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Pressures on DB scheme affordability and the options available to trustees and sponsors

 

What I am about to say, will come as no surprise to the vast majority of you reading this newsletter. Employers, in the main, are currently faced with increased financial pressure. Not the most earth-shattering statement I have ever made, especially with the added burden of Auto Enrolment on the minds of Finance Directors up and down the country. However, because of these financial constraints the pressure naturally increases on trustees, especially in negotiating their triennial recovery plan.

How big is the problem?

Let’s look at some recent figures, so we can get a feel for the quantum of the problem:

  • The PPF’s latest 7800 Index update for October claims that, of the 6,432 eligible schemes, 5,248 are in deficit. That’s 81.6%.
  • TPR’s research finds that a quarter of schemes in ‘tranche 7′ are unlikely to be required to amend their recovery plans. So, of the 5,248 schemes in deficit, around 1,749 are in tranche 7, with 437 apparently not needing to increase deficit repair contributions.
  • Of the 1,312 remaining, 35% (459 schemes) would need to extend their recovery plan by three years and increase contributions by up to 10%.
  • This leaves 700 schemes in this tranche alone that will require significant increases in contributions and recovery plan length.

Whilst these figures are sobering enough, they do not tell the whole story. Just because TPR believes an employer doesn’t need to find additional monies for the scheme, it doesn’t necessarily mean that the employer can afford the current contributions. The regulator recognises this by stating that, even with a three year extension and weakened recovery plan assumptions, some employers would be unable to cope. Bill Galvin, Chief Executive of TPR said “There are a small number of mostly smaller schemes where the sponsor will be unable to pay, in those situations we will have discussions with the trustee and we might have to say ‘no, you cannot continue, because to do so would be to take a one-way bet on the Pension Protection Fund’”.

We predicted this back in April, after TPR’s last major statement. In our view, if there is ‘PPF drift’, where the scheme is not treading water on a s179 basis, TPR will look to bring about the insolvency of the sponsor to crystallise the s79 deficit and draw a line under the deficit that will be passed to the PPF. This may seem harsh, but it should be remembered that TPR is a creature of statute. They are there to protect calls on the PPF and members’ benefits – not to directly protect employees or sponsors.

So, what can be done?

As is always the case the more cash there is available, the greater the number of options opens to trustees or sponsors. If there is lots of money sloshing around or the scheme is very close to full funding (however unlikely either scenario may seem in the current climate) then the insured options of buy-out or buy-in are realistic possibilities, but cash-rich employers are clearly in the minority.

TPR has indicated that it is willing to listen to revised recovery plans, with extensions and reduced contributions, although usually if some form of security has been provided. In reality, if an employer is struggling, any assets are likely to be used as security for finance. Yes, positive and negative pledges or profit-related promises can be taken into account, although these types of promise are less robust than, say, a property signed over to the scheme or cash in an escrow account. Trustees will need to have undertaken an assessment of covenant and affordability though, before agreeing to any weakening of a recovery plan.

The escrow account can be used in a variety of ways – not just as a pot of money that sits in stasis for a period of time, passing to employer or scheme on a given date. Significant flexibility can be built into them, allowing trustees greater security and the option to be more supportive of an amended investment strategy (anticipating gilt yield reversion, for instance) and giving the employer the comfort of avoiding a potential trapped surplus.

Will restructuring help?

Where there is significant financial pressure, our experience shows that a Regulated Apportionment Arrangement (RAA) could be worth exploring. If there is likely to be an inevitable insolvency event, the process can be managed via a RAA, in conjunction with TPR and the PPF – although there will need to be mitigation paid to the PPF, so availability of cash (or a significant asset, as in the case of Uniq) is still an issue.

The ‘last chance saloon’ for an employer is to manage an insolvency process outside of the RAA or other apportionment options (Flexible or Scheme Apportionment Arrangements). This can be known as a ‘pre-packaged administration’ and can only be considered when certain conditions are met. In the right circumstances, a pre-pack or RAA can help an otherwise profitable employer trade on, saving jobs for some or all employees. These really are the options of last resort though and should only be considered when all other doors are closed.

We have found that these two solutions work best where the scheme, which is usually the largest creditor, is present at discussions and party to a clear and transparent process. That could be said for all aspects of scheme funding – dialogue between trustee and sponsor is vital for a smooth and mutually beneficial negotiation.

What are the key points?

In summary, we can support trustees and employers in exploring the options available to them, even when cash is tight, by helping them to:

  • Engage in regular targeted and robust conversations;
  • Fully understand the covenant/affordability/PPF drift position and the various paths open i.e. contingent security/apportionment arrangement/managed insolvency; and
  • Ensure regulatory compliance is adhered to, ensuring no actions are taken that give rise to TPR using their ‘moral hazard’, or other, powers.

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Category : Employer Covenant,Uncategorised — admin @ 10:49 am October 23, 2012