LEGAL

Using contingent assets to help eliminate a pension fund deficit is gaining in popularity as an alternative to cash payments from employers.And there are some innovative ways of doing it, finds Margaret Taylor.

In case of emergency

As many cash-strapped companies continueto struggle with the funding requirementsof their defined benefit pension schemes,

the use of contingent assets is gaining inpopularity. Contingent assets are assets that arenot put into the pension scheme but are set asidefor its potential use.

Until recently a relatively unknown pheno-menon, contingent assets can give

recession-hit companies somebreathing space when it comesto meeting the demands oftheir scheme’s funding

plan while

also giving trustees some peace of mind thattheir fund’s members won’t be left short.

Fiona Franklin, a partner at the law firmSacker & Partners, explains: “Trustees can say toemployers “we‘d like the cash but we understandthat you can’t pay immediately. So give us acertain amount a year for the next 15 years and,because you’re having a difficult time and wedon’t know if you’ll be around in 15 years, we’dlike some charge over property or a parent

company guarantee. This is popular with

employers because it means that theydon’t have to put so much cash into

the scheme so quickly.”Rather than stumping up the cash

they would normally pay to the schemeon a regular basis, employers could choose to

put the cash in an escrow account. This meansthe money hasn’t actually been swallowed up bythe scheme’s deficit but the trustees would havethe first claim on the money if the companywere to fail.

Alternatively, the trustees could come toan agreement that would see the sponsoringcompany put assets such as property intoa standalone vehicle that the pension schemehas charge over and, in some cases, would seethe company pay rentto the pension scheme(see case study right).

A more popular,and easier to negotiate,structure would seethe sponsoringcompany’s parentagree to fund thescheme should the employer itself go intoinsolvency, while it is also possible to packageup a number of assets, effectively creating asecuritised vehicle that the trustees havecharge over.

Encouraging innovationClearly none of these options are asattractive, or as simple, as receiving

regular cash payments. But, asNabarro partner Anne-Marie

Winton, points out, when comingup with the cash is no longer

easy, contingent assets are aviable alternative.

“While pension scheme trustees will inevitablyprefer to receive cash, there’s an increasingrealisation and acceptance that some employerssponsoring final salary schemes are simply unablein the current economic climate to meet thefunding requirements of the pension schemesolely by cash payments,” she says. “Agreeingsome form of direct additional security with thetrustees, such as a charge over UK or overseasproperty, can show support for the scheme.Using a contingent asset is a way of providing

the trustees with security against employerdefault during the period of agreed deficitreduction payments, and may persuade thetrustees to agree to a longer period for makingthose payments.”

And from the trustees’ point of view the useof contingent assets can be beneficial when itcomes to calculating their scheme’s levy to thePension Protection Fund (PPF). Franklin atSackers says: “When the PPF is assessing howmuch each scheme should pay to be a memberit will look at how risky the employer is andwhether there’s a possibility that it could gounder [thereby pushing the scheme into the PPF].If the employer puts in place a contingent assetmeeting the PPF’s requirements then the scheme

won’t have to pay so muchto the PPF.”

That is not to say thatthe use of contingent assetsis trouble free. As Franklinpoints out, from a legaladviser’s point of viewone of the first obstaclesencountered when any

scheme is looking to undertake such an arrangement is actually valuing the assets involved.

“You have to make sure that the asset is worthwhat the employer says it is,” she says. “Wherethe assets are packaged debt they would needto be managed professionally and continuallychecked to see that they were worth what theywere when the deal was agreed.

“The documentation is critical. It must workboth to create a valid asset (eg a charge over aproperty) and from a pensions perspectivefor trustees.”

Linklaters partner Isabel France, whoadvised the trustees of the Marks & Spencerpension scheme on their property deal (see

48 PensionsInsight / July 2009www.pensions-insight.co.uk

[ ]When coming up with thecash is no longer an easyoption contingent assets area viable alternative

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below), agrees. “You have to identify the assets that can be

used and the restrictions on their use,” she says.“For example, if you want to use property youhave to be sure that you’ve got good title on it andthat there aren’t restrictions regarding what youcan and can’t do with it.”

From the trustees’ point of view a fear ofthe unknown and of having to explain extremelycomplicated – and often not very transparent –financial arrangementto their memberscould put them offthe concept of usingcontingent assets.

As France says:“Trustees often geta lot of comfortknowing that otherpeople have been doing what they are about todo. That said, a lot are willing to innovate to getthe right result.”

Cost considerationsThe problem is that structuring these innovativedeals comes at a cost. While the documentationfor a parent company guarantee is relativelysimple and can be carried out by regular pensions

advisers,when more complexstructures are putin place the skills of amuch wider legal team arerequired – and that advicedoesn’t come cheap.

“A property deal will needproperty, structured finance and taxlawyers as well as the pensions adviser,” says

France. “When you boilthem down, fundingarrangements like the M&Sstructure are basicallystructured financevehicles,” she says. “Largelaw firms have a lot ofexperience of putting inplace structured finance

in the context of corporate or banking deals. “A property deal, for example, will need

property, structured finance and tax lawyers aswell as the pensions adviser. They are all thingswhich lawyers in a full service firm will be used to– it’s the arena and the clients that are different.”

Nothing will entirely protect a scheme from thecorporate failure of its sponsoring company, butif a contingent asset is put aside in a watertight

vehicle it can at least be insulated against theeffects of that failure.

But, while contingent assets are a product ofthe recession, and should go some way to mitigateat least some of the effects it is having on schemedeficits and scheme funding, arrangements beingentered into now are certain to last wellinto any upturn.

As Franklin says: “This is just a means ofgetting over the hiccup caused by the fact thatliabilities are increasing while available cash isreducing and employers are weaker. Actuallywhat we need is a stronger economy so thatemployers can create the wealth to pay theschemes the cash they need, but contingent assetswill last as long and longer than any recession.” ■

July 2009 / PensionsInsightwww.pensions-insight.co.uk

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casestudy: M&S, Whitbread and Tesco

One of the first, not to mention highest profile, schemes to engagewith the concept of contingent assets is the Marks & SpencerPension Scheme.

In 2007 the scheme established a joint venture company along withthe sponsoring company. The innovative arrangement saw M&S-ownedproperties with a then market value of around £1bn transfer to the newcompany to be leased back to the retailer. The pension scheme wouldthen receive annual payments of £50m from the joint venture until2022. Crucially, under the terms for the agreement if M&S fails, controlof the valuable real estate portfolio will pass to the pension scheme.

In the past year the company restructured the terms of the jointventure, allowing it to reclassify its obligation from debt to equity.

More recently, similar arrangements have been put in place byWhitbread and Tesco.

In May hospitality company Whitbread, which owns brands such as

Premier Inn and Costa Coffee, granted security over £150m of propertyassets to its pension scheme trustees. This is to be used as acontingent asset on the scheme, whose deficit was recently valued at£388m.

Although Whitbread had made a £50m contribution to its scheme’sdeficit in the last financial year, the funding gap had widened over the12-month period.

The company had agreed in a recovery plan drawn up in 2003 to paythe scheme £20m in the current financial year and the same sum in2010-11. Under the terms of the property deal the company will make nofurther contributions until August 2011, granting the scheme securityover the property assets in the meantime.

Tesco has provided its pension scheme’s trustees £500m of securityover a portfolio of its property assets after its pension deficit rose to£1.1bn.

[ ]The problem is thatstructuring these innovativedeals comes at a cost

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