Navigating choppy waters - can funding flexibilities help sponsors find calm in the storm?

For sponsors of DB pension schemes and their members it is a worrying time. The financial disruption caused by COVID-19 has caused a painful set of asset and liability shocks to schemes’ finances and a further prolonged period of uncertainty seems likely.

But perhaps most worrying is the significant impact of the crisis on sponsor covenants. In the worst cases, the Company’s financial stakeholders (shareholders, creditors, pension trustees etc) may perhaps need to co-ordinate to pause or restructure cash obligations to avoid insolvency.

UK schemes are overall in far better shape than at the time of the last financial crisis in 2008 (figures from PPF’s 2019 “Purple Book” suggest schemes were on average around 77% funded on buyout metrics compared to only around 60% in 2008). Nevertheless, company insolvency can be a very poor outcome for pension scheme members, who then need to rely on either PPF benefits or, in better funded schemes, slightly higher (albeit still reduced) benefits with an insurer or consolidator.

New TPR Guidance

TPR has now issued guidance for Trustees of DB schemes on how to respond to requests from employers to temporarily defer deficit payments. In particular, this will require Trustees to:

• Establish the need – by understanding as far as possible the employer’s cashflows over the next 13 week period (after having assessed other support the Government has made available to companies around COVID 19) and ensuring dividends or other similar payments are not made;
• Ensure all parties are playing their part – by satisfying themselves that other creditors remain supportive and they get a fair share of any new security; and
• Have a clear, but flexible, ability to restart making deficit contributions when appropriate – that is, once trading conditions become more normalised.

This is likely to require companies and trustees to produce more financial and covenant analysis, although TPR has acknowledged that, as forecasting will be difficult in the current environment, this may not be as robust as it would normally be.

At present the precise mechanism for implementing the change to recovery plans is not clear (for example a new schedule of contributions would rapidly need to be certified) and it seems likely that more detailed guidance will emerge in TPR’s 2020 Annual Funding Statement (which is expected around Easter), or possibly sooner. For now, companies and trustees are encouraged to reach out directly to TPR.

The new pensions regime

The upcoming period will be a key test for TPR’s emerging new regulatory approach which is in the process of being codified in the Pension Schemes Bill and TPR’s funding consultation issued earlier this month (see Jon Camfield’s blogs here and here).

In particular, at its heart, the developing new regime seeks to codify principles of fairness to pension schemes versus other creditors and shareholders (notably around dividend payments). It is also clear that in the new regime TPR retains its “sustainable employer growth” objective (which taken to the limit, this could be interpreted as an objective to promote employer “survival”).

It remains to be seen how TPR will balance these considerations. However, given the likely strain on TPR’s resources and wider economic backdrop, it seems possible that TPR will take a relatively permissive approach to requests to defer contributions – especially if Trustees are clearly already in agreement as part of a joint approach.

Whilst this approach would be helpful for companies in the short term, they should bear in mind that any actions taken around pensions now, would likely be judged in less extreme times. This means that company boards will need to take appropriate legal advice and carefully document their decision-making processes.

However events play out, some companies and trustees are going to need to work together to solve some significant challenges. Sponsors should start preparing for these discussions now.