COVID-19 continues to challenge the pension industry. Charles Counsell, The Pensions Regulator’s Chief Executive, explains what defined benefit trustees can expect from the regulator and how to prepare as the economic impact of the coronavirus continues to hit schemes and sponsoring employers.
When lockdown began on 23 March the long-term economic impact of the coronavirus was far from clear.
We quickly released guidance helping trustees, employers, scheme managers and savers navigate immediate challenges. But, four months on, it’s clear we’ll be dealing with the economic fallout for some time.
The pandemic will be challenging all scheme types, but I’d like to take some time to focus on the emerging issues facing defined benefit (DB) schemes. We will, in due course, be highlighting important messages for other scheme types, including defined contribution, master trusts and automatic enrolment pension schemes.
We are committed to protecting savers and driving up pension standards. This is still at the heart of what we do. But an altered environment needs an altered response. To help schemes weather the storm, our supervision teams have been busy engaging with DB trustees, sponsoring employers and administrators to address key risks.
We contacted schemes already subject to our Relationship Supervision to build a picture of their COVID-19 response. Initial conversations focused on ensuring core work – such as paying benefits – continued. We found business continuity plans had worked well, ensuring scheme administration remained strong despite the challenges from transitioning to remote working.
We refocused our Relationship Supervision approach to meet emerging challenges. Where we would have reviewed every part of a scheme, we moved to concentrating on the areas highest risk – such as the increased risk of an insolvent employer or a weakening covenant. This is temporary, and we will revert to our original approach when circumstances allow.
We have also increased our Rapid Response and Events Engagement teams, who manage situations of crystallising risk, including the impact of corporate distress or transactions on DB schemes. To do this, we temporarily paused our regulatory initiatives – targeted engagements on specific risks, for example equitable treatment of DB schemes against dividend payments, or investment governance. By targeting individual risks, we have been able to cover many schemes, regardless of size.
Despite the very positive results from these initiatives, we did not want to overburden trustees during the pandemic and wanted to free resources to support those schemes particularly hit by rising levels of corporate distress. This approach remains under review and we will return to these initiatives as soon as appropriate.
Since March, we have received 108 revised recovery plans. Of these, almost 86%  have seen schemes agree to defer their employer’s deficit repair contributions (DRC) allowing some room for manoeuvre. The majority were from small schemes and relate to sectors under increased strain from the impact of COVID, such as the manufacturing, retail and airline industries.
With the government’s coronavirus job retention scheme ending in October, and other support being unwound, employers will continue to experience significant financial challenges and some, sadly, will fail. Despite figures showing corporate insolvencies declined between April and May, insolvency and restructuring trade body R3 argue this is the “calm before the storm”. Ric Traynor, Group Executive Chairman of business rescue and recovery specialist Begbies Traynor warned at the end of last month “we’ll see numbers of insolvencies in excess of what we saw in 2008” and the firm would be increasing its insolvency division’s staff to handle an expected spike in numbers. The Pensions Regulator (TPR) expects more COVID-linked insolvencies in the autumn and during 2021 and more companies to be looking at restructuring. In these situations, trustees continue to be the first line of defence for savers.
With about 5,500 DB schemes, TPR cannot get involved in every situation – which is why it’s so important trustees engage with employers early and engage well. This will help trustees understand the flexibilities that could be offered to distressed employers where appropriate and how to structure support so it doesn’t disproportionately weaken their scheme.
Empowering trustees through our guidance to have the right conversations at the right time, means TPR can concentrate on areas of greatest risk and reduce any potential extra burden on trustees from a regulatory intervention. Employers should, by this stage, be able to provide necessary financial information to inform trustees’ approach.
Fair treatment in tough times
We know, long term, the best protection for a DB pension scheme is a strong, solvent employer, which works with trustees to put the needs of the pension scheme on an equal footing to other business considerations.
As DB pension schemes are often a businesses’ largest unsecured creditor, trustees may be asked to support restructuring plans for businesses which are struggling. Trustees should be open to reasonable requests from an employer in distress but must make an informed decision if it’s in members’ best interests to agree.
If it is judged necessary and appropriate to suspend or reduce contributions from an employer experiencing financial distress, trustees should seek appropriate mitigations. These may include:
• cessation of dividends and other covenant leakage until deferred or suspended contributions are paid
• arrangements for contributions to resume or increase based on appropriate triggers (for example, if the employer’s performance is better than expected, automatic increases in repayments linked to performance exceeding forecasts or when access to liquidity above a certain level is restored)
• ensuring the payment period for recovering suspended contributions is no longer than the scheme’s existing recovery plan timeframe, unless there is sufficiently reliable covenant visibility available to suggest otherwise
• ensuring the scheme has the same recourse and access to security or valuable assets as other creditors, for example with deferred sums being given the same protections as new money lending
• ensuring the scheme is treated equitably compared with other creditors
• agreeing appropriate, regular, forward-looking and actual financial information is shared to identify changes in employer circumstances and the position of its funders
In restructuring situations, our supervision teams will expect trustees to have a robust plan, which may include bolstering the expertise of the trustee board and seeking professional advice. Trustees may need to look beyond their usual advisers and not be limited to just covenant advice but also on understanding their scheme’s position and options during restructuring and insolvency.
Trustees may be conflicted about their duty to their members and desire to support a distressed sponsor. If this becomes difficult to manage, trustees should consider conflict management advice or bringing independent trustees with restructuring experience onto the board.
Asking an employer to pay for advice at a time of financial distress may feel uncomfortable, but trustees will need a good understanding of their options if they are to support the business effectively without disproportionately disadvantaging their scheme.
Trustees facing difficult decisions should, especially if hindsight proves they made the “wrong” call, be able to show they made an informed choice by demonstrating that they obtained all the relevant information they could, took advice when appropriate and made decisions in good faith and in accordance with scheme rules. Keeping clear records of the basis of decisions will also be important.
Keeping a struggling employer afloat should not come at any cost. For those DB schemes with an insolvent sponsor, savers will be protected the Pensions Protection Fund (PPF). However, TPR also has a statutory obligation to protect PPF. While the PPF plays a vital role in compensating pensioners where employers do fail, we need to minimise financial claims as they put a further burden on PPF levy payers – those companies (with DB schemes) that have not failed.
Armed with robust financial information, good advice and guidance, trustees can manage the risks from a struggling sponsor and continue to act as the first line of defence for their members.
While TPR cannot solve all scheme problems and must focus available resources in a strategic and risk-based manner, we stand ready to provide trustees with the tools needed to protect their members and, where appropriate, support a sponsoring employer without disproportionately weakening their scheme.
By Charles Counsell