Defined benefit (DB) scheme members with B rated sponsoring employers face a “whopping” 50 per cent chance of a cut in benefits due to their sponsoring employer going insolvent before the pension scheme is fully funded on a buyout basis, according to analysis by Hymans Robertson.

The firm stated that, based on the average buyout funding level of 70 per cent in the UK, even those corporates with better credit ratings “did no fare well”, with members in a scheme with a BB rated sponsor facing a 33 per cent chance of a cut to their benefits.

For a credit rating of BBB, the most common credit rating in the FTSE 350, there was still a 15 per cent chance of a reduction in benefits, according to the analysis.

Hymans Robertson also emphasised that the risk of a cut continues even when the scheme is no longer reliant on sponsor contributions because an insolvency event triggers a wind-up of the scheme, forcing annuity purchase.

Commenting on the analysis, Hymans Robertson head of corporate DB, Alistair Russell-Smith, stated: “In reality the position is likely to be even worse than this because schemes with weaker sponsors unfortunately tend to be more poorly funded.

“TPR’s 2020 funding analysis shows that the average buyout funding level for schemes with weak or tending to weak covenants is only 62 per cent.

“The likelihood of employer default and a haircut to benefits is therefore very real for the 32 per cent of UK DB members in these schemes.”

Considering this, the firm has now called on trustees to fully understand and consider the advantages of commercial consolidators to mitigate this risk.

Russell-Smith explained that consolidators mitigate this risk because scheme wind-up is no longer triggered on the insolvency of the ceding employer, meaning members continue to receive full benefits.

He explained, for instance, that if a scheme moved to a commercial consolidator there is only a ‘haircut’ to members’ benefits if the consolidator’s wind-up trigger is reached, calculating this risk to be less than 3 per cent for Clara-Pensions, for example.

He continued: “The risk is so much lower because of the improved funding and lower risk investment strategy, and because wind-up is no longer triggered on employer insolvency.

“Trustees in these schemes should seriously consider transferring to a consolidator if the funding is available. It improves member security when taking full account of the exposure to covenant risk.

“In some cases this may even be without the need for a cash injection from the ceding employer.”

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