Without Guarantees, More Cash for Pensions is Required Sooner AND Later
The Pensions Regulator’s funding statement requires pension schemes to be funded to a level at which they are financially independent of their corporate sponsor – ASAP. Pension Sufficiency Guarantees backed by leading banks and insurers can help achieve the new target.
“The Pensions Regulator spells out its expectations clearly. Long term funding targets have to be put in place. Corporates should respond positively. Move decisively to a defensible position. Protect members and look after your cash. All is achievable through third-party, risk diversifying guarantees. Banks and insurers are ready to make it happen. (Corporates’ New Pension Funding Dilemmas. Problem: Solution: Action Plan)” William McGrath, Founder C-Suite Pension Strategies
The Pensions Regulator – Annual Funding Statement March 2019: A Summary
The objective of a defined benefit scheme is to pay the members benefits when they fall due. To achieve this the trustees and employer need to agree a long-term funding target (LTFT) which is self-sufficiency described by TPR as follows;
This target would, for instance, be for the amount of assets the scheme would need by the time it has reached a level of maturity when it would be prudent to reduce the scheme’s dependence on the employer, in order to allow it to be managed thereafter with a high degree of resilience to investment risks.
In the meantime;
Investment and funding strategies in the interim period are then aligned to the LTFT via journey plans which look beyond becoming fully funded on a TPs basis, to becoming fully funded up to the LTFT.
Thus, TPR is now expecting DB schemes to be funded to self-sufficiency and as quickly as possible.
The length of the recovery plan relative to the level of deficit, the strength of the employer covenant, and the scheme’s maturity. Our data indicates the median recovery plan length to be seven years, so we take the view that the schemes with strong covenants should generally have recovery plan lengths which are significantly shorter than this.
the important consideration is the interaction between (a) the level of assets, the degree of underfunding and the amount of benefits paid out, and (b) the scheme’s ability to close the funding gap from investments and new contributions in a reasonable timeframe.
Strengthen TPs, increase DRCs and reduce recovery plan lengths.
Also, TPR has concerns about equitable treatment for the pension scheme
The steps taken by trustees to challenge covenant leakage and secure a fair deal for the scheme.
Where dividends and other shareholder distributions exceed DRCs, we expect a strong funding target and recovery plans to be relatively short.
However, TPR does acknowledge that it may be appropriate to introduce “external” funding into the equation.
Test and evidence the ability of the covenant to support downside investment risk (supportable investment risk) by means of additional cash and non-cash funding, without extending the length of the recovery plan
consider using escrow, asset-backed contributions (ABCs), and contingency planning
in addition to enhancements to the recovery plan, strengthen short-term security through other means such as contingent assets and guarantees where available.
priority being to protect the scheme and employer from further downside while improving funding position by further cash and/or contingent assets
Consider non-cash funding options, eg ABCs, guarantees to strengthen security
TPR is also able to consider Group support.
Where employer is part of a stronger group, seek wider group support through cash and non-cash support
with a greater focus on securing wider group support where available
trustees consider that further support is possible (from the employer or wider group)
For many international groups the UK is a high cost, low return market because of the cash contribution required of their UK operations for their pension schemes. Particularly hard hit are long established, niche manufacturing and industrial businesses right across the country.
Research by C-Suite Pension Strategies using Company House filings shows pension contributions are often greater than capital expenditure, research and development and corporation tax. Making the case for investment for modernisation is hard for local management when most of the profit is taken up in funding pensions. Cash requests are set to increase from trustees responding to a newly “Stronger Pensions Regulator” wanting funding beyond the current statutory requirements. Fines and criminal sanctions are to be introduced. It does not tip investment decisions in favour of the UK over other available facilities.
Last year, The Pensions White Paper and practice notes from The Pensions Regulator showed determination to see schemes well-funded and members protected. This has been seen as requiring derisking of investment and more cash sooner from the sponsor. An alternative is needed. That can come from Groups with UK schemes explicitly using their standing with their banks/insurers to provide contingent back-up for their obligation to make, eventually, the scheme financially self-sufficient. With a guarantee in place, now all parties can look again at the long-term investment strategy and avoid its growing dependence on a sponsor’s cash.
The research shows that in numerous low profile companies pension funding is a major issue. Many jobs are at stake. Sympathy in distant head offices is not to be expected. Action is needed.
The beneficiaries of an alternative approach can be the niche subsidiaries of major groups. The pension industry can adjust to bring in new money from banks/insurers whose credit assessments are directly relevant. Achieving sustainable growth is an established regulatory objective. Offering well resourced Groups more attractive UK investment propositions is needed to sustain the industrial base.
“All stakeholders are better off, if a sponsor provides risk diversifying, third-party insurance back-up for its obligations. Derisk the covenant and trustees can go with investment strategies which reduce the heavy, growing dependence on the sponsor. Redirect resources to the sustainable growth of today’s business.” William McGrath, Founder C-Suite Pension Strategies
“Balancing risk and return can be an impossible task for trustees, sponsors and their advisors. Using third-party back-up through Pension Sufficiency Guarantees can make a real difference and should become part of mainstream product offerings to address the challenges of Integrated Risk Management (IRM).” Alan Baker, C-Suite Partner, Former DB Risk Leader, Mercer
The Krusevac Illustration
.Cooper Tires of Ohio is spending €40m expanding in Krusevac and cutting 300 jobs at its Avon Tyres plant in Melksham, Wiltshire.
In the six years since its Serbian plant was acquired for €13m, it has already received €50m in new investment. In the same timeframe the UK operation has made £55m in operating profits. It has paid £42m into its closed final salary pension scheme – more than capital expenditure of £25m and development costs of £15m. The position is not set to change with a newly ‘tough’ Regulator and consensus thinking wanting schemes funded by their sponsors to buy-out.
With UK pensions absorbing such a high proportion of profits, it must affect any corporate’s steering of investment decisions.
Pension funding is behind a generation of old industrial businesses – many now parts of major international businesses – withering away. Pension contributions are often far higher than the tax bill and dividends. It makes pensions a major negative when groups allocate capital for investment. And it is unnecessary.
Coopers are not alone. From basic industries to specialist engineers, many are on the same track. Even Berkshire Hathaway – not a great credit risk – has six UK industrial companies paying on aggregate 30% of their UK profits into pension schemes – in two cases with funding topping profits.
The car industry has many issues to address. One for Honda Europe is that over the last 6 years it has contributed £265m to its still open to accrual pension scheme while in that time making an overall loss in that time. Its Swindon plant shuts in 2022. Jaguar Land Rover put £285m last year into its £8bn pension which had an accounts deficit of £415m.
Right now, when a Group Board looks at the profit and cash hits UK pension funding causes; realises that the returns on any new investment could be syphoned off by independent trustees - heads shake and the conclusion is “avoid”.
There needs to be a Plan B if the rubber is to continue to hit the road in Melksham and for whole sectors not to be breaking steadily to a stop. Pension Sufficiency Guarantees can trigger a Plan B