Trustees, employers guarding against insolvency risk

The consultant’s annual SFO Valuations Survey of 257 pension plans finds that employers have agreed to stronger technical provisions for funding, while trustees are seeking assets outside the scheme and longer recovery plans to cover any shortfalls.

The survey results also highlight an increase in the use of contingent assets as trustees attempt to balance plan funding requirements with the ability of organizations to contribute. Both actions, explains Mercer, come in response to a higher risk of corporate insolvency.

Employer covenant
Sixty-six percent of plans now have a regular employer covenant monitoring regime in place, according to the survey. The covenant outlines a company’s willingness and ability to contribute to the pension plan. Twenty-seven percent of plans now review the covenant on an annual basis, and 26% do so more frequently. This is up from 2008, when 23% of plans reviewed the covenant on an annual basis and 17% reviewed it more frequently.

More than one-quarter of plan trustees in the 2009 survey commissioned an independent covenant review, while 45% of plans now obtain additional data beyond what is publicly available, or seek employer presentations on the covenant. Only 2% intend to carry out no covenant analysis at all.

“Recent company insolvencies have given the covenant a much higher profile,” says Alison Pollock, a principal at Mercer and the author of the survey report. “Both trustees and employers involved with the schemes in the survey commented on how the valuation process had helped them understand the importance of the covenant to the scheme’s funding position.”

Contingent assets
Mercer explains that there has also been an increase in the use of contingent assets and other forms of security required by trustees to provide explicit reassurance in the employer covenant. In 2007 and 2008 only 14% and 17%, respectively, of respondents stated that they were used. This increased to 24% in the 2009 survey.

The most prevalent form of security is the parent company guarantee, which is used in 88% of these cases. Letters of credit, escrow accounts, contribution insurance, and charges over property and other assets are also used.

Investment strategy
The typical investment strategy is reviewed every three years by 40% of plans—which is the legal minimum and is unchanged from 2008. Forty-six percent of plans stated that they did not follow a periodic review of investment strategy but that reviews tended to be event-driven. Mercer expects that most plans would review investment strategy following certain events in addition to their regular triennial reviews.

Funding targets
In setting funding targets, 63% of plans now report that they have reached agreement on the basis of assessing their technical provisions. Half of the respondents are targeting a funding level equivalent to between 76% and 91% of the funds required for a buyout with an insurer, with the average target funding level at 83%—up from 69% in 2008.

The impact of the recession is clear, Mercer says, with 45% of plans expecting to go beyond the statutory requirement to produce annual actuarial reports, and request more frequent or detailed funding updates. Thirty-three percent intend to report quarterly on the plan’s funding position, with a further 10% reporting bi-annually and 2% on a monthly basis.

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