Pension trustees and sponsor covenant

Feb 8, 2021

Six lessons for trustees now

As we write this, with the UK in Lockdown 3.0, nerves are more strained than ever. Whilst there is encouraging news on the vaccine front, the real fear that we are not yet at the peak of the Covid 19 crisis stalks our lives.

As trustees then, this is absolutely the time when they should be constantly in touch with the scheme sponsor to make sure the pension scheme is in the best possible health in the current circumstances. Whilst absolutely not a one size fits all solution, our experience to date has taught us the following:

1. ‘Expect the unexpected’ – I’m not sure how many of us would have put money on a third national lockdown since Covid 19 hit our shores, yet here we are. Some scheme sponsors got through the first lockdown, possibly the second, but can they survive a third? Particularly with no end currently in sight. If 2020 taught is one thing, it is that Black Swans do exist and trustees need to think more widely about the factors which can impact a sponsor covenant than ever before. Polishing our crystal ball, it seems a fairly safe bet that 2021 and 2022 will be a time when sponsors and trustees will be entering difficult and unchartered territory.

2. Sit down with the scheme sponsor with the appropriate advisers in place, over Zoom or similar, and discuss with them issues including:

a.  Liquidity – as income has dried up, how long can the company keep paying all of its expenses, including pension scheme contributions. TPR has made it clear that (2020 Annual Funding Statement) Trustees will need to understand their sponsors cash flow before agreeing to giving leeway on deficit repair contributions

b.  Borrowing – has the company fully drawn down all of its debt commitments or does it still have access to bond issuance or accessed additional government funding

c.  Costs – costs reduce because employees have been furloughed or made redundant as well as how the company dealt with suppliers possibly reducing orders and increasing payment terms (particularly in the case of commercial landlords)

3. Trustees and sponsors need to agree a journey plan for the pension scheme. Outside of the TPR’s requirement, the Trustees have an understanding of where the pension plan should be at different points in the future and how this will be funded.. It is essential to understand what the scheme sponsor is planning for. There should ultimately be agreement as to what the final destination for the pension scheme will be and a timeline to achieve this. As with most journeys, very few are ever a straight line. Therefore, it’s important to understand what the possible choices are in different scenarios.

4.  One of the reasons TPR is keen that Trustees achieve a level of funding which does not require sponsor company contributions is that it is increasingly difficult to be able to see covenant strength into the future. High street retail has pretty much fallen off a cliff in 2020 and, whilst it may have been in long-term decline, we don’t recall too many forecasts saying that hundreds of thousands of jobs will be lost and many High Street units be boarded up in less than twelve months. Since defined benefit pension schemes tend to be the preserve of more traditional industries that may be less able to meet the challenges which we now face, Trustees need to keep this thought in mind. Whilst the sponsor may still be able to afford contributions now, it is not always possible to be sure that this will be the case in five years time.

5.  That said, a covenant where the sponsor continues to pay pension scheme contributions in accordance with the Schedule of Contributions is not to be underestimated by Trustees. However, trustees need to understand their sponsor’s business model in order to gauge how reliable the business, and the wider sector, is likely to be over time. This enables them to understand how much they can reasonably require from the sponsor whilst allowing the sponsor to invest in the business in order to meet challenges which they are facing.

6.  Trustees need to maintain an audit trail of these discussions with the scheme sponsor in order to review progress and make amendments as required along the way.

Trustees and sponsors will have their own way of having these covenant discussions and dealing with the output from them. What is increasingly clear is that Trustees need to be able to keep on top of their sponsors’ finances and need to know what questions to ask or have access to advisers who can. The most important lesson is to have these discussions, agree a plan and document them.

The road ahead looks a rocky one for both Trustees and sponsors. Trustees owe it to their members and to themselves to make sure they manage the sponsor covenant proactively and professionally. This is not a declaration of war with the sponsor but a professional and collaborative ongoing project to ensure the pension scheme is well run.

If you’d like to know more, please contact us for an informal chat:

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