By Richard Farr
With one third of the UK’s six thousand Defined Benefits pension scheme covenants categorised as ‘weak’ or ‘tending to weak’ according to The Pensions Regulator (TPR), this autumn will mark the start of a period of retrenchment and reform. UK companies face a period of increased turbulence caused by their defined benefit pension liabilities which could lead to significant financial difficulty or even collapse for some companies.
According to the ONS, private sector final salary pension liabilities top £1.7trn. Directors in companies with defined benefit schemes need to take a hard look at their obligations and how they plan to meet them over the long term – not least because they can be personally liable. Starting this autumn, it will no longer be possible for directors to think about this later. A tightening of FRC reporting rules from September means that, for the first time, a listed company must fully review its ability to meet its pension liabilities over a five-to-10 year period before its accounts can be signed off as a going concern. In addition, every UK company with a final salary scheme has been assessed, and will shortly be issued with a government-endorsed Experian rating based on the strength of the company relative to its scheme liabilities.
If a company’s rating is weak, directors must take steps to safeguard their companies. They must ensure their pensions advisers really do offer joined up advice and can prove it – or if they do not, take steps to find advisers that can. Sometimes incumbent advisers can be part of or prolong the problem, and finding this out when a crisis has come to a head can cause fatal damage. For some companies, creating a new chief pension officer role can help embed a decisive change in the way the company’s relationship with a pension scheme is managed.
The futile to-and-froing of the defined benefit discussion over the past 20 years has given directors pensions fatigue and led many to think that the problems must be totally intractable. In fact, they’re not. Over the past decade, several pioneering restructuring approaches have been applied successfully to struggling schemes with the blessing of TPR. These have included debt-for-equity swaps (Uniq plc), asset based funding for pensions, and scheme compromises. The common denominator for all of these is that they assume a different sort of relationship between a company and its pension scheme, with the scheme being recognised as a partner, rather than a creditor. The upshot is that company directors no longer have to choose between the health of their company, or the wealth of their pension scheme: taking responsible pensions decisions means they can choose both.
So the message to company directors is clear: own the issue, or let it own you. Businesses with pension covenants that are ‘weak’ or ‘tending to weak’ are being lumbered with the equivalent of a poor credit score, and are being monitored by the Pension Protection Fund and TPR. They may find that the pensions lifeboat cannot or is no longer prepared to support them if they go into difficulty – especially with the range of potential fixes now out there. If a company’s covenant rating is weak, a company’s problem is now out in the open. But the good news is that fixing it is usually less painful than feared. As the author Antoine de Saint Exupéry said, “only the unknown frightens men” – and facing up to the unknown problems in the DB pensions space are often the biggest challenge for companies and trustees. However they can take comfort from the fact that the solutions involve techniques that are already proven in non-pension situations.
Richard Farr is head of pensions advisory at BDO
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