DB Scheme members with weaker employers have a 50% chance of a cut in benefits due to sponsor insolvency
16 Sep 2020
Covenant risk is far higher than many DB schemes realise, and members with B rated sponsors face a whopping 50% chance of a cut in benefits due to their sponsoring employer going insolvent before the pension scheme is fully funded on a buy-out basis, according to analysis by Hymans Robertson. The leading pensions and financial services consultancy is therefore urging Trustees to fully understand and consider the advantages of commercial consolidators to mitigate against this risk.
Based on the average buy-out funding level of 70% in the UK at the moment, Hymans Robertson calculated that even those corporates with better credit ratings did not fare well. For a scheme with a BB rated sponsor there is a 33% chance of a haircut to members’ benefits while for a BBB rated company – the most common credit rating in the FTSE 350 - there is still a 15% chance of a reduction in benefits. This risk of a ‘haircut’ continues even when the scheme is no longer reliant on sponsor contributions because an insolvency event triggers a wind-up of the scheme, forcing annuity purchase.
Commenting on the analysis Alistair Russell-Smith, Head of Corporate DB, Hymans Robertson says:
“In reality the position is likely to be even worse than this because schemes with weaker sponsors unfortunately tend to be more poorly funded. TPR’s 2020 funding analysis shows that the average buy-out funding level for schemes with weak or tending to weak covenants is only 62%. The likelihood of employer default and a haircut to benefits is therefore very real for the 32% of UK DB members in these schemes.”
Continuing to explain how a move to a commercial consolidator can help schemes mitigate this risk, Alistair continues:
“Consolidators mitigate this risk because scheme wind-up is no longer triggered on the insolvency of the ceding employer, meaning members continue to receive full benefits. For example, if a scheme moved to a commercial consolidator there is only a haircut to members’ benefits if the consolidator’s wind-up trigger is reached. For Clara-Pensions, we have calculated this risk is less than 3%. The risk is so much lower because of the improved funding and lower risk investment strategy, and because wind-up is no longer triggered on employer insolvency.
“Trustees in these schemes should seriously consider transferring to a consolidator if the funding is available. It improves member security when taking full account of the exposure to covenant risk. In some cases this may even be without the need for a cash injection from the ceding employer.”
For those Trustees and schemes wanting to know more about Consolidators, Hymans Robertson is publishing a series of reports looking at each one. The latest, A Closer look at Clara-Pensions can be found here. Others in the series include A Closer look at Citrus DB Master Trust and the next to be published will be A Closer Look at The Pension SuperFund.