A new study entitled “The Elephant in the Room: Accounting and Sponsor Risks in Corporate Pension Plans,” drawn from the AXA Investment Managers “Regulation and Institutional Investment” research chair at EDHEC-Risk Institute, surveys how pension funds and sponsors manage the main risks they face and how institutional constraints—accounting and prudential regulations, the organisation of the relationship between the pension fund and its sponsor, and social laws—influence the investment strategy of sponsors and pension funds.
The survey elicited 100 responses. The assets under management (AUM) of the pension funds with which the respondents are associated amount to more than €730 billion. Sponsoring companies have a total balance sheet size of more than €5.5 trillion.
Among the main results of the survey:
- Sponsors of pension funds are concerned primarily about the economic risk of facing higher than expected pension costs—95% mention this risk. 93% of respondents mention accounting risk, the reported cost of pensions in the sponsors’ books as opposed to the true cost of providing pensions, and the balance sheet volatility it causes. Reputation risk comes third.
- For pension funds (especially for traditional defined-benefit ones), the main risk is sponsor default and reduced pensions or curtailment. Respondents rank sponsor risk as the greatest risk in pension funds (77% mention this risk, usually with the greatest intensity).
- However, 84% of pension funds do not manage sponsor risk. The primary reason in Europe for not managing sponsor risk is the presence of pension fund insurance (46% of respondents). In “other reasons”, 15% of respondents argue that the pension fund’s sponsor is a government or quasi-government entity, and 4% of respondents have purchased protection from sponsor insolvency.
- The survey finds that the institutional setup has a great influence on the risk management practices of sponsors and pension funds and that it contributes to inefficiencies in the management of risks.
- Last, respondents fear regulatory changes because such changes cannot be hedged. In the debate on IAS 19 changes, respondents favour transparency: 49% (54% in the UK) think that reporting the market value of the pension liability in the balance sheet, even if it leads to increased volatility in the balance sheet, leads to improvements, as it provides “better incentives to manage risk" or "adds necessary transparency.” But the main worry of sponsors is those changes that lead to an increase in the cost of providing pensions. The possible use of a risk-free discount rate to discount liabilities would imply an automatic increase in the pension liability and in reported shortfalls.
A copy of the study can be downloaded via the following link:
This research was produced as part of the “Regulation and Institutional Investment” research chair at EDHEC-Risk Institute supported by AXA Investment Managers.