UK – Hewitt Associates says it has discussed credit default swaps with some companies and trustees as a way to help manage pension deficits.
“One idea which Hewitt has been discussing with some companies and trustees is the use of a financial contract called a credit default swap,” the firm said, adding that the contract’s relevance has not been fully tapped in the pension fund market.
It said: “It allows a corporate bondholder to buy protection against the risk of the company defaulting on its bond and not repaying the debt.
“In return for an agreed level of premiums, the financial institution involved undertakes to pay the difference between what the defaulted bond is worth and its nominal value.”
“In order to give trustees comfort in the short term while a sponsor waits for a long-term investment strategy or cash funding plan to bear fruit, companies and trustees may want to look at innovative solutions to improve the security of their members’ benefits,” said consultant Lynda Whitney.
“There are a number of solutions available and different schemes will need different approaches, according to their particular circumstances and the advice they receive - but some companies might encourage their plan trustees to buy credit default swaps.
She said the instrument “are a way of filling the gap between bond worth and bond value in the event of default; but trustees and companies may find them a useful complement in their funding strategies".
Hewitt’s pensions strategy consultant Raj Mody added: “It makes a lot of sense for large funds in particular to at least look into the opportunities provided by instruments such as credit default swaps.
“This isn't about "betting against the company" behind closed doors - companies and trustees can work together openly and constructively on this. It may seem unsavoury to plan in such a calculated way for dealing with the possibility of a sponsoring company going bust - but nothing is certain nowadays.
“I suspect most pension fund members would prefer a proper airing for all ideas which could help improve their benefit security."
The British Bankers Association has estimated the credit derivatives market is worth around $4.8trn.