DB members with weak employers face 50% chance of benefits cut
Defined benefit (DB) scheme members with weaker employers face a 50% chance of a cut in benefits due to sponsor insolvency, according to Hymans Robertson.
The consultant warned covenant risk "is far higher than many DB schemes realise", noting members with B rated sponsors face the risk of a cut in benefits due to their sponsoring employer going insolvent before the scheme is fully funded on a buy-out basis.
The firm's analysis revealed that, based on the average buyout funding level of 70% in the UK at the moment, even those corporates with better credit ratings did not fare well.
It found that, for a scheme with a BB rated sponsor, there is a 33% chance of a cut to members' benefits; for a BBB rated company there is still a 15% chance of a reduction in benefits.
Head of corporate DB Alistair Russell-Smith said: "In reality the position is likely to be even worse than this because schemes with weaker sponsors unfortunately tend to be more poorly funded. The Pensions Regulator'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."
He also noted a move to a commercial consolidator may help schemes mitigate this risk.
"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."
Russell-Smith added: "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."
The firm urged trustees to "fully understand and consider the advantages of commercial consolidators" to mitigate against the risk of a cut to members' benefits.
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