UK - A new study by Standard & Poor's has found UK pension schemes fail to account for risk of default by their sponsoring company when determining funding and investment policy.
The study, which covers the 346 private sector defined benefit schemes in the UK, revealed trustees are not factoring the sponsor’s financial strength into decisions about funding and investment policy, exposing scheme members to additional risks, S&P said.
However, the research, ratings and indices agency said this should change as a result of the 2004 Pensions Act, which 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 S&P.
“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.”
The study found 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%. S&P said this was concerning, in light of the Pension Protection Fund’s methodology for the risk-based levy, which will reflect both 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,” MacLachlan said.
The study also found no relationship between the investment risk within schemes and the strength of the sponsor. High equity exposure was almost as prevalent among schemes with financially weak sponsors as among those with strong sponsors, S&P said.
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