UK - Hewitt Associates has urged trustees and companies to consider credit default swaps (CDS) as a means to manage their current pension plan deficits.
The consultancy said limited relief from stock market returns and cash contributions able to plug only part of the hole; innovative techniques such as contingent payments or external contracts should be explored.
A CDS allows a corporate bondholder to buy protection against the risk of the company defaulting on its bond and not repaying the debt. In return for an agreed level of premiums, the financial institution involved undertakes to pay the difference between what the defaulted bond is worth and its nominal value.
Hewitt said while the instrument is common in the financial markets, its relevance to pension funds did not seem to have been “fully tapped”.
Consultant Lynda Whitney said: “There are a number of solutions available and different schemes will need different approaches, according to their particular circumstances and the advice they receive – but some companies might encourage their plan trustees to buy credit default swaps.
“These instruments should not be considered a replacement for insurance policies, because – unlike an insurance policy, where you pay certain premiums for a certain level of cover – credit default swaps are a way of filling the gap between bond worth and bond value in the event of default; but trustees and companies may find them a useful complement in their funding strategies.”
Raj Mody, pensions strategy consultant, added: “It makes a lot of sense for large funds in particular to at least look into the opportunities provided by instruments such as credit default swaps. This isn’t about “betting against the company” behind closed doors – companies and trustees can work together openly and constructively on this. It may seem unsavoury to plan in such a calculated way for dealing with the possibility of a sponsoring company going bust – but nothing is certain nowadays.”
This week's top stories included Cardano announcing plans to acquire Now Pensions from a Dutch pension fund later this year.
Royal Bank of Scotland (RBS) faces a £102m impact on liabilities as a result of equalising guaranteed minimum pensions (GMPs), according to its annual results.
Malcolm Mclean says getting the channels of communication right and engaging more openly is a good starting point