Despite BHS and Tata, many DB pension schemes not factoring in risk of ‘sponsoring’ employer going bust as they bid for accelerated growth

16th September 2016

The independent trustees of many of the UK’s largest pension schemes are not factoring the risk of the sponsoring employer getting into financial difficulties in their investment strategy, a leading consultancy has warned.

The issue has risen to the top of the agenda following the high profile failure of BHS leaving its pension scheme members to fall on to the Pension Protection Fund which provides a safety net but which can be at a substantially reduced level of pension for long serving or mid ranking employees.

The second annual survey by leading pension consultancy Hymans Robertson of 36 independent trustees showed that a quarter believed sponsor failure – known as ‘convenant risk’ in the industry is one of the biggest risks to schemes.

Some 43% surveyed say this risk isn’t integrated into the schemes’ investment and funding decisions.

The consultancy says that the insolvency risk of all UK DB schemes is around £450bn worth of pension benefits. It argues that in the event of failure of the sponsoring employer, members would be £23,000 better off if a fully integrated, slower and steadier approach was taken. It says that some schemes have a strategy aimed at accelerating growth but that this can risk employees’ benefits.

It says this amounts to £250bn across the range of UK DB schemes.

The survey also shows that some 79% of independent trustees think that some or all of the trustees boards they work with could benefit from taking a slower and steadier approach to reaching their objectives.

The consultancy argues this would lessen the impact of insolvency in distressed markets, as well as reduce the chance by 10 fold of UK DB deficits standing still over the next 20 years despite hundreds of billions of cash injections’ anticipated from sponsors over that time.

Calum Cooper, partner and head of trustee consulting at Hymans Robertson, said: “Recent high-profile examples of sponsor failure, most notably BHS and Tata Steel, serve as a salutary reminder to trustees of the importance of covenant risk. In the end, the only risk that really counts is covenant. If there is no scheme sponsor, members typically lose a big chunk of their lifetime savings.

“Although DB risk management is at the forefront of trustees’ minds, independent trustees worry that not enough is being done to monitor scheme covenants. We agree this is a concern. Covenant should be properly accounted for in guiding strategic investment and funding decisions of DB schemes. Currently the cost of covenant risk is a £450bn reduction in the value of benefits. It needn’t be this high.

“A trustee board’s primary responsibility should be to ensure that there is a healthy scheme sponsor to stand alongside the scheme. This can be delicate balancing act, particularly in the current economic environment, between keeping sponsors competitive and safeguarding members’ benefits.”

Commenting on the need for schemes to set clear objectives and timeframes, he added:

“Our worry is that many DB schemes lack a clear, measurable long-term objective. Without measurable goal setting, it isn’t possible to bring clarity or scale to the risks schemes are running. This means many are exposed to more liability and investment risk than is necessary. If schemes continue with a heavy foot on the accelerator, we estimate there’s a one in six chance of UK DB schemes standing still with deficits remaining at around £1 trillion in 20 years time, despite additional cash injections from sponsors expected to run to hundreds of billions.

“One way to mitigate against that is to take less risk and instead look for a steady stream of income over a longer period. This is about less pace and more certain progress. There is no rush to get to full funding. We believe, along with the majority of the trustees we surveyed, that a slow and steady approach will better serve ultimate objectives. For many, this increases benefit security and reduces risk”

Discussing how factoring in the impact of long-term sponsor default risk can improve the security of pension benefits by £250bn, he says: “We applied a fully integrated approach to the entire UK DB universe. By adopting a lower risk and higher income strategy, as well as extending the target time period and contribution commitment to reach goals, it’s possible to materially improve the security of member benefits across UK DB. While it’s not a ‘one size fits all’ approach, looking at the effects in aggregate show how a fully integrated approach, guided by factoring in the impact of long-term sponsor default risk, can improve the security of pensions by £250bn.


Hymans Robertson interviewed 36 independent trustees advising trustee boards in the UK in Q2 2016

£1.75tn = the value of the benefits promised to members following the average strategy that UK DB schemes take, and allowing for some benefits not being paid due to covenant risk;

£2.2tn = the value of benefits assuming they will definitely be paid (no covenant risk);

£1.75tn-£2.2tn = £450bn loss of value due to insolvency risk and prevailing contribution and investment strategies.

Hymans Robertson tested its fully integrated 3D approach on the UK DB universe by applying an alternative strategy. The results show that through adopting a lower risk / higher income based investment strategy, as well as extending the period over which stable deficit funding is targeted and contributions are made, it’s possible to materially improve the security of member benefits across UK DB. Under such a strategy:

The chance of success (i.e. being fully funded on a low risk basis) materially increases – being fully funded is accelerated by c7 years;
The chance of standing still over the next 20 years reduces almost 10 fold – from 1 in 6 to around 1 in 50.
Member benefit security is improved by £250bn factoring in the impact of long-term sponsor default risk.
Faced with sponsor failure, members would, on average, be £23,000 better off (than a typical strategy which involved a higher allocation to growth assets and less income based assets) than under the current UK DB strategy, equivalent to a staggering £250bn in aggregate across UK DB.

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