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The Actuary The magazine of the Institute & Faculty of Actuaries

Insuring deficits

Hewitt has been urging companies and trustees to consider a wider range of solutions to manage their current pension plan deficits. With limited relief coming from stockmarket returns, and cash contributions able to plug only part of the hole, innovative techniques such as contingent payments or external contracts also need to be considered.

One idea which Hewitt has been discussing with some companies and trustees is the use of credit default swaps. These allow a corporate bondholder to buy protection against the risk of the company defaulting on its bond and not repaying the debt. In return for an agreed level of premiums, the financial institution involved undertakes to pay the difference between what the defaulted bond is worth and its nominal value. This instrument is common in the financial markets, but its relevance for pension funds does not seem to have been fully tapped.

Pension plan trustees will be keen to explore ways of improving the security of members’ benefits in a period for pension fund deficits which Hewitt has described as ‘stagnant’. Hewitt has estimated that the combined deficit for FTSE100 plans measured on the company accounting standard FRS17 remains around £60bn. Solely paying extra contributions to meet FRS17 deficits would for over a quarter of companies represent more than a full year’s profits, and for more than one in ten companies it would require over five years’ profits. Even then, an additional £100bn would be required over and above the FRS17 deficit before plans had enough money to meet the buyout cost of their pension commitments.

Raj Mody, pensions strategy consultant at Hewitt said: ‘It makes a lot of sense for large funds in particular to at least look into the opportunities provided by instruments such as credit default swaps. This isn’t about “betting against the company” behind closed doors – companies and trustees can work together openly and constructively on this. It may seem unsavoury to plan in such a calculated way for dealing with the possibility of a sponsoring company going bust – but nothing is certain nowadays. I suspect most pension fund members would prefer a proper airing for all ideas which could help improve their benefit security.’