The difference a week makes

March 23, 2020

by Eimear Kelly Scheme Financing Actuary

Email +44(0)7768 051416

Market turmoil puts ‘security’ for UK defined benefit pensions firmly back on the agenda

If ever I needed proof about how quickly the narrative changes in our ever connected world, I only have to look at the last few days. Last week, the new funding code consultation and its implications was firmly top of the pensions agenda. This week we are still weighing up the aftermath of ‘Black Monday’ and the likely effects on the wider economy and business confidence. So what does all of this now mean for defined benefit (DB) pension schemes?

When I started writing this blog, I was primarily focused on the increasingly positive tone that the Regulator had adopted in the consultation on the role that ‘security’ has to play in the funding of DB pension schemes. I should say at this point that when I refer to ‘security’ I use it as an umbrella term for any structure or product that enhances the security position of the pension scheme such as Asset backed contributions (ABCs), company guarantees, surety bonds, letters of credit, contingent assets, prudence forgiveness mechanisms, escrow accounts, reservoir trusts etc. The list is extensive and growing as the demand for innovative security solution structures in the new funding world increases, so watch this space in the coming months.

The consultation refers to it as a source of ‘real value’ to schemes as it envisages the assets of the employer will play a ‘leading role’ in bespoke funding solutions. Whilst this might not necessarily be as applicable to well funded schemes with strong employers, I expect that a significant number of schemes will fall into the ‘bespoke’ camp. For the schemes that fall into the ‘bespoke’ camp, additional security will provide a much needed lifeline for schemes by underwriting recovery plans that are ‘too long’ (but can’t be shortened because to do so would make them unaffordable) and employer covenants that look less than strong.

Recent events do not change any of this or the role that non-cash security solutions have to play in pension scheme funding. If anything, they make the argument stronger. Whilst we are still getting to grips with the implications of the market turmoil, it is more likely than not that it will have damaged the funding levels for all but the best hedged/best funded schemes. The uncertainty caused by coronavirus (COVID-19) is likely to create further business disruption in the weeks and months ahead as official response adapts to changing circumstances. For example, enhanced isolation policies could leave many people unable to get to work and supply chains disrupted. In essence, businesses will almost certainly have a greater focus on cash and retaining sufficient cash in their business at a time of great uncertainty.

For those with DB pension schemes (particularly those with a triennial valuation in 2020) this couldn’t have come at a worse time. However, for companies in this situation, security solutions like ABCs can provide some relief. By providing a pension scheme with the security of a company asset via an ABC structure, it can help to retain much needed cash in the business whilst giving the pension scheme the comfort that if the underlying business becomes distressed they have recourse to that asset. Any asset which retains its value in a distress scenario may be suitable provided it’s not encumbered elsewhere. Encouragingly, the Regulator appears to be on board with the principle that an ABC can add value (albeit they are some tests and conditions that must be met).

I expect to have many conversations on this topic over the next few months and I believe that we are likely to see a steady stream of non cash funding structures like ABCs considered by organisations for the first time as well as those that have previously discounted them for various reasons. If you would like to have a conversation on this topic, please get in touch.

by Eimear Kelly Scheme Financing Actuary

Email +44(0)7768 051416