22% of FTSE 350 DB schemes face 50% chance of sponsor insolvency before buyout

Almost a quarter (22 per cent) of FTSE 350 defined benefit (DB) schemes with rated sponsors face a 50 per cent chance of corporate insolvency before they reach buyout, according to analysis from Hymans Robertson.

The analysis, which was part of the company’s annual FTSE 350 DB Report, added that almost half of schemes (43 per cent) with rated sponsors had a 33 per cent chance of corporate default before they reach buyout.

Hymans said the findings would act as a caution to schemes and stated that they should be putting in measures to mitigate the risk of a sponsor insolvency triggering early wind-up, forcing annuitisation and potentially a haircut to members’ benefits.

Hymans Robertson head of corporate DB, Alistair Russell-Smith, said: “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.”

The report also examined the impact of Covid-19 and found that most of the 93 FTSE 350 DB schemes were “well positioned to absorb Covid-19 stresses”.

Nearly three-quarters (71 per cent) had both an investment grade sponsor and a DB recovery plan of under seven years, though 9 per cent were “at risk” and would have “little capacity to absorb Covid-19 stresses” as they had both a sub-investment grade sponsor and a DB recovery plan of seven years or longer which puts them at risk.

Russell-Smith continued: “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 per cent chance of corporate default before they reach buyout, and nearly a half of schemes facing a 33 per cent chance of corporate default before they reach buyout.

“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.”

He added that he expected 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”, pointing out that these measures could “provide a financial covenant to fall back on in the event of sponsor insolvency”.

Russell-Smith concluded: “Interestingly, sponsors for nearly half (48 per cent) of the schemes that have a 33 per cent chance of corporate default before reaching buyout, 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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