THE SOCIETY OF PENSION CONSULTANTS The representative body for pensions Dealing with the Downturn: Issues for Employers and Trustees

THE SOCIETY OF PENSION CONSULTANTS

The representative body for pensionshttp://www.spc.uk.com

Dealing with the Downturn: Issues for Employers and Trustees

SPC/APL JOINT EVENING MEETING JANUARY 26TH 2010

Peter Esam

Jason Coates

Association of Pension Lawyers

www.spc.uk.com


The representative body for pensions

Introductions and Overview

• Speakers’ Introduction• Overview of Session

Employer covenant in the downturn

• Why does it matter?

• Assurance that employer will be able to pay allows greater risk

- investment strategy

- lower technical provisions

- or longer recovery plan

Relevance of downturn

• Deteriorating funding situation likely

• Even stronger employers struggle with size of deficits

• And they want to conserve cash

• Heightened risk of employer failure

Corporate insolvencies 2008 Q1 to 2009 Q2(Source - The Insolvency Service Policy Directorate)

0

1000

2000

3000

4000

5000

6000

7000

8000

1

08Q1 08Q2 08Q3 08Q4 09Q1

Funding on technical provisions basis

• Provides cash flow

• Does not fully protect against increased insolvency risk

• But allows some risk management

- review prudence

• Higher funding level means less abatement on insolvency

Assessing employer covenant against employer risk of insolvency

• Unlikely to get very helpful guidance on extent of recovery

- Would need to know cause of insolvency – economic collapse, market

collapse, unique event affecting this company, etc.

• More realistic to seek to assess risk of insolvency happening at all

- Will this be the last company to go in this sector or the first?

- Is the sector strong?

Understand the employer obligation

• In insolvency scenario primarily interested in section 75

• Understand which employer would pay what

• "Last man standing" concept unhelpful here

- Captures idea of scheme where liabilities are carried forward in the

general pool after one employer insolvency

- But liabilities often do not fall on last man

- Regulation 9 Employer Debt regs

• Unless there are cross guarantees – there is no joint and several liability

Sharing the liabilities under section 75Last active employer becomes insolvent

Former employers

Employer B now insolvent

Employer A insolvent first

When does the group covenant matter? – tpr’s view

• Employers alone cannot support scheme

• Changes are affecting wider group

• Employers have indicated group covenant relevant

• Existing support – e.g. parent co guarantee

• Interdependency between group and employer

P

S

Scheme

E

X

Strong parent

P

X

S

X

Scheme

E

Strong employer – weak parent

P

X

S

X

Scheme

E

Strong employer – weak parent

Intercompany debt

Bank

Guarantee/Security

Why might group covenant matter?

• Additional support from wider group

AND/OR

• Risk of employer being dragged down by rest of group

Is tpr power to issue FSDs relevant?

• Not very

• Triggers may be difficult to satisfy – service company, insufficiently resourced

• Reasonableness test – tpr likely to start with s 43(7) factors including

- Benefit received from employer

- Connection with the scheme

• Even if trustees believe threshold crossed, will tpr agree?

• It's discretionary

• If there's a strong case for a FSD why not ask tpr to issue one and see what

happens?

tpr guidance on guarantees

The trustees should normally only allow a company guarantee as part of the scheme's funding strategy for relatively short periods (eg for three years or less) even though the guarantee may have been offered for a longer period. The reasons for this are:

the value of a company guarantee can reduce significantly even over relatively short periods; and

the triennial valuation process provides a natural point for the trustees to reconsider the role of the group company guarantee in a scheme's funding strategy.

Given this, a company guarantee would not normally be suitable to support an extended recovery plan but could be used to support a back-end loaded recovery plan.

The role of contingent assets

• Tpr official position not entirely logical

- parent company guarantee allows trustees to take account of parent covenant

• Trustees may be better off giving something on funding and getting contingent

asset or long-term guarantee

• A guarantee

- protects commitment of parent to scheme

- allows recovery vs guarantor in insolvency situation

- does not give direct power to trustees to get cash into scheme from weak

employer

• Similarly other contingent assets allow covenant to be assessed as stronger

Should trustees act more like banks?

When dealing with corporates, banks generally

• Collect other people’s money and give it to company

• Can choose their counter-party carefully

• Aim to recover a qualifiable debt in full

• Vary terms according to quality of counter-party

• Maximise their chances of full recovery by making loan conditional

- Security, guarantees, etc.

Trustees’ negotiating position - funding

• Technical provisions

- Assumptions must be chosen “prudently”

• Recovery plan

- must be agreed (most schemes)

• Don’t agree and wait for the cavalry?

- how will tpr exercise powers?

- the clock runs

• Difference acknowledged by tpr guidance on downturn

• Partly explains why higher insolvency risk does not lead to more prudent

investment

Trustees’ negotiating position – restructuring

• Downside of insolvency for Bank

• Bank may benefit from deal with trustees

- so may give at least share of up-side

Is the PPF relevant?

• Yes

• Members would prefer to be with insurer

- No power to abate

- Less funding risk

- Transfers

• Hope does not mean this is wrong

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Funding – The Employer’s View

• Overview – a continuing sponsor… • TPR and the courts • Cash is king • Revising schedule of contributions • Use of contingent assets • Managing liabilities • Compromise agreements

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Cash is king

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Cash is king

• Key business objective• TPR statements: “reasonable affordability”

“a continuing sponsor” • TPR’s position and politics • Develop the business case• Sharing upside later

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Revising Schedules of Contributions

• Current SoC unaffordable• Can SoC be ‘undone’ and re-written?• Issues to consider

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Contingent asset solutions

• Way of reducing immediate cash call• Types • Creative solutions

– Property – IP – Securitisation of income streams

• Issues to consider

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Future service change

Reminders from IMG

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Taking the PPF into account

• Can it be appropriate to take the PPF into account?

Yes – it’s a mater of purpose and degree• Investment strategy• Wind up powers

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Managing Liabilities

• Enhanced Transfer Value exercises• Pension increase exchanges• Compromises

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Enhanced TVs / Pension increase swaps

• Change of tune from TPR? • Employer’s reaction • Key issues:

– Informed consent– S67 vs s91 and IMG case– Financial advice

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Compromise Agreements

• Revisit Bradstock at PPF plus level • Japan Airlines? Revise the law? • Clearance and the TPR view

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Investment

• Link funding and investment• More control for Employer• Investment Sub-committees• Contingent assets

– Link to investment strategy / swap style – Is it legal?

Trustees’ response

• Employer involvement in investment

- Decision-making

- Conditionality

• Cash is king – always?

Documents

THE SOCIETY OF PENSION CONSULTANTS The representative body for pensions Dealing with the Downturn: Issues for Employers and Trustees