Pension schemes backed by a weak employer are adopting more aggressive investment strategiesand effectively doubling the risk of collapse, warns Lane Clark & Peacock.
In the latest figures from its ‘Prudence Index’ which launched in November, the firm of consulting actuaries reveals there is a wide variation in the way defined benefit (DB) scheme trustees and employers are interpreting the concept of ‘prudence’ under the new scheme specific funding regime.
LCP says the index provides trustees and employers with an indicator of the prudence of their scheme’s funding and investment strategy compared to other pension schemes, based on the financial strength of the sponsoring employer.
But findings from the study, consisting of more than 150 schemes with an average fund size of £300m, reveal schemes backed by the weakest sponsoring employers are adopting more aggressive investment strategies by holding a large proportion of their assets in equities.
As a result, LCP warns the trustees of these schemes need to look carefully at optimising their funding and investment strategy, as at the moment they are simultaneously exposing the fund and members to high levels of both sponsor and investment risk.
However, the Index also suggests although schemes run by companies in the manufacturing sector are often the most mature, they do not appear to be reducing their investment risk as appropriate, which LCP is “particularly significant given the employers backing these schemes are typically at the weaker end of the spectrum”.
Research also shows over half of DB schemes have not yet carried out an independent assessment of the employer’s covenant despite strong encouragement from the Pensions Regulator.
In its code of practice on funding defined benefits, the Regulator warns it is “essential for the trustees to form an objective assessment of the employer's financial position and prospects as well as his willingness to continue to fund the scheme's benefits [the covenant]. This will inform decisions on both the technical provisions and any recovery plan needed”.
LCP, meanwhile, points out the research suggests larger schemes, and schemes run by larger companies, are generally better funded than smaller schemes or schemes run by smaller companies.
James Hughes, partner at LCP, says the industry is still in the early days of the new scheme specific funding regime and it is clear many trustees are still to get to grips with the new requirements.
But he adds: “As more and more schemes go through their first new-style valuation, there should be an increasing emphasis on investment risk in the context of the employer’s financial strength. The Prudence Index will continue to capture these trends over time and help trustees get a feel for what others are doing.”
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