Key findings of Hymans Robertson’s second annual Independent Trustee Survey:
• A quarter of independent trustees believe sponsor failure – also known as ‘covenant risk’, is one of the biggest risks to DB schemes;
• Yet 43% of independent trustees say long-term covenant risk isn’t integrated into schemes’ strategic investment and funding decisions;
• Almost a quarter say the biggest challenge facing trustee boards is incorporating covenant alongside contribution and investment strategy;
• The insolvency risk of all UK DB schemes is around £450bn worth of pension benefits[1];
• In the event of sponsor failure, members would be £23,000 better off if a fully integrated, slower and steadier approach was taken, amounting to £250bn across the UK DB universe[2] - this reflects that in the value diminishing perfect storm of growth asset falls and sponsor insolvency, there will be more cash available to pay pensions;
• 79% of independent trustees think that some or all of the trustees boards they work with could benefit from taking a slower and steadier approach to reaching their objectives;
• This would lessen the impact of insolvency in distressed markets, as well as reduce the chance by 10 fold of UK DB deficits standing still over the next 20 years despite hundreds of billions of cash injections’ anticipated from sponsors over that time.
Commenting on this, Calum Cooper, Partner and Head of Trustee Consulting at Hymans Robertson, said: “Recent high-profile examples of sponsor failure, most notably BHS and Tata Steel, serve as a salutary reminder to trustees of the importance of covenant risk. In the end, the only risk that really counts is covenant. If there is no scheme sponsor, members typically lose a big chunk of their lifetime savings.
“Although DB risk management is at the forefront of trustees’ minds, independent trustees worry that not enough is being done to monitor scheme covenants. We agree this is a concern. Covenant should be properly accounted for in guiding strategic investment and funding decisions of DB schemes. Currently the cost of covenant risk is a £450bn reduction in the value of benefits. It needn’t be this high.
“A trustee board’s primary responsibility should be to ensure that there is a healthy scheme sponsor to stand alongside the scheme. This can be delicate balancing act, particularly in the current economic environment, between keeping sponsors competitive and safeguarding members’ benefits.”
Commenting on the need for schemes to set clear objectives and timeframes, he added: “Our worry is that many DB schemes lack a clear, measurable long-term objective. Without measurable goal setting, it isn’t possible to bring clarity or scale to the risks schemes are running. This means many are exposed to more liability and investment risk than is necessary. If schemes continue with a heavy foot on the accelerator, we estimate there’s a one in six chance of UK DB schemes standing still with deficits remaining at around £1 trillion in 20 years time, despite additional cash injections from sponsors expected to run to hundreds of billions.
“One way to mitigate against that is to take less risk and instead look for a steady stream of income over a longer period. This is about less pace and more certain progress. There is no rush to get to full funding. We believe, along with the majority of the trustees we surveyed, that a slow and steady approach will better serve ultimate objectives. For many, this increases benefit security and reduces risk”
Discussing how factoring in the impact of long-term sponsor default risk can improve the security of pension benefits by £250bn, he concluded:
“We applied a fully integrated approach to the entire UK DB universe. By adopting a lower risk and higher income strategy, as well as extending the target time period and contribution commitment to reach goals, it’s possible to materially improve the security of member benefits across UK DB. While it’s not a ‘one size fits all’ approach, looking at the effects in aggregate show how a fully integrated approach, guided by factoring in the impact of long-term sponsor default risk, can improve the security of pensions by £250bn.
“Some schemes in the UK will already be clear on their purpose, their risk tolerance and the journey ahead. Even for these schemes, genuine integration of long term covenant risk will improve decision making and lead to more resilient strategies for managing DB schemes.”
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