In their recent report, ‘Occupational pension scheme governance’ The Pensions Regulator identified that whilst overall, scheme governance was good, there are important gaps.

The Regulator’s Code of Practice (CoP) on Internal Controls is reaching its final form. In July, the second draft, produced following consultation, gives a strong indication of exactly what the final Code (which is due imminently) will look like.

In essence, the Regulator favours a risk based approach – hardly surprising given that the Regulator itself aims to work in this way!

The draft CoP gives a table of examples of risks and the possible controls that can be established to deal with them. A link to the draft appears at the right of this page if you’d like to see them all but for now, I’ll focus on just one – investment risk.

You don’t have to scan the pensions press for long before you come across some article or advert which talks about Liability Driven Investments (LDI). Quite simply, LDI assesses the liabilities (and assets) of a pension scheme and looks at the cash flow situation. It then proposes a suitable investment solution to cope with these risks.

But LDI can be complicated and expensive to run and so in general, LDI is only really cost-effective for larger schemes with suitably appointed investment advisers. On the other hand, smaller schemes are often wholly insured with a pensions provider as this makes it easier and cheaper for them. How can trustees satisfy the Regulator’s requirement to provide a suitably risk balanced investment for their schemes if they’re using a provider?

The answer may lie in an insured fund which mimics the LDI route, albeit on a smaller scale – and that’s where our Managed Strategies for Defined Benefits (MSDB) comes in.

Like LDI, MSDB attempts to assess the risk of a scheme and its cash flow signature. The liabilities then drive the asset allocation of the investment rather than the other way around.

For example a scheme with no short term cash flow difficulties can take a longer term investment view and perhaps equities would be more suitable. Whereas a scheme with significant short term significant liabilities or negative cash flows may well want to invest in lower risk funds.

But it’s not quite that simple as inevitably, the risk profile and cash flow of the scheme will change over time. Switching investments to compensate can again be an unwieldy and costly business. So MSDB will wind forward the analysis of liabilities to look at the position at the next review in 3 years and a new asset allocation will be calculated. And as we use the information that’s already there it’s not costly. We just use the data derived from the scheme’s valuation process and feed this into our robust asset management process.

It’s not for every scheme but for some it can provide Trustees with an investment solution that can provide both peace of mind and the confidence that it satisfies the Regulator’s requirements.

Contact your normal Scottish Life consultant or see our Investment for trustees page for further details on MSDB.

Investment returns may fluctuate and are not guaranteed.  The price of units can go down as well as up.

The Scottish Life defined benefit investment policy is provided by Royal London Mutual Insurance Society Limited. Other defined benefit pension services, which are not regulated by the Financial Services Authority are provided by Royal London Corporate Pension Services Limited, a wholly owned subsidiary of Royal London. Royal London Corporate Pension Services Limited are not regulated by the Financial Services Authority.