Employer growth emphasis will separate the wheat from the chaff

This clearly benefits employers – but what about scheme members? The recent market movements on interest rates, inflation, longevity, bonds, gilts and equities have all conspired to highlight, or exaggerate, the significant deficits contained within defined benefit schemes.

The problem is these widening holes in scheme finances merely highlight the inherent risk the schemes are running, and giving the employer more time to fund the gap does not really address this issue.

The regulator has recently stated that only 20 per cent of UK schemes have a “strong” employer

Also, every pound that is not in the hands of the trustees is at risk of being lost. Many chief financial officers may argue trustees also have an alarming tendency to lose that pound, but the recent policy shift to give employers more time to pay makes member security less certain. 

Its certainty will depend on the risk of the employer losing that pound compared with the risk of the scheme losing it.

Of course, the stronger companies will no doubt argue they need the money to reinvest in the business, where the internal rate-of-return calculations are significantly higher than what the cautious trustee is investing in – but there is a reason for that. 

The capital projects are not guaranteed to return their targeted IRRs, and the trustees have to be a lot more conservative in their investment choices. 

Understanding pension risk and how it interacts with business risk is part of the journey upon which the employer and trustee must embark. 

The problem is that it is only the larger schemes and businesses that historically have had sufficient resource and expertise to harvest the necessary learning points as part of their flight paths to derisking.

These are normally strong employers and they are the ones to which the trustees will have little trouble agreeing to give more time to and demand less cash from – no problem for member security and good for the economy generally.

Where does your scheme sit?

Unfortunately, the regulator has recently stated that only 20 per cent of UK schemes have a “strong” employer. What about the rest?  

Another 40 per cent are deemed “tending to strong”, and those trustees should therefore be on their guard when these employers ask for more time to pay. 

Giving extended credit is not the whole answer. These schemes have to partner with the employer to allow it to become strong again, by being given a significant reward to take that risk – a substantial share of the upside – so the scheme can derisk later when things improve.

If this somewhat radical answer of deferring significant cash calls is not taken, the trustees risk making the employer even weaker and falling into the third "tending to weak" category, which contains 20 per cent of all UK schemes.

Any turnaround expert will tell you that playing lockdown with a troubled business will only exacerbate the problem

In this category the trustees should be preparing to derisk further to cut their losses. Unfortunately, this will almost always guarantee the actual demise of the employer by demanding unreasonably high funding levels at a time the employer cannot afford them.

And at what point on this demise curve will the trustees press the nuclear button and be forced to cut their losses?

And finally, what about the 1,000-plus schemes who have a “weak” covenant? The trustees, according to the regulator, have to derisk at this point and protect against any further erosion of value. But any turnaround expert will tell you that playing lockdown with a troubled business will only exacerbate the problem and lead to its early demise.

The original guidelines to the Pensions Act 2004 emphasised a "healthy employer, and a healthy scheme". Note the priority. 

There is no real change in the recent developments, but its publicity has given some employers the opportunity to buy some time at the expense of the members. The strength of the employer covenant will determine whether the gamble by the trustees has paid off.

The latest regulatory announcements will separate the wheat from the chaff. Giving more time to the chaff will not make it wheat again.

Richard Farr is a partner at BDO Pensions Advisory