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THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensionshttp://www.spc.uk.com
Dealing with the Downturn: Issues for Employers and Trustees
SPC/APL JOINT EVENING MEETING JANUARY 26TH 2010
Peter Esam
Jason Coates
Association of Pension Lawyers
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www.spc.uk.com
THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Introductions and Overview
• Speakers’ Introduction• Overview of Session
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Employer covenant in the downturn
• Why does it matter?
• Assurance that employer will be able to pay allows greater risk
- investment strategy
- lower technical provisions
- or longer recovery plan
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Relevance of downturn
• Deteriorating funding situation likely
• Even stronger employers struggle with size of deficits
• And they want to conserve cash
• Heightened risk of employer failure
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Corporate insolvencies 2008 Q1 to 2009 Q2(Source - The Insolvency Service Policy Directorate)
0
1000
2000
3000
4000
5000
6000
7000
8000
1
08Q1 08Q2 08Q3 08Q4 09Q1
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Funding on technical provisions basis
• Provides cash flow
• Does not fully protect against increased insolvency risk
• But allows some risk management
- review prudence
• Higher funding level means less abatement on insolvency
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Assessing employer covenant against employer risk of insolvency
• Unlikely to get very helpful guidance on extent of recovery
- Would need to know cause of insolvency – economic collapse, market
collapse, unique event affecting this company, etc.
• More realistic to seek to assess risk of insolvency happening at all
- Will this be the last company to go in this sector or the first?
- Is the sector strong?
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Understand the employer obligation
• In insolvency scenario primarily interested in section 75
• Understand which employer would pay what
• "Last man standing" concept unhelpful here
- Captures idea of scheme where liabilities are carried forward in the
general pool after one employer insolvency
- But liabilities often do not fall on last man
- Regulation 9 Employer Debt regs
• Unless there are cross guarantees – there is no joint and several liability
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Sharing the liabilities under section 75Last active employer becomes insolvent
Former employers
Employer B now insolvent
Employer A insolvent first
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When does the group covenant matter? – tpr’s view
• Employers alone cannot support scheme
• Changes are affecting wider group
• Employers have indicated group covenant relevant
• Existing support – e.g. parent co guarantee
• Interdependency between group and employer
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P
S
Scheme
E
X
Strong parent
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P
X
S
X
Scheme
E
Strong employer – weak parent
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P
X
S
X
Scheme
E
Strong employer – weak parent
Intercompany debt
Bank
Guarantee/Security
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Why might group covenant matter?
• Additional support from wider group
AND/OR
• Risk of employer being dragged down by rest of group
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Is tpr power to issue FSDs relevant?
• Not very
• Triggers may be difficult to satisfy – service company, insufficiently resourced
• Reasonableness test – tpr likely to start with s 43(7) factors including
- Benefit received from employer
- Connection with the scheme
• Even if trustees believe threshold crossed, will tpr agree?
• It's discretionary
• If there's a strong case for a FSD why not ask tpr to issue one and see what
happens?
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tpr guidance on guarantees
The trustees should normally only allow a company guarantee as part of the scheme's funding strategy for relatively short periods (eg for three years or less) even though the guarantee may have been offered for a longer period. The reasons for this are:
the value of a company guarantee can reduce significantly even over relatively short periods; and
the triennial valuation process provides a natural point for the trustees to reconsider the role of the group company guarantee in a scheme's funding strategy.
Given this, a company guarantee would not normally be suitable to support an extended recovery plan but could be used to support a back-end loaded recovery plan.
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The role of contingent assets
• Tpr official position not entirely logical
- parent company guarantee allows trustees to take account of parent covenant
• Trustees may be better off giving something on funding and getting contingent
asset or long-term guarantee
• A guarantee
- protects commitment of parent to scheme
- allows recovery vs guarantor in insolvency situation
- does not give direct power to trustees to get cash into scheme from weak
employer
• Similarly other contingent assets allow covenant to be assessed as stronger
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Should trustees act more like banks?
When dealing with corporates, banks generally
• Collect other people’s money and give it to company
• Can choose their counter-party carefully
• Aim to recover a qualifiable debt in full
• Vary terms according to quality of counter-party
• Maximise their chances of full recovery by making loan conditional
- Security, guarantees, etc.
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Trustees’ negotiating position - funding
• Technical provisions
- Assumptions must be chosen “prudently”
• Recovery plan
- must be agreed (most schemes)
• Don’t agree and wait for the cavalry?
- how will tpr exercise powers?
- the clock runs
• Difference acknowledged by tpr guidance on downturn
• Partly explains why higher insolvency risk does not lead to more prudent
investment
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Trustees’ negotiating position – restructuring
• Downside of insolvency for Bank
• Bank may benefit from deal with trustees
- so may give at least share of up-side
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Is the PPF relevant?
• Yes
• Members would prefer to be with insurer
- No power to abate
- Less funding risk
- Transfers
• Hope does not mean this is wrong
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www.spc.uk.com
THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Funding – The Employer’s View
• Overview – a continuing sponsor… • TPR and the courts • Cash is king • Revising schedule of contributions • Use of contingent assets • Managing liabilities • Compromise agreements
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THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Cash is king
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THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Cash is king
• Key business objective• TPR statements: “reasonable affordability”
“a continuing sponsor” • TPR’s position and politics • Develop the business case• Sharing upside later
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www.spc.uk.com
THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Revising Schedules of Contributions
• Current SoC unaffordable• Can SoC be ‘undone’ and re-written?• Issues to consider
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THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Contingent asset solutions
• Way of reducing immediate cash call• Types • Creative solutions
– Property – IP – Securitisation of income streams
• Issues to consider
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www.spc.uk.com
THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Future service change
Reminders from IMG
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www.spc.uk.com
THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Taking the PPF into account
• Can it be appropriate to take the PPF into account?
Yes – it’s a mater of purpose and degree• Investment strategy• Wind up powers
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www.spc.uk.com
THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Managing Liabilities
• Enhanced Transfer Value exercises• Pension increase exchanges• Compromises
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THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Enhanced TVs / Pension increase swaps
• Change of tune from TPR? • Employer’s reaction • Key issues:
– Informed consent– S67 vs s91 and IMG case– Financial advice
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www.spc.uk.com
THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Compromise Agreements
• Revisit Bradstock at PPF plus level • Japan Airlines? Revise the law? • Clearance and the TPR view
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THE SOCIETY OF PENSION CONSULTANTS
The representative body for pensions
Investment
• Link funding and investment• More control for Employer• Investment Sub-committees• Contingent assets
– Link to investment strategy / swap style – Is it legal?
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Trustees’ response
• Employer involvement in investment
- Decision-making
- Conditionality
• Cash is king – always?