Don't Let Pensions Disadvantage the Home Team

International Groups with UK Subsidiaries
Pension Funding Constraints on Investments

Over a long period, international groups have acquired UK businesses, often as part of expansion and rationalisation programmes.  Corporates in manufacturing and basic industries with long histories and material DB pension schemes have fallen into this category.

The potential cost of the schemes was not recognised on acquisition.  As pension funding has become a more material factor it has also become a major drag on performance.  This in turn leads to uncertainty and can create disincentives to invest in the UK.  The concern is that better performance could simply trigger more rapid cash contribution requests.

Balancing statutory obligations in the context of International Groups
As The Pensions Regulator looks to balance protection of the PPF and member benefits with sustainable growth, there is a sub-group of sponsors and their pension schemes which may benefit from a reassessment of options available.  This applies particularly where the UK operation has a scheme that is material to it but where the scheme is not substantial from a Group perspective.

Factors to Consider for International Groups with UK Subsidiaries

• Low level understanding at Group of UK pensions.
• Confusion about the role and powers of UK trustees.
• Corporate governance: communications/responses between group and UK subsidiary are often weak.
• Reluctance of central team to delegate authority to the subsidiary on financial matters.
• No desire to provide Group guarantees or allow subsidiaries to provide them.
• Legal advice aims to avoid taking legal responsibility beyond corporate veil.
• Group not in a position to challenge advice/requirements of trustees/advisors, given the strength of the trustees’ team and access to data.
• Mechanism not effective to make Group’s strength reflected in approach to subsidiaries - scheme specific funding not very specific.  Strong to weak makes little difference to actuarial assumptions.  Benefits of providing additional support are unclear
• Consequence is international groups overfund UK pensions and are unsure what the economic drivers are.
• Makes UK unattractive for investment as the future cash flows are uncertain.
• Significant number of extreme cases: reflected in low levels of investment in UK.
• Old plant with ageing workforce not receiving support.

The way the sector operates is not serving the interests of the workforce or economy and the concern is that there is now the quiet death of old economy UK plant with increasingly absentee landlords.

Against this background, C-Suite Pension Strategies thinks the scale of the issue warrants attention.  Looking harder at the options that should be considered by international businesses looking at the approach to financing UK pensions schemes should be considered.

C-Suite believes that the strength of international groups should be impacting more on pension funding.  To make this possible, such groups should provide third party guarantees of a level of funding.  This means that the trustees of the UK schemes and its advisors can tap into the credit status of the Group without having to make the credit appraisal themselves.  They know, however, that a fall-back position exists.

The guarantees mean the investment strategy of the UK scheme can be reset to provide steady, long-term, balanced returns.  It also means that the actuary can look at the levels of prudence required in actuarial assumptions.

To support the approach, C-Suite combines key threads:

• Major investment managers would expect to deliver low risk, largely interest rate hedged portfolio, generating +/- gilts plus 2%.  This can be on a fiduciary basis.
• Major banks / insurers will provide on demand letters of credit to trustees to cover remaining funding gaps to low dependence or buyout.  Resource levels depend on sponsor strength.
• Letting schemes “run on” can generate surpluses, particularly when actuarial prudence in demographic assumptions “trues up”.  The benefits arising can help finance the letter of credit costs and add to pension benefits of a sponsor’s employees of yesterday and today.
• A rethink is warranted and all stakeholders can benefit.

International groups are ready to do the right thing.  Provide the framework to look after pensioners and invest in the future.
​
International groups are unlikely to be advised to provide Section 75 guarantees taking on liabilities directly which third-parties set and can reset.  They can, however, provide from established financial capacity, guarantees through third-parties of funding to self-sufficiency.  The impact on pension contribution requirements shorter term and the balance with R&D and capital expenditure can then be reassessed by the Group.  It provides an approach by which TPR can make progress against all its statutory obligations.