Coverage Ratio Caps Could be Good for Pension Schemes
23 May 2012 (PLANSPONSOREurope.com) - The placing of a cap as well as a floor on the funding ratio of pension schemes can be positive for both pensioners and bondholders, according to a publication from the EDHEC-Risk Institute.
The publication entitled “Dynamic Investment Strategies for Corporate Pension Funds in the Presence of Sponsor Risk,” produced as part of the BNP Paribas Investment Partners research chair on asset-liability management and institutional investment management says imposing a cap on funding ratios as well as a floor, has a positive impact on both pensioners and bondholders, while only having a minor negative effect on equity value.
The paper recognises that pension risk is not only driven by the funding ratio of the pension fund, but also by the financial strength or weakness of the sponsor company. It analyses the benefits that arise from a variety of dynamic liability-driven investing strategies designed to maximise stakeholders’ welfare within an integrated asset-liability management context. The publication finds that implementing risk-controlled strategies aimed at insuring a minimum funding ratio level allows shareholders to gain access to the upside performance of risky assets, while ensuring that pensioners will not be overly hurt by the induced increase in risk.
Strategies that aim to control sponsor risk by providing insurance mitigating the effects of an underfunded pension plan and a weak sponsor company are found under most circumstances to increase pensioners’ and bondholders’ welfare compared to basic CPPI strategies adapted to the asset-liability management context.