Negotiation is the only way to resolve pension scheme trouble
BAKER TILLY
BRUCE MACKAY
FOR all but a lucky few, final salary pension provision is rapidly becoming a thing of the past. Already in inexorable decline as companies struggled to manage the escalating costs of gold-plated pension schemes, the recent challenging economic environment has accelerated fund closure, and not just for new members but to all future accrual.
For members, the state of their scheme’s funding and their employer’s ability to meet funding commitments should never be taken for granted. Arguably now more than ever they should take an active interest and look behind the scenes to appreciate the challenges faced by trustees and sponsoring employers.
The latest figures from the Pension Protection Fund (PPF) revealed scheme deficits (measured on the PPF basis) totalling £131.5bn at the end of October, which is a significant improvement on September’s £174.9bn deficit, but still represents a huge burden for UK businesses to bear.
Shutting the doors to future contributions removes some of the ongoing risk, but it doesn’t make good the deficit nor pay existing members’ benefits. Ultimately the trustees and sponsoring employer must cooperate to meet these responsibilities without crippling the company, and this is where the balancing act begins.
For trustees now is definitely the time to establish a clear picture of the sponsor’s financial covenant; given the economic turmoil, the employer’s financial strength may have been compromised and schedules of contributions agreed as recently as 12 months ago may be obsolete.
CASH INJECTION
If a review of the covenant does reveal a substantial weakening of the employer, trustees might look for a cash injection. But such action could push the employer over the precipice and undermine the long-term objective of securing benefits. Trustees need to be sensitive to their employer’s immediate situation and look to secure financial commitment when economic conditions start to ease. An investigation of the company’s recent financial performance should be supplemented with a more in-depth investigation of the business’s future direction and prospects, and trustees should engage in dialogue with the employer to find funding terms on which both sides can agree. Weaker covenants should be backed up, where possible, by other sources of contingent support, for example group guarantees and security over properties and other assets.
Dealing with deficits should not just be a priority for the trustee board; it ought to be a key consideration for employers. While it may be tempting to push the pension fund down the financial agenda in favour of paying dividends or eradicating debt, we have seen from recent merger and acquisition activity that a hefty deficit can hamper corporate transactions, not to mention hold a business back as it tries to survive in a recession and to compete in the longer term. Companies need to engage with their trustee boards and work to find an affordable solution over the long-term.
Companies often see aggressive investment strategies as an attractive solution, hoping that such tactics will deliver enough return to alleviate the need for additional contributions. Yet the market crashes over the past two years demonstrate that when these strategies backfire, the funding gap can end up bigger than ever. Employers have to be sensitive to trustees’ limited appetites for carrying additional risk or volatility in their investment strategies.
They should try to negotiate an investment strategy that suits the employer’s circumstances, including its covenant strength and ability to underpin a widening deficit if the investment strategy does backfire.
Tackling these sensitive issues is a difficult task for trustees and for companies. If they hold frequent discussions and ensure an open and honest exchange of information, then even the trickiest sticking points can be dealt with. Ultimately, the key to success lies in understanding and appreciating both sides of the deal.
Resolving the final salary pension issues is undoubtedly tricky, but whether the scheme closes or not, members’ benefits have to be paid. Trustees and employers alike must share responsibility for making that happen. As a scheme member, you should raise your awareness about how those responsibilities are being discharged.
Bruce Mackay is Head of Covenant Assessment Services, Baker Tilly. [email protected]