Yesterday CF reported the news that Uniq, the UK food company, had been strong armed by its pension trustees into backing out of bidding talks over fears that a deal might have harmful consequences for the pension scheme. But a new study shows that more often UK pension schemes are less assertive, routinely failing to take account of the risk of default by their sponsoring company when determining funding and investment policy. The Standard & Poor’s study covers the 346 largest private sector defined benefit schemes in the UK, and examines the funding and investment profile of schemes relative to Standard & Poor’s credit assessment of their sponsors.
It shows that trustees appear not to have factored the sponsor’s financial strength into decisions about funding and investment policy, thereby exposing scheme members to additional risks. This practice should change significantly as a result of the 2004 Pensions Act, which explicitly requires trustees to take account of the strength of the sponsor’s covenant in setting funding principles.
“Trustees have a long way to go to understand the significance of the sponsor’s credit strength upon their decision taking,” said Jim MacLachlan, European head of pension services at Standard & Poor’s. “The new Act in the UK requires trustees to adapt funding and investment policies according to the financial strength of sponsors, but our study shows such a concept is in its infancy. Schemes face major challenges living up to these principles.”
Among the findings of Standard & Poor’s study are that:
· There is no correlation between the scale of scheme deficits and sponsor credit strength. The median FRS 17 deficit for schemes sponsored by entities rated AA is 20%, while for those in the B category – which carry a much higher risk of default – it is 21%. This is a cause for concern, particularly in light of the Pension Protection Fund’s methodology for the risk-based levy, which will reflect both these factors. “Trustees with weaker sponsors should consider restoring funding levels relatively quickly, given the significant potential for the sponsor to default before full funding of the scheme can be achieved,” Mr MacLachlan said.
· Similarly, there appears to be no relationship between the investment risk within schemes and the strength of the sponsor. High equity exposure is almost as prevalent among schemes with financially weak sponsors as among those that have strong sponsors. The median scheme sponsored by entities rated AA has 68% of its portfolio in equities, compared with 64% for those with sponsors rated B. “A high equity exposure in the pension scheme, compared with bonds, compounds the risk to the security of members’ benefits,” Mr MacLachlan noted.
· Pension liabilities are a significant proportion (18%) of the net assets of scheme sponsors, and in many cases substantially exceed the resources of the company supporting them. Consequently, the sponsor’s own financial strength may well depend on the effective management of the risks within the scheme. In aggregate, FRS 17 scheme deficits represent 13% of the net worth of sponsors.
