The past year has seen a sharp decline in the funding position of defined-benefit schemes. Increased pension scheme deficits come at the worst possible time for employers, many of whom are struggling to survive the economic downturn. At the same time, trustees are faced with the difficulty of having to balance the need to support their sponsor through the current crisis with their duty to protect members’ benefits.
Statements from the Pensions Regulator
There is some good news for employers who find themselves struggling to keep up with payments due under a scheme’s existing funding arrangements. In its statement to trustees on the current financial pressures, issued in February, the Pensions Regulator (the Regulator) said that:
‘There is no reason why a pension-scheme deficit should push an otherwise viable employer into insolvency… If any employer believes that an existing recovery plan is at serious risk of jeopardising the company’s future health or solvency, then they should discuss this with their pension-scheme trustees.’
Recovery Plans
If a valuation shows that a scheme has insufficient assets to meet its liabilities, trustees and employers must agree a recovery plan showing how the funding position will be improved and over what time period. The Regulator’s statement opens the way for employers in extreme financial hardship to approach the trustees to re-negotiate the contributions due under an existing recovery plan. Trustees are entitled to agree to a longer recovery period if this is appropriate in the circumstances. Trustees should, however, satisfy themselves that the current arrangements are seriously jeopardising the employer’s survival before agreeing to make any changes. Where an employer is experiencing short-term cash flow difficulties, it may also be appropriate for trustees to consider entering into back-end loaded recovery plans to give an employer more breathing space.
Where an existing recovery plan is already in place, that plan should continue so that the original deficit is cleared within the recovery period agreed at the last valuation. Any additional deficit that is identified at the next valuation should then be dealt with in a separate recovery plan. This is to avoid the deficit simply being re-spread.
If any changes to a recovery plan are agreed between an employer and the trustees, the Regulator must be informed. The Regulator has the power to intervene if it is not satisfied that the new recovery plan complies with the statutory requirements. Trustees will be required to show how they have sought to mitigate the potential detrimental impact on the scheme (for example, by seeking additional security from the employer).
Valuations
Even where it is not necessary for trustees and employers to re-negotiate existing arrangements, they are still likely to face some significant challenges when it comes to their scheme’s next valuation, given the current economic conditions. Most schemes have now completed their first valuation under the new statutory funding regime and several schemes are now preparing for, or are in the process of completing, their second such valuation.
Setting the method and assumptions
Trustees are responsible for setting the actuarial methods and assumptions that will be used to calculate a scheme’s liabilities. Generally speaking, the method and assumptions will need to be agreed with the sponsoring employer. Whether the present economic downturn should affect the method and assumptions used will depend on the specific circumstances of the scheme. If a scheme’s sponsor has materially weakened, the Regulator expects more conservative assumptions to be considered with a view to protecting the long-term position of the scheme. The length of the next recovery plan will also be affected by any perceived weakening in the employer covenant. However, if there is evidence to show the employer’s long-term future is not in jeopardy, a longer recovery plan might be agreed.
Employers and trustees also need to bear in mind that the Regulator has recently been given greater power to intervene where it is unhappy with the outcome of a scheme’s funding negotiations. To date, the Pensions Regulator has only been able to intervene where the trustees and employer have failed to reach agreement over the method and assumptions to be used to calculate the scheme’s technical provisions. However, the Regulator now has the power to intervene where it considers a scheme’s technical provisions are not sufficiently prudent.
Conclusion
Employers and trustees need to work together to address the challenges posed by the credit crunch. Employers struggling to fund their schemes should open up a dialogue with the scheme’s trustees as soon as possible. Provided it can be demonstrated that the employer has a viable future, the message from the Regulator appears to be that there will be flexibility and pragmatism in its supervision of funding arrangements.
By Stuart Earle, associate, Eversheds LLP.
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