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Some of the Pension Schemes most reliant on their sponsors are taking the greatest risks
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Pension Regulator’s guidance not being reflected in practice
As well as examining the extent of the investment risk that sits within the FTSE 350, the study assesses how the investment risk supported by FTSE 350 members is distributed across this population and how it varies according to level of dependence a pension scheme places on the employer support that underwrites it (“Employer Dependence”) and the strength of that employer support (“Employer Covenant”). The findings show that Pension Schemes that have the highest Employer Dependence relative to their Employer Covenant have among the highest allocations of riskier Return Seeking Assets indicating that schemes may be trying to invest their way to full funding. In doing this they may be taking too much Investment Risk relative to the Employer Covenant rather than seeking increased contributions from their employers.
The key findings of the research are:
The FTSE 350 carries considerable financial risk in DB Pension Schemes
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The FTSE 350 members, 225 of whom have Pension Schemes, disclose an aggregate accounting deficit of approximately £72bn as at their most recent accounting dates.
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Lincoln Pensions estimates that they are also underwriting approaching £100bn of investment risk (being the aggregate Value-at-Risk of Pension Schemes of constituent companies in the FTSE 350) in their Pension Schemes.
This investment risk is supported by the “Employer Covenant” of the FTSE 350 members
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Lincoln Pensions believes Employer Dependence (being the aggregate of the funding deficit and the Value-at-Risk from time to time) is a key measure that Pension Schemes should assess when considering the financial capacity of the employer to underwrite the Pension Scheme (the Employer Covenant).
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The stronger the Employer Covenant is, the greater the capacity to support investment risk and higher Employer Dependence.
The Pension Schemes most reliant on their supporting companies are taking the greatest risks
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Across the FTSE350 the average share of a Pension Scheme’s assets invested in riskier Return Seeking Assets was a little over 44%.
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Lincoln Pensions found that the Pension Schemes that have the highest Employer Dependence relative to their Employer Covenant have among the highest allocations of riskier Return Seeking Assets.
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It appears such Pension Schemes may be trying to invest their way to full funding (and may be taking too much Investment Risk relative to the Employer Covenant) rather than increasing contributions from their employers.
Little evidence that the Pension Regulator’s guidance is being reflected in practice
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Contrary to the expectation of the Pension Regulator (“TPR”) in its Code published in July 2014, we have found limited evidence that the investment risk profile of Pension Schemes is being set in the context of the Employer Covenant standing behind it.
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This may reflect certain Pension Schemes supporting “sustainable growth” of the employer by leaving money with their sponsor rather than requiring funding for the Pension Scheme.
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But it is building up risk in the DB system by placing greater reliance on the employer to stand behind, sometimes disproportionate, investment risk.
Commenting on the research Matthew Harrison, Managing Director of Lincoln Pensions said:
“Building a clear picture of the risk and volatility in a scheme’s investment profile should be a key consideration for both pension trustees and employers as they assess its overall risk profile of the Pension Scheme and its reliance on employer support.
“What is perhaps surprising however, is the share of Return Seeking Assets does not decrease as the schemes get larger in the context of their employer despite clear guidelines in TPR’s code of practice on Funding Defined Benefits.
“We hope that this analysis may lead to scheme funding discussions which move away from the historic focus on funding today’s deficit, towards a greater understanding of investment risk volatility and a balance in the scheme’s overall risk profile.”
To download the full report click on the document below
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