Scheme funding and clearance case studies
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These scheme funding case studies (original versions published in 'Scheme funding: an analysis of recovery plans' in December 2008) demonstrate how The Pensions Regulator, employers and trustees have worked together to resolve funding issues.
The regulatory cases on which these case studies are based were completed before September 2008.
However, the principles that we apply to cases remain constant:
- Funding targets need to be set prudently.
- We expect trustees and employers to engage in positive and open dialogue.
- There is flexibility in how recovery plans are drawn up both in terms of length and structure, in all cases affordability needs to be considered; back-end loading and contingent security can provide further options.
- Conflicts of interest need to be appropriately managed.
- If scheme security is reduced, adequate mitigation needs to be provided.
We provide these case studies for illustration only. They are summary versions and cannot be relied upon as precedents for other cases. The regulator considers each case on its merits.
Case study 1
The scheme's employer was in the design and manufacturing industry. In a transition period and changing its business structure, the company had very little free cash at the time.
However, the trustees expected the business to improve in the coming years. The scheme was large in comparison with the employer.
A 15-year recovery plan was submitted, with technical provisions set below both FRS17 and s179 measures. The regulator had lengthy discussions with the trustees regarding the prudence of the valuation assumptions.
In particular, the pre- and post-retirement discount rates were high for an employer that is currently unlikely to be able to make up the shortfall should the investments not perform as expected.
Following correspondence between the trustees and the regulator, the trustees agreed to revisit the valuation.
Technical provisions were increased, doubling the deficit. Contributions were increased from year 3 to reflect the expected improvement in the company's financial position. This meant that the length of the recovery plan was not increased.
Case study 2
The scheme's employer was in an industry in which technological developments had made the market very competitive. The employer and trustees were aware that the employer was in difficulties.
The trustees and the employer agreed the technical provisions and recovery plan and submitted them to the regulator.
The technical provisions were viewed as not sufficiently prudent for a weak employer. This lack of prudence arose from the choice of discount rates and the mortality assumptions adopted.
In discussions with the trustee and the employer, the regulator emphasised the importance of the technical provisions and the need to set these at a sufficiently prudent level, even if the recovery plan needed to be longer as a result.
The trustees submitted a revised valuation and recovery plan. Although the recovery plan length had greatly extended due to affordability issues, the technical provisions had increased by 30%.
Case study 3
The sponsoring employer operated in the household goods sector. The scheme was small with a stable business supporting it.
A valuation was submitted and the technical provisions were viewed as acceptable given the strength of the employer.
The recovery plan, however, was viewed as too long, given that it was likely the employer could afford to clear the deficit in a shorter time frame than the 22 years set out in the plan.
Following discussions with the trustees regarding the affordability of the employer to make payments to the scheme, the trustees renegotiated with the employer. The trustees were able to reduce the length of the recovery plan considerably by nearly doubling the contributions to the scheme from year 2 of the recovery plan.
The revised recovery plan was viewed as being more in line with the affordability of the company. It would improve the medium-term funding position of the scheme, as well as increase protection for the Pension Protection Fund in the event of future insolvency.
Case study 4
The sponsoring employer was a union for workers across the UK. The employer was considered to be reasonably strong, but with limited cash flows due to the way in which it produced income.
The technical provisions were viewed to be reasonable, given the strength of the employer. The regulator decided to investigate the scheme because the recovery plan was 15 years long, which represented an increased level of risk for scheme members.
After communication with the trustees, it was found that they had come to an agreement on a contingent assets with the employer to support the recovery plan.
As the employer did not have high levels of cash flow, the recovery plan was in line with affordability. As the contingent asset was in place, this provided the trustees with the mitigation needed to accept a longer recovery plan.
Case study 5
The employer sponsored a number of separate defined benefit pension schemes, one of which was open to future accrual.
The employer had a strong financial covenant and was a subsidiary of an overseas parent. As part of the global group restructuring plan a number of businesses, both in the UK and elsewhere, had closed and the assets were sold.
As a result of these closures, the schemes (other than the one which remained open) became frozen with no active members.
Assets were gradually sold with the intention of passing the proceeds back to the parent company by way of dividends.
The original plan was to inject funds only into the scheme with active members. The regulator considered that all of the pension schemes should be treated equally. As a result, mitigation to offset the reduction of the employer's balance sheet strength was paid to each of the schemes.
The trustees of all the schemes were able to support the clearance application.
Case study 6
Clearance was requested for the refinancing of a large plc group, which would result in the new lenders acquiring significant security where previously there had been none.
The group was the sole sponsoring employer of the defined benefit scheme, which was open to future accrual.
The proposed mitigation offered by the group, which the trustees supported, was for a cash payment to be made into an escrow account as and when the group sold its entire shares in another company.
The regulator considered that the mitigation was not acceptable in view of the risk to the scheme going forward should the refinancing proceed.
The regulator held meetings with the group and the trustees.
The mitigation finally offered was for a third charge to be given to the scheme (thereby improving its outcome in the event of employer insolvency). This would be reduced when the sale of the employer's ownership in the other company materialised, and the cash payment previously discussed would go straight into the scheme.
In addition, it was promised to the trustees that no further extension to the group's borrowings would be made without their agreement. It was also agreed that cash payments over a fixed period would be made into the scheme to reduce the deficit.