Hymans Robertson’s FTSE 350 DB Report this year looks at how widespread the issue of insolvency could become and shows that when corporate default probabilities of less than 50% are considered, the position becomes even more stark. The research shows, for example, that almost half of schemes (43%) with rated sponsors have a 33% chance of corporate default before they reach buy-out.
Commenting on what schemes in this position should do, Alistair Russell-Smith, Head of Corporate DB, Hymans Robertson says: “DB schemes with a significant risk of corporate default ahead of reaching buy-out should be looking at ways to mitigate the risk of sponsor default forcing early wind-up and members’ benefits facing haircuts. Providing security to the scheme can help by improving scheme recovery on insolvency. But it does not prevent the insolvency event triggering wind-up in the first place. Schemes should look at all options, and newly emerging solutions such as capital backed solutions and superfunds can protect against this risk by providing a financial covenant to fall back on in the event of sponsor insolvency.”
While the analysis in the Report relates to data from the year end 2019, Hymans Robertson undertook additional research this year to put the findings in the context of the Covid 19 backdrop. It looked at the rated schemes in the FTSE 350 (93 schemes) and found that most of them are well positioned to absorb COVID-19 stresses. Nearly three quarters of these schemes (71%) have both an investment grade sponsor and a DB recovery plan of under seven years. However, one in ten (9%), have a sub-investment grade sponsor and a DB recovery plan of seven years or longer which puts them at risk. They will have little capacity to absorb COVID-19 stresses and will ultimately struggle.
Commenting on how FTSE 350 schemes are coping with the pressure of 2020 and how they need to prepare for the future, Alistair Russell-Smith, Head of Corporate DB, Hymans Robertson, says: “In an extraordinary year where the COVID-19 pandemic and the economic measures taken to try and contain it have led to an extremely challenging environment for schemes and their sponsors, it is encouraging to see that 71% of schemes in the FTSE350 with rated sponsors are well placed to absorb the COVID-19 stresses in the shorter term. Their pension scheme funding has generally held up with low levels of equity exposure and hedging of much of the yield and inflation risk. However, 9% of schemes with rated sponsors, and undoubtedly other schemes with unrated sponsors, are in a far more difficult position with sponsor affordability constrained and little ability to extend recovery plans any further.
“COVID-19 has undoubtedly focused minds on covenant risk, and our longer term analysis of schemes with rated sponsors shows just how real this is, with nearly a quarter of schemes facing a 50% chance of corporate default before they reach buy-out, and nearly a half of schemes facing a 33% chance of corporate default before they reach buy-out. Long term funding plans are predicated on having an ongoing sponsor. They conveniently ignore the point that insolvency forces early annuitisation and in many cases members’ benefits will be trimmed. Schemes in this situation need to manage this covenant risk. I expect to see more security being pledged to schemes, and also the increasing development of solutions to manage this risk, such as capital backed solutions and superfunds. These can provide a financial covenant to fall back on in the event of sponsor insolvency.
“Interestingly, sponsors for nearly half (48%) of the schemes that have a 33% chance of corporate default before reaching buy-out, could fund a superfund transaction now with less than six months earnings. This should be seriously considered if the funding is available, as a way to mitigate long term covenant risk.”
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