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Key points

  • The employer covenant is your legal obligation and financial ability to support your defined benefit (DB) scheme now and in the future.
  • Provide relevant and timely information to the trustees of your scheme so that they can assess and monitor the employer covenant and understand your sustainable growth plans where appropriate.
  • You may need to work with the trustees to improve the security of the scheme.

Importance of the employer covenant

The employer covenant is your legal obligation and financial ability to support your DB pension scheme now and in the future.

It’s important that the trustees have a good understanding of the strength of the covenant. This is so that they take appropriate investment and funding risk and agree funding solutions with you that don’t threaten the sustainability of your organisation. For an overview of the employer covenant see our 'at a glance' guide:

Your role in helping trustees to assess the covenant

As a minimum, the trustees of your DB scheme should assess the covenant at each scheme valuation. They should also monitor the covenant regularly in between formal covenant reviews.

You should work openly and collaboratively with the trustees to ensure that they have the information they need to do this effectively.

Trustees need to understand the employer covenant from the perspective of your legal obligations, the funding needs of the scheme and your ability to contribute cash when it’s needed. Therefore you should expect them to ask you for certain information to enable the assessment to be carried out, eg financial statements, accounts and management forecasts.

Trustees should understand the potentially sensitive nature of the information you provide. It’s important that you work with the trustees to find solutions to overcome confidentiality or disclosure issues, eg by using confidentiality agreements or sub-committees.

If trustees aren’t able to fully assess the covenant that supports the scheme because of lack of information, they may have to take a more prudent view of the covenant and place less reliance on it. This may lead them to take less investment risk and require more contributions.

It’s important for you to be able to invest in your organisation. You can consider capital expenditure required to maintain existing assets as a non-discretionary expense and you should distinguish it from investment for 'sustainable growth'.

In many cases, you will be able to invest in the sustainable growth of the business and support your scheme at the same time. Where you want to prioritise investing in sustainable growth at the expense of contributions required by the scheme, you need to justify to the trustees why you need support from the scheme and how this investment will benefit the scheme in the future. You should also treat the scheme fairly with your other stakeholders, eg shareholders should also provide support for your investment plans.

If your plans for investment aren't detailed enough, the trustees may not be willing to compromise the position of the scheme to support your growth plans.

Improving the security of the scheme

The trustees may ask you to help them improve the security of your scheme so that they have more flexibility to manage the scheme's funding strategy. This in turn may be of benefit to you as it may lead to more balanced funding solutions tailored to both your circumstances and those of the scheme.

For example, they may ask you to do one or more of the following:

  • commit to increase funding when certain events occur, eg if scheme assets underperform
  • provide asset security to the pension scheme, eg credit letters and asset-backed contributions
  • provide guarantees from other entities in your employer group
  • commit not to perform certain actions without agreeing it with the trustees

Not-for-profit employers and non-associated multi-employer schemes

There are additional issues you should consider if you’re a not-for-profit employer or you’re part of a non-associated multi-employer (NAME) scheme.