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Annual survey of Pension financial risk

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ANNUAL SURVEY OF PENSION FINANCIAL RISK

 

Special contributions to pension schemes have risen for the third year in a row as companies continue to address pension risk, according to the Annual Survey of Pension Financial Risk carried out by Mercer and the Association of Corporate Treasurers (ACT).

 

According to the report, the number of FTSE 350 companies making special contributions (i.e. over and above normal contributions) to their UK or overseas schemes increased from 58% in 2007 to 66% in 2008.  This group was driven by general pressure from trustees (19%), general risk mitigation (27%), PPF Levy (eight per cent), strengthened mortality assumptions (16%) tax (13.5%) and Pension Regulator triggers (5.6%). The number of respondents undertaking specific financings in connection with special contributions has fallen from 20% to around 11% – the same level as 2006.

 

Dave Robertson, Worldwide Partner in Mercer’s Financial Strategy Group, said: “This suggests that some sponsors believe discretionary risk mitigation and improved funding levels add value to the firm.”  

 

Another reason offered by respondents is the utilisation of strong cash flow from operations.  In one case, a special contribution related to a deal between sponsor and trustees on discretionary benefit increases.

 

The report also highlighted that 37% of schemes had strengthened their mortality assumptions but noted that even these revised levels fell short of the benchmark which the Pension Regulator recently focused on. Just over half the respondents felt that there had been a change in perception of the sponsor’s credit risk as a result of the upheaval in the market place. Perhaps more surprisingly, more than a third thought that there had not.  

 

After a significant increase in 2007, the proportion of schemes using interest and inflation hedging derivatives has remained almost unchanged. Both stand at close to 20%. The proportion using derivatives for currency protection (approximately 25%) has also changed little since 2007, while there was negligible use of credit protection derivatives and no use at all of longevity derivatives. Three-quarters of those undertaking interest rate and inflation hedges had used derivatives directly while the remainder had used indirect methods such as investing in ‘bucket funds’. In these cases, trustees took the initiative in negotiating derivatives documentation in over half of cases, despite the potential greater existing familiarity of sponsors. Notwithstanding the turmoil in credit markets, only one-third of schemes had reviewed the underlying collateral arrangements.

 

The use of contingent assets by schemes has fallen back, from 16% to 11%. Of these, 60% were using parent/other group company guarantees. Fifty-two per cent of respondents said that they were likely to consider further de-risking of their schemes in the event that the PPF modified the risk-based levy formula to take into account investment risk.

 

A large proportion of respondents (31%) believed that there was an adverse general impact of recent pension legislation on corporate activity, almost unchanged from last year. The proportion that thought there was an adverse impact on their company specifically was also little changed, at 53 percent. In the event that proposed changes to pension accounting standards (such as the introduction of a risk-free discount rate) are adopted, 60% of respondents said that they were likely to modify the funding or investment strategy of their schemes, or modify benefits. Just under half (40%) stated that these changes would make them consider buy-out more seriously.

 

“There is no single right or wrong level of risk that should be acceptable to a pension scheme and its sponsor,” concluded Robertson. “However, the contention that scheme trustees and sponsors should understand the level of risk that they are running is now broadly accepted. Once this has been done, they can make informed decisions about whether to modify that level of risk and, if so, how they should do so.”

 

 

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