Kevin Dolan
A scheme sponsor in financial distress can shift a pension trustee’s world. In many instances an insolvency, or the threat of one, wouldn’t be on a trustee’s plan at all. There’s plenty to consider and action to be taken. Without the right skills and experience, a lot can potentially go wrong too.
But there's always the Pension Protection Fund (PPF)! Well, yes and no – and we've seen industry commentators question how trustee boards consider the PPF's existence, particularly where the sponsor is in distress, so perhaps there is a lack of clarity.
Let's address that first. Ahead of an insolvency event, when performing their duties under part 3 of the Pensions Act 2004, a pension trustee/board should not consider nor take advantage of the PPF's existence as a justification for acting in a way which would otherwise be inconsistent with those duties (as decided by Hope v Independent Trustee Services, 2009).
Put simply, trustees shouldn't consider the PPF's existence when making decisions in the lead up to insolvency and should continue to focus entirely on the interests of members by protecting and potentially enhancing their position. Following insolvency, an eligible defined benefit (DB) scheme will nearly always fall into PPF assessment but this isn't the same as the scheme automatically transferring into the PPF. That's an important point. During assessment, the PPF will consider matters including a scheme's governing documents, member benefits and funding position to determine whether the scheme should eventually formally enter the PPF. This means a trustee's work in the lead up to insolvency can prove critical.
Key factors for trustees to consider
There are many issues for trustees to consider when their scheme's sponsor is in financial distress. They need to look critically at the way they operate the scheme, reviewing structures in place, consider the risks posed by the employer's financial position and ensure the trustee board has the right mix of skills, knowledge and expertise to overcome the challenges encountered and make decisions in the best interests of members.
The are many questions trustees should be asking. Are pension scheme rights protected relative to other creditors? How can we best manage and potentially seek to enhance potential recoveries for the scheme? What options are there for scheme funding and investment – should a derisking strategy be adopted? Trustees should always, if feasible, look to secure benefits for members in excess of PPF levels of compensation.
Early and ongoing consultation with the employer and its advisers to monitor covenant strength is often key, especially if a financial restructuring of the employer's financial position is proposed. That way trustees can get a seat at the table and have some influence on negotiations that follow.
Dealing with a distressed employer is typically fraught with challenges where outcomes can be uncertain, emotions can run high, relationships can be strained and stakeholder interests are varied. This is a time when negotiation and stakeholder management skills are crucial for trustees as there are a plethora of parties involved, including representatives from The Pensions Regulator (TPR) and the PPF, with potentially differing agendas. The interests of all stakeholders need to be recognised and understood. While the interests of pension stakeholders are often aligned, trustees taking risk based decisions should focus on the expected outcome whilst complying with regulatory guidance and legislative duties.
Whatever happens, it's important for the trustees' journey plan to consider all available options and final destinations – including insurance (PPF+ or full scheme benefits), alternative solutions (eg capital backed journey plans and consolidators) and the PPF.
Throughout the process, trustee decisions should be made to make members as secure as possible. This involves balancing the level of benefits for members, the cost of securing those benefits and the level of certainty about whether those benefits will be paid. Insured buy-out solutions often provide the most certainty, but this transfer of risk can prove expensive. Consolidators and capital backed journey plans are less certain but can achieve higher benefits at a lower cost than insurance. No one size fits all and all options should be considered carefully.
One thing that's often consistent across employer distress cases is complexity. To handle the challenges that arise effectively and give the scheme and its members the best chance of a positive outcome, trustees need to understand the entire process from beginning to end and how that can impact every decision that needs to be made. Pension trustees need to act as soon as they have the slightest hint of potential sponsor distress. Effort, collaboration and negotiation can often produce a much improved outcome for a scheme and its members with no reliance placed on the possibility the PPF assuming responsibility.
Kevin Dolan is a client director at Vidett
