PLAN B
The trustees could also decide to put plans in place with their sponsoring employer if the worst-case scenarios were to arise. Delo says: “If the trustees have serious concerns about the financial viability of a company after the next five years, they should be pushing to receive additional cash now.”
If, however, that viability were only an issue in the worst-case scenario, a contingent arrangement could be reached. Butcher says: “Trustees can ask the company to provide security contingent on the company being unable to pay the money the scheme needs to meet its funding requirements.”
This contingent security could be a guarantee from the company or a bank.
Bourne adds: “A group guarantee might be provided from a stronger entities within the global group.” These entities might have more resources or be more geographically diversified.
Butcher says: “It could also take the form of a charge over assets.” This greater security could also allow a scheme to increase its investment risk which relieves some of the pressure on the employer to contribute as the financial assets in the scheme are doing more of the heavy lifting.
While the trustees can ask the company for a contingent security, the company could refuse. Bourne says: “While many trustees might want to secure a group guarantee, a company is unlikely to concede unless it gets something in return or faces direct pressure from the pensions regulator.”
Trustees can force a company into a difficult relationship with the regulator.
Butcher says: “Trustees could then say they were not prepared to sign off the valuation report, which would have to be reported to the regulator.”
This regulatory intervention could make the company provide the necessary security. But this tactic should be a last resort.
Some companies might be happy to provide the guarantee. For example, a company with a US parent might care about the implications of the pension liability for its balance sheet.
Bourne says: “So if a guarantee meant the volatility of the scheme was reduced, it would be glad to provide it.”
But others might be much more reluctant. Butcher says: “There may well be a good reason why a company cannot provide security.”
The company may simply not have any assets with sufficient size which could provide the security required by the scheme and would not be able to persuade its bank to make the necessary guarantee.
Bourne says: “If it’s a standalone company, it will only be able to generate a certain level of cash and have limited resources.”
Butcher adds: “Trustees need to keep an open mind and see if they agree with a company’s arguments.” Companies also have to consider a number of competing demands.
Bourne says: “They need to balance the requirement for future investment along with the needs of the shareholders as well as those of the scheme.”
BACK TO BASICS
If a security cannot be secured, the trustees might have no option but to do the best job they can with the available resources. Reviewing their processes to ensure the scheme is being operated as efficiently as possible would help the scheme to cut back on unnecessary waste.
Butcher says: “For example, trustees need to ensure they are not overspending either on investment advisers or on the administration of the scheme.” The Pension Protection Fund levy should also be minimised as should other risks.
While the concerns about the strength of covenant sponsor reflect the impact Brexit could have on the economy, the nervousness about the implications of Brexit reflects investment worries.
Butcher says: “Trustees find volatility hard to manage. If Brexit creates an investment storm, it makes it much harder to keep the fund on track to achieve its funding goals.”
Some schemes have already seen their liabilities spike under Brexit, which has made them more reliant on the covenant sponsor.
Bourne says: “If investments are not performing, then the trustees might have to re-visit the strategy.” Or more radical decisions might be needed such as switching the inflation link from one linked to the retail-price index to the consumer-price index.
Brexit has made the difficult job of managing a company pension scheme even harder. Trustees now have additional concerns about its impact on the strength of the employer covenant along with the possible implications for investment volatility.
