Ian Smith explores how the Air Products plan and others have dealt with their overseas parent employer to avoid covenant risk, as experienced by Alitalia's UK scheme
Schemes with overseas sponsor companies risk insolvency if they fail to communicate openly with those parents about covenant guarantees.
The ongoing fight by Alitalia's UK pension scheme to recover its deficit demonstrates the risk to members' retirement income posed by a weak employer covenant.
The scheme's parent employer was once 49.9% owned by the Italian government, but it landed in the Pension Protection Fund (PPF) assessment period in 2009. If it had entered the PPF, members would receive a reduced pension.
Richard Blamey, trustee to the Air Products plan, said the onus was on the scheme to make sure the overseas employer was "fully aware" of the covenant regulations around UK schemes.
In his experience at Air Products, where he was previously pensions manager, Blamey said he had not experienced any trouble on securing commitments from the parent, once the management had understood what was expected of them.
“It is really to have a good dialogue with the employer," he said. "You need to make sure they are on board and understand what the requirements are. No one’s going to give you money for free."
He added: "I don’t think there’s any need to pussyfoot around.”
Covenant experts, along with the Pensions Regulator and schemes including Air Products, have told managers to build communication with their sponsor over UK regulatory requirements, and to be forceful in their negotiations.
Air Products trustee Richard Blamey said schemes should start a "good dialogue" with the employer around UK legislative requirements, adding there was no need to "pussyfoot around" the subject.
They have also been urged to look at how integral they are to the wider financial health of the group within which they are situated. If necessary, they could request further security from those parent companies.
"The first question the trustee needs to be asking is can we have a guarantee from the parent," said Adrian Duncan, a partner at Jackal Advisory. "If the trustees cannot get that it becomes more difficult.”
Negotiations can descend into a "circular argument", Duncan added, if the parent refuses security, assuring the scheme of the wider health of the group. For the scheme, this begs the question why it will not provide cash or other support.
The covenant assessor looks at the potential damage to the brand of neglecting its UK pension promises, and how integral the UK scheme is to the wider group. Duncan said schemes can be asking the same questions of themselves.
There are all kinds of security schemes can be offered, from a contingent asset such as property, to an escrow account being set up which pays out funds once certain conditions are met. These security measures incur their own charges which need to be taken into account.
Winners and losers
Italian airline Alitalia's UK pension scheme entered the PPF assessment period in 2009, after its parent company – in which the Italian government was the major shareholder – was broken up by a state move. This effectively separated the scheme from much of the company's assets.
Last year, the scheme agreed a £53m buy-in with Pension Corporation while it attempted to recover its £22m buyout deficit. This extreme case demonstrated how even government-backed schemes can suffer from covenant difficulties.
Great Lakes Pension Plan was more immediately successful in securing a £60m funding deal using a combination of regulator pressure and an innovative legal move in the US courts.
In its most recent guidance on monitoring the employer covenant, the regulator offered a case study of an underfunded scheme attached to a UK subsidiary of a US firm. The parent provided a letter of recognition of the scheme, but no "legally enforceable guarantee".
As the UK was no longer the company's centre of production, the scheme's covenant assessment led it to request a guarantee from the parent company.
Agree certain performance thresholds, with scheme to be informed if broken;
Grant the scheme insolvency priority, and even relegating other creditors;
Negative pledges: agree not to perform certain actions without scheme consent;
Step payments: increase funding upon certain triggers;
Take on joint and several liability for the scheme;
Change the scheme rules to give it more power;
Make use of non-cash transfers and contingent assets.
Source: Pensions Regulator
In return, the scheme accepted a longer recovery plan and no strengthening to the technical provisions.
A regulator spokesperson urged schemes to understand the "wider corporate family" of their employer, while acknowledging the complexity of the task for schemes when their corporate structures break into other jurisdicitions.
But the regulator added: "Trustees can consider putting in place information arrangements to understand what is happening in the wider company structure.
"A guarantee or other form of security at the parent company level, if properly enforceable, may help mitigate some risk."
Schemes should "prepare plans for realising the employer support" behind them, including any necessary extra protection. It called on sponsors and the wider groups concerned to "work openly" with their plan representatives.
“When considering the use of contingent assets, trustees are likely to require specialist independent legal advice to ensure the agreement is appropriate, enforceable, and to also clarify if any other parties also have a legal interest in the asset,” said the regulator.
