RBS 2012 Annual Report Download - page 294

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Business review Risk and balance sheet management continued
Other risks continued
Pension risk*
The Group is exposed to risk from its defined benefit pension schemes to
the extent that the assets of the schemes do not fully match the timing
and amount of the schemes’ liabilities. Pension scheme liabilities vary
with changes in long-term interest rates and inflation in particular, as well
as pensionable salaries, the longevity of scheme members and changes
in legislation. The Group is exposed to the risk that the market value of
the schemes’ assets, together with future returns and any additional
future contributions could be considered insufficient to meet the liabilities
as they fall due. In such circumstances, the Group could be obliged, or
may choose, to make additional contributions to the schemes or be
required to hold additional capital to mitigate such risk.
The RBS Group Pension Fund (‘Main scheme’) is the largest of the
schemes and the main source of pension risk. The Main scheme
operates under a trust deed under which the corporate trustee, RBS
Pension Trustee Limited, is a wholly owned subsidiary of The Royal Bank
of Scotland plc. The trustee board comprises six directors selected by the
Group and four directors nominated by members.
The trustee is solely responsible for the investment of the Main scheme’s
assets which are held separately from the assets of the Group.
Significant changes to asset strategy are discussed with the Group’s
Pension Risk Committee, which was established in 2011. The Group and
the trustee must also agree on the Main scheme’s funding plan.
In October 2006, the Main scheme was closed to new employees. In
November 2009, the Group confirmed that it was making changes to the
Main scheme and a number of other defined benefit schemes including
the introduction of a limit of 2% per annum (or the annual change in the
Consumer Price Index, if lower) to the amount of any salary increase that
will count for pensionable purposes. In October 2012, the Group
confirmed that it was increasing the charge made through its flexible
benefits programme for membership of the Main scheme by 5% of
salaries, with employees having the alternative of accepting an increase
in their Normal Pension Age from 60 to 65 in respect of service from
October 2012 at no additional cost.
Risk appetite and investment policy are agreed by the trustee with
quantitative and qualitative input from the scheme actuaries and
investment advisers. The Investment Executive, which acts on behalf of
the trustee of the Group’s largest pension schemes, also consults with
the Group to obtain its view on the appropriate level of risk within the
pension fund.
Risk management framework
The Group manages the risk it faces as a sponsor of its defined benefit
pension schemes using a pension risk management framework that
encompasses risk reporting and monitoring, stress testing, modelling and
an associated governance structure that helps ensure the Group is able
to fulfil its obligation to support the defined benefit pension schemes to
which it has exposure.
Reporting and monitoring
The Group maintains an independent view of risk from a sponsor
perspective within its pension funds. It achieves this through regular
pension risk reporting and monitoring to the Group Board, Group
Executive Committee and Group Board Risk Committee on the material
pension schemes that the Group has an obligation to support.
Stress testing and modelling
Throughout 2012, various pension risk stress testing initiatives were
undertaken, focused both on internally defined scenarios and on
scenarios to meet integrated FSA stress testing requirements. On an
annual basis, the Internal Capital Adequacy Assessment Process is also
modelled. This entails assessing changes in pension asset and liability
values over a 12-month horizon under various stresses and scenarios.
Governance
A key component of the pension risk framework is the Pension Risk
Committee. This committee also serves as a formal link between the
Group and the Investment Executive, which acts on behalf of the trustee
of the Group’s largest pension schemes, on risk management, asset
strategy and financing issues and has facilitated an agreement between
the two on mechanisms for reducing risk within the RBS Group Pension
Fund.
As part of the continuing development of the pension risk management
framework within the Group, key achievements in 2012 focused on
developing an improved pension risk reporting, monitoring, modelling and
stress testing capability for the Group. The focus for 2013 will revolve
around extending and embedding these improvements across the Group.
Main scheme
The most recent funding valuation, at 31 March 2010, was agreed during
2011. It showed that the value of liabilities exceeded the value of assets
by £3.5 billion at 31 March 2010, a ratio of assets to liabilities of 84%. In
order to eliminate this deficit, the Group agreed to pay additional
contributions each year over the period 2011 to 2018. These
contributions started at £375 million per annum in 2011, increasing to
£400 million per annum in 2013 and from 2016 onwards will be further
increased in line with price inflation. Further details are provided in Note 4
of the consolidated accounts. The next funding valuation is due at 31
March 2013.
The assets of the Main scheme, which represent 85% of Group pension
plan assets at 31 December 2012, are invested in a diversified portfolio of
quoted and private equity, government and corporate fixed interest and
index-linked bonds, and other assets including property and hedge funds.
The trustee has taken measures to partially mitigate inflation and interest
rate risks both by investing in suitable physical assets and by entering
into inflation and interest rate swaps. The Main scheme also uses
derivatives within its portfolio to manage the allocation to asset classes
and to manage risk within asset classes.
*unaudited