Pensions Conference 2011: Review of Workshop D2: Schrodinger's pension fund

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Pension scheme sponsors live or die, there is no in-between, so why do we assess covenant on a sliding scale that is certain to be wrong?

Mark argues that under scheme specific funding the technical provisions are likely to either be too prudent (if the sponsor outlives the scheme) or too weak (if the sponsor fails and full solvency is needed).

This leads to the suggestion that there are only two sensible assumptions for sponsor covenant:

1. Assume insolvency within the scheme’s lifetime
   Must fund to solvency (not attractive for sponsors)
2. Assume sponsor never fails
   Weaker funding may be appropriate, possibly some form of “best estimate”

Both options are appropriate if the covenant assumption is borne out, but unpalatable otherwise.

Mark suggested one way of ensuring a satisfactory outcome regardless of the sponsor’s solvency:

• Best estimate funding plus
• Some form of insolvency insurance to plug the gap to buyout (possibly in the form of a revamped PPF)

This pooling of covenant risk would lead to efficiency savings since the overall level of funding required across all schemes would fall relative to scheme specific funding requirements.

There was plenty of debate about the feasibility of such a system, in particular Mark’s assertions that:

• “best estimate” funding should be based on smoothed asset values
• The revamped PPF should be more willing to reduce benefits if it has insufficient assets

Overall a good idea for a possible funding framework, but the discussion got bogged down in practical considerations and discussions of smoothed asset values.