UK – Trustees must respond to the threat of corporate insolvency and should consider their exposure to counterparty risk, Mercer warns.

The consultant said FTSE350 pension schemes were “heavily exposed” to market fluctuations and faced an increasing risk of corporate insolvency and volatile funding levels.

Its report highlighted the growing threat of counterparty risk and corporate insolvency as fall out from the economic crisis, and called for greater diligence by trustees and companies.

Mercer principal Deborah Cooper said: “This counterparty risk originates from schemes’ reliance on the ability of external entities to meet their obligations and relates to positions in investments such as swap contracts.

“The demise of some of the world’s largest banks shows that, while risk can be mitigated and transferred, eliminating it altogether is nearly impossible.”

The report also noted that there remained an investment bias towards return-seeking assets, so exposure to equity market volatility still accounts for a substantial portion of total risk.

The headline equity proportion was estimated at 47% for FTSE350 companies. However, 25% of FTSE350 companies continue to hold over 60% of their pension scheme assets in equities.

Cooper added: “Schemes have reduced their exposure to volatile ‘return-seeking’ assets in recent years, with a marked increase in bond holdings, but often for good reasons they remain considerably exposed to equity markets.

“Those schemes most exposed to equity markets continue to present the highest risk to their sponsoring employer – especially with the uncertainty in global financial markets.”

However, despite current market volatility, using standard accounting measures, defined benefit (DB) funding levels have not been hit as hard as drastic stock market falls might have expected.

When measured using IAS19, the aggregate FTSE350 pension scheme had a surplus of £1bn (US$1.75bn) as at 30 September this year.

Mercer's concerns echoed the sentiment of The Pensions Regulator head of scheme-specific funding Ian Cordwell, who earlier this month warned trustees it was likely scheme sponsors' assets would have been depleted by the credit crisis.

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