustainability modelling examined areas such as: exit rates, profiling of those exiting, inactive vs active, pension takeup rates, and investment options used.
Third, risk review for a financial condition report included a consideration of the fund’s experience of risks and compliance failures during the past year.
And fourth, stress testing included deep-dives into liquidity and unit pricing.
For liquidity, Mercer had developed tools to examine the impact of various short- and medium-term scenarios, Wickham said.
For unit pricing stresses, Wickham said, Mercer’s experience in unit pricing and custody/operations was applied to identify problems before they became substantial rectification costs for the fund.
When applied to investments, good governance contributed to performance, Wickham said, citing Ambachtsheer research (Ambachtsheer Letter, no.245, June 2006) which showed annual increased returns of up to 3 per cent due to better decision-making.
At least five benefits flowed from a financial condition report, Wickham said.
1. A sophisticated management report which befitted the increasing complexity of funds
2. A level of comfort about the risks provided by an external expert
3. Insights into behaviour of members which allowed funds to tailor communications, products and services
4. Modelling of the fund for strategy, examining fee basis sustainability, and setting reserves
5. Due diligence in preparation for possible mergers of funds