Download a PDF version of the results (PDF - 1mb)

The impact of the global financial crisis on financial markets and the wider economy deepens by the day. For those entrusted with managing defined benefit (DB) pension schemes, the problems brought by the credit crunch and the ensuing recession are making an already difficult task even harder.

Our Covenant Assessment Services group has recently completed a survey, targeted at DB pension scheme trustees, to determine how employers are coping with the current turmoil and how confident scheme trustees are in their employers’ ability to survive the recession.

The majority of DB schemes were already in deficit before the global credit crunch hit and have a recovery plan in place. We wanted to see if the current crisis has put those payment plans under threat and to determine the extent to which trustees have been able to mitigate risk of employer default.

79% of survey respondents reported that their scheme is in deficit, with recovery plans in place. The average length of these recovery plans is just below nine years. This sits well with the Pension Regulator’s unofficial ‘target’ of keeping recovery plans at ten years and under.

Reasons to be cheerful

Despite the gloomy reports about the economy, our survey showed that trustees are, so far, satisfied that recovery plans are on course to be fulfilled and were surprisingly optimistic about the future:

• Recovery plans are not currently in danger – only 2% reported that their employers have defaulted on their recovery plan and only 2% reported a request by their employer to re-negotiate the recovery plan.
• Trustees are confident that their sponsoring employers will survive the recession – the average confidence factor was a surprisingly high 85%, with almost one third giving their employer a 100% confidence score.

The minimal incidence of recovery plan defaults to date may be an indication that employers have been highly prudent in what they have offered to pay out of free cash flow, allowing for eventualities such as the recession we are now witnessing.

Another explanation could be that the full extent of the economic crisis has yet to impact on the employers’ profitability and cash generation that there could be a steady increase in the number of defaults – or re-negotiations – in the coming months. 

Baker Tilly intends to keep a close eye on this over the coming months and will survey pension trustees again later this year to monitor any potential increase in the number of defaults in recovery plan payments.

Mitigating risk

Our survey also aimed at examining the extent to which trustees have used other techniques to mitigate the risk of employer default to their DB scheme.

One way is to ask for security over the sponsor company’s assets, giving the scheme some asset value to turn to if the company were to go bust. Only 6% of our survey respondents have security in place. While this seems low, our experience is that security is not easy for trustees to obtain.  The main reasons for this are either a lack of available security, or effective blocks being imposed by existing secured lenders, or lenders imposing ‘negative pledges’ preventing the granting of security to the pensions scheme.

Baker Tilly’s view is that trustees should be persistent in trying to obtain security, but they should recognise that the credit squeeze is likely to harden banks’ attitudes such that they will grab all available security for themselves.

Securing a scheme guarantee

On a more positive note, nearly a quarter (23%) of those surveyed said that they had secured a guarantee from the parent company to protect the scheme. This seems to be the most readily accessible form of ‘contingent asset’ cover available for schemes whose employers are part of a group. Baker Tilly encourages trustees to press hard for these guarantees where relevant. They act as a good hedge against the risk of groups dropping the sponsoring employer but unfortunately the guarantees would be of dubious worth in the event of a total group collapse.

To conclude our survey, we asked trustees which one piece of legislation they would like to see implemented, which they think would be most helpful in addressing the DB underfunding problem.

The vast majority called for a reinstitution of ACT credits on dividend income. The repeal of these tax credits was one of the first pieces of tax reform that Gordon Brown introduced when he became Chancellor in 1997. Twelve years later, it remains the pension community’s most reviled piece of legislation, albeit one which seems beyond the point of reversal.

Reflecting on the findings

“I was pleasantly surprised to see the very low incidence of recovery plan default so far, despite what must be mounting pressure on most sponsoring employers' cash flow. On top of that, the trustee chairs who responded to the survey are showing a generally high level of confidence in the ability of their employers to survive the recession. This is great news and I sincerely hope that these sentiments are proven right. We intend to do a follow-up survey later in the year to track these confidence levels and the 'stickability' of recovery plans.

The Regulator has signalled the way for trustees and employers to be pragmatic and flexible about dealing with employer cash pressures and that is very helpful. However, trustees must never lose sight of opportunities to optimise their scheme's position, balancing that imperative with the long term objective of allowing the scheme sponsor to survive and support the scheme for its entire life-cycle. The life of a typical DB scheme trustee will get appreciably tougher over the coming months and their professional advisors should be on hand to help steer them through some difficult times”

Bruce Mackay, National Lead Partner, Baker Tilly’s Covenant Assessment Services Group

 Download a PDF version of the results (PDF - 1mb)