Question

Describe the risks faced by sponsors of defined benefit schemes and discuss what the government could do to help them control these risks.

Answer 1

Liquidity risk:the risk that an entity, although balance sheet-solvent, cannot maintain or generate sufficient cash resources to meet its payment obligations in full as they fall due, or can only do so at materially disadvantageous terms”, see FSA (2007). Some view a part of the spread payable on non-default free bonds as relating to their liquidity characteristics, again highlighting the difficulties in rigidly demarcating between different types of risk. Liquidity risk might not appear to be particularly relevant to pension schemes. Many commentators if anything argue that pension schemes should think about being providers of liquidity to others, like banks, who may be more exposed to liquidity risk. By doing so they might be able to gain a premium for ‘renting out’ their balance sheet to others.
Market risk:Market risk is generally understood to involve the risk of loss due to adverse market movements. What is important here is not primarily the risk of a fall in the capital value of the scheme’s investments in isolation. Instead, the focus would normally be on the impact that adverse market movements might have on the entity’s asset/liability position.
This might also be called asset-liability risk. Market movements in this context would typically include movements in equity values and in interest rates and inflation expectations.
 Credit risk, including sponsor covenant risk:Credit risk is the risk that the creditworthiness of a name or counterparty to which an entity is exposed declines, causing the entity loss. At one extreme would be actual default of the counterparty. A subtlety here is whether credit risk should be deemed to include only default risk (i.e. some intrinsic assessment now of the risk that the counterparty or issuer might default in the future); or
also be deemed to include ratings migration risk and/or spread risk (or other equivalent risks that also take into account uncertainty in future default experience).
Regulatory risk:Regulatory risk might be viewed as a subset of legal (or political) risk or as a separate, although related, risk category in its own right. It relates to the risk that the regulatory framework within which the entity is operating might change adversely. This could involve a change in either the general regulatory framework applicable to the entity or in its own relationship with its specific regulator/supervisor (or both). For example,
there might be a change in general regulations affecting pension scheme transfer values (or, specifically, how the regulator thinks these regulations should be interpreted by the scheme in question).
Reputational risk:Most of the above risks can combine with reputational risk. For example, a firm may face political risk because it operates in areas of the world with unsavourypolitical frameworks. An inappropriate business approach to such matters might lead to customers blacklisting the firm, with an adverse impact on the firm’s revenue base or profitability
Employment/Human Resources risk:The social aspect of pension provision introduces someadditional risks. For example, historically, pension schemes have mitigated HR risk. They have helped with recruitment and retention of employees and also provided a headcountrelease valve in recessionary times if the business was not prospering. Employers were
able to offer enhanced early retirement benefits to those who were being made redundant,if they were at an age when early retirement was feasible.
References 
Ring, P. J. (2012). Trust: a challenge for private pension policy. Journal of Comparative Social Welfare, 28(2), 119-128.

Antolín, P., & Stewart, F. (2009). Private pensions and policy responses to the financial and economic crisis.

Liquidity risk, market risk, credit risk, including sponsor covenant risk,  regulatory risk, reputational risk,  employment/Human Resources risk,  legal risk,  political risk,  project risk and group risk