UK - Scheme trustees need to include the views and position of the sponsoring employer when considering strategies to deal with the impact of the current financial turbulence, consultants have warned.

Problems in the financial markets mean the surpluses in pension schemes have reported over the last 12 months may have been wiped out, but Mercer has suggested the increase in liabilities may not be as high as expected as the UK government's bailout of the banking industry will increase the supply of gilts, resulting in higher yields.

The consulting firm admitted the new pension deficits will damage companies' balance sheet positions in the short-term, which in turn could affect the employer's ability to pay deficit contributions, though it argued the potential increase in bond yields from the increased supply could actually reduce the cost of de-risking measures.

Deborah Cooper, head of the retirement resource group at Mercer, said: "Corporate bond yields are also higher than they have been for a number of years - even after allowing for increased insolvency risk. As a result, balance sheet liabilities have not fallen as steeply as markets suggest. The cost of taking steps to mitigate future risk exposure could also become more reasonable since these are often tied to bond yields."

Mercer revealed the most common action taken by employers to reduce risk is to make large additional contributions to the scheme, but Cooper warned, "if the trustees choose to invest these in equities, this may not be an effective risk management strategy".

The firm has instead suggested trustees should consider alternative investment strategies that are "more likely to protect the company from the risk that new deficits will emerge in the future", such as allow employers to make additional contributions on the condition trustees make specific investment decisions.

Cooper argued although the main aim of trustees is to secure members' benefits, "they must also consider the employer's position", and suggested if they take the view the company has a "reasonably strong covenant, they can afford to be more considerate towards its funding and financing demands".

Marcus Whitehead, partner at actuarial consultants Barnett Waddingham, pointed out trustees need to consider "a combination of increased contributions and more aggressive investment strategies" where schemes' investments have fallen and created a new funding gap.

"Pension funding strategies are implemented with a long-term perspective, however if any factors of the strategy fundamentally change such as the scheme's funding level or long term future expectations of investment returns then a review should be considered."

"For example a higher funding level may afford greater investment freedom, however if funding levels deteriorate trustees may be caught between a rock and a hard place in wanting to seek greater investment returns in future to make up a funding gap, just when they know the sponsoring employer can least afford the risk of further falls in value from riskier assets," he added.

PricewaterhouseCoopers (PwC) also claimed the current market conditions should encourage employers to run their defined benefit (DB) pension schemes "like business subsidiaries".

In a three-point plan PwC claimed employers should:

Allocate resources to the management of pension risk as if it was a separate business, including quicker implementation of decisions, Relate the financial risks of the pension scheme to the overall business, including the impact on the balance sheet and credit rating, Take a more active approach to scheme investments, with the potential for a change in legislation to require the formal agreement of the employer in investment strategy.

Raj Mody, partner at PwC, said: "Looking at a scheme's financial or risk position in isolation is not meaningful. If a scheme's funding ratio drops by 20% but the company could write a cheque for the difference, it is not necessarily a matter for great concern. But if a 5% drop in scheme funding ratio would wipe out the company's annual profitability, that matters.

"Funding and investment strategy are two sides of the same coin. While setting investment strategy remains the pension scheme trustees' legal responsibility, more active company involvement and intervention would help ensure strategies are appropriate to that business," said Mody.

Whitehead added the most important consideration for occupational schemes is usually the employee covenant, so trustees need to ask whether the employer is "able and willing to make additional contributions if risks undertaken in investment strategies turn out adversely. If the answer is no, an alternative strategy should be adopted".

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com