Boards should respond positively to the Government’s recent initiatives on pension funding. They should, however, be aware that pension trustees have the remit to cut across their dividend, leverage and transaction plans. The Pension White Paper and the Consultation on a stronger regulator shows there will be no let up until a pension scheme is financially self-standing. With fines and criminal charges as threats, financial and reputational risks need reassessment as part of good corporate governance.
The accounting consequences for balance sheets and profit and loss accounts of higher funding targets could prove significant for some corporates.
Responses should be decisive. Muddle through or ignore can no longer be the Board’s approach. Move to a defensible position - from there the Board can again look at the wider picture.
To achieve it Boards need to allocate financial capacity to provide third party, investment grade back up to their covenant. This is to cover the gap between assets held today and the value of assets needed to reach self-standing status. The gap is often large but bridgeable given the sponsor’s financial capacity. Unless the cover is rolled forward, it becomes payable.
The Board covers the key contingent risk. Trustees and actuaries can then look themselves more positively at the journey ahead. The aim should be to set and keep a solid, long term investment strategy without excessive further de-risking. That means more investment returns and less company cash contributions to make up any funding gap. How much prudence do they want in their assumptions and how much cash do they need now? All stakeholders benefit.
“Government action can trigger a positive reaction with sponsors allocating contingent resources to deal with funding gaps. Then investment returns not company cash can provide plan A to achieve self-sufficiency. Act decisively, move to a defensible position and all stakeholders benefit”. William McGrath, Chief Executive, C-Suite Pension Strategies
The Trustees’ journey plan to self-sufficiency can hit company balance sheets and profits.
The 2018 White Paper on Pension Funding requires trustees to have pension scheme plans to achieve self-sufficiency. They have to report on the plan to The Pensions Regulator. Liabilities for self-sufficiency are around 15% to 20% above the actuarial technical provision numbers. The money can only come from investment outperformance or from the sponsor. However, for most schemes there is little asset outperformance post the recovery plan. That means the sponsor is paying. So if the company has to pay, why is the additional deficit not shown as a balance sheet liability and being reflected in a higher annual P&L charge? This is an area in which accounting standards changes must come soon.
The wind has already picked up in this area. IFRIC14 questioned what to do when the recovery plan payments to a pension scheme are larger than the deficit to be covered as set out in the accounts. The idea was that so long as a surplus could be retrieved, then there was no additional liability. But trustees will not let a surplus arise because they can settle liabilities. The get out clause falls away.
The higher funding targets provide an extension to the logic flow of IFRIC14 and there may be consultations to come on this subject.
The clouds are dark: how to disperse them
Companies should be looking to agree to keep investment return assumptions for longer. For trustees to agree to less derisking, they will need a rationale. The sponsor can give this rationale by having a third party insurance policy to cover the gap between assets held and the asset value that gives self-sufficiency. Now the assumption can be that there will be less derisking and the investment returns will cover the gap. There is no need to book the additional liabilities and related P & L impact.
As the weather has changed Boards should address the subject of pension funding.
Founder of C-Suite Pension Strategies, William McGrath, has long experience as an executive director of preparing company accounts where accounting for pension schemes has been a material item.
The C-Suite team has the breadth of experience needed to optimise outcomes for all stakeholders.
The Problem Statement
Pension funding is bringing new reputational, governance, finance and accounting problems to Boardrooms. 2018 Government actions and regulatory changes have raised the stakes.
The mix of low interest rates and the derisking of investment returns is recognised as causing issues. Now, the funding targets set for schemes under the Pension White Paper are to move to self-sufficiency and buyout. Unless asset returns deliver the extra money, corporates will be paying considerably more in cash than their accounts suggest.
Further, the “Stronger Pensions Regulator” can cut across corporates’ dividends, leverage and transaction plans. The powers are backed with reprimands, fines and criminal sanctions. Reputational risks for directors and trustees have increased considerably. Corporate governance processes will need to give executives clear guidance for the thankless task of reaching agreement with trustees and the Regulator.
With higher financing targets coming, accounting rules will soon catch up and cause balance sheet and profit hits.
Corporates can respond positively to the problem and move decisively to a defensible position.
– Third-party, risk-diversifying insurance carved out of the sponsor’s financial capacity. If it is not maintained the amount becomes payable before the insurance can lapse. Covering the gap between assets held today and self-sufficiency means the scheme cannot fall into the Pension Protection Fund.
In exchange for:
– An agreed investment strategy that can generate returns to cover the funding gap over time without recourse to the corporate for high cash contributions.
– An agreed framework for actuarial liability calculations as part of an agreed Integrated Risk Management exercise which makes prudence levels more transparent.
The benefit of the higher returns is much greater than the cost of the insurance.
The Action Plan
C-Suite Pension Strategies has the ideas and the actuarial and insurance sector contacts to make implementation possible
The Government triggers action; corporates respond and all stakeholders’ interests are well served.