Protecting pension schemes from employer distress

Written on 18 Nov 2020

New guidance from The Pensions Regulator gives trustees strategies to consider

When a scheme employer is in financial distress, the options available for protecting defined benefit (DB) schemes and their members can be limited and actions taken by the employer can result in serious scheme losses.

With this in mind, the Pensions Regulator (TPR) has published guidance on steps that all DB scheme trustees should take to help protect their scheme from employer distress. The guidance aims to "empower… trustees to be aware of risks and tackle challenges themselves, allowing TPR to concentrate resources where they are needed most."

The guidance states that trustees are "the first line of defence for savers and their pension schemes, and it is vital that [they] remain alert, prepare, plan and are ready to act as the economic impact of global events develops".

Corporate 'stress curve'

The guidance uses the concept of a corporate "stress curve" to illustrate a hypothetical employer's downturn towards insolvency. It highlights the steady decrease in options for trustees to improve a scheme's position as a sponsor becomes more distressed. It also picks out strategies that trustees should focus on, depending on where their employer sits along this stress curve.

The stress curve divides sponsors into three groups, depending on the level of distress they are facing: sponsor showing no signs of distress (best practice integrated risk management (IRM) approach); sponsor showing signs of distress; and distressed sponsor facing the prospect of insolvency.

Trustee top tips

We've pulled out six top tips that DB trustees should take from TPR's guidance.

Sponsor showing no signs of distress

Put effective IRM processes in place This ensures that warning signs are spotted early on to minimise potential damage to the scheme. Ideally, legally enforceable contingency plans (with specific trigger points) should be put into place, but, where this is not possible, trustees and sponsors should agree the actions to take if signs of distress were to materialise.
Monitor the covenant This helps determine the potential impact of stressed scenarios on the sponsor and its ability to cope with adverse market conditions.

Sponsor showing signs of distress

Increase frequency of covenant monitoring and review investment strategy Intensify the level and frequency of employer covenant monitoring proportionate to the amount of risk as soon as possible after signs distress start to show. Consider whether the investment strategy needs to be changed: is the level of investment risk still supportable given the sponsor ultimately underwrites this risk?
Understand other stakeholder interests Be aware of the position of other stakeholders, such as Banks and other creditors, and request to be informed if stakeholders seek to negotiate improvements to their position that may damage the scheme's position.

Distressed sponsor facing prospect of insolvency

Engage with the Pension Protection Fund (PPF) and seek professional advice

The PPF has provided guidance on contingency planning, setting out the practical steps to take to ensure a scheme is in the best shape should it enter PPF assessment. To find out more, please contact Helen Beckinsale at the PPF either at helen.beckinsale@ppf.co.uk or by telephoning 0208 633 5850.

Trustees should take advice from a specialist restructuring adviser to make sure they have explored all options to protect the scheme's position, and, if the scheme has a contingent asset or other security, understand the steps to take to enforce it. Helen Beckinsale at the PPF can put you in contact with a member of the Trustee and Support Services Panel who provides schemes with this specialist advice.

Implement a communication strategy for members This is crucial for making sure members understand the protections in place for DB schemes, including PPF compensation, and to help with any concerns they may have of the circumstances surrounding the sponsor. Members should also be made aware of the potential for pension scams, particularly around transferring out to an arrangement that is not in their best interests, by issuing the joint letter on pension scams to any member requesting a cash equivalent transfer value.

Osborne Clarke comment

Regardless of the current strength of the employer covenant, trustees should act now to ensure they are prepared for the risk of employer distress by following the strategies outlined in TPR's guidance. This includes familiarising themselves with the PPF's guidance on contingency planning and implementing the practical steps suggested.

The earlier trustees take action, the more options they will have to protect the scheme from any negative impact in the event the "worst case scenario" materialises. They do not need to wait until their sponsor shows signs of distress.

Osborne Clarke is a member of the PPF’s Legal Panel, providing legal advice in all areas to the PPF and specialist pensions law advice jointly to the PPF and trustees of schemes that have entered a PPF assessment period.

Additionally, Open Trustees Limited, a sister company to Osborne Clarke and a member of the PPF’s Trustee and Support Services Panel, is appointed by the PPF to act as trustee of schemes that have entered a PPF assessment period. Open Trustees is also on the Pensions Regulator’s list of approved trustees.