Trustee briefing: How deficits can destroy companies
Last month 140-year-old cashmere manufacturer Dawson (UK) had its proposal to transfer its scheme to the PPF rejected and now the company has entered administration. But what can schemes do in the face of volatile funding levels?
Rock-bottom gilt yields and quantitative easing have had a disastrous effect on the books of pension funds. With economic turmoil in Europe showing no signs of receding any time soon, UK government bonds (gilts), seen as a safe option, are in high demand, which is pushing their yields down. Pension funds typically hold a high proportion of bonds and so their liabilities have been driven up.
At the same time, the Bank of England’s continued policy of quantitative easing – where the central bank buys government and corporate bonds in a bid to increase liquidity – has further enlarged the black hole of pension funds’ liabilities.
With these issues in mind, the Pensions Regulator has published a statement setting out its approach to the scheme valuation process during a time when liabilities will be much higher than usual.
The statement opens by asserting its awareness of the worrying funding situation of many schemes. The Regulator recognises that employers who have pumped billions of pounds into reducing scheme deficits have seen little in the way of reward on their balance sheet. However, the Regulator advised that trustees need to “undertake contingency planning” as it would be unwise to bet on the returns of gilts rising in the short term.
As long as provision is being made for future uncertainties, the Regulator was happy for most schemes to stick to their funding plans. Those schemes that have suffered particularly badly with regard to growing deficits, were given some breathing space. Yet it remained strict in its position: extension to recovery plan end dates will only be allowed in exceptional circumstances and “will require sound justification”.
What does this mean for trustees?
While trustees will welcome signs that the Regulator understands the challenges they continue to face, they were reminded in no uncertain terms of the importance of sticking with recovery plans. If end date extensions are required and approved, this is only on the condition that schemes and trustees arrange “viable alternative options” and “be convinced that the employer could realistically support any higher level of contributions required if the actual investment return falls short of that assumed”.
TPR also made very clear that those with scheme responsibility needed to be aware that although gilt yields could not go much lower, it is by no means inevitable that yields will rise.
Some trustees and the National Association of Pension Funds were pleased that the Regulator recognised their concerns and responded with advice but many, including CBI director of employment and skills policy Neil Carberry, were left unsatisfied by the Regulator’s lack of concrete suggestions on dealing with shortfalls.
Andrew Waring, chief executive of the Merchant Navy Officers Pension Fund, was likewise cautious, warning that “it should not be read as a one-size fits all piece of guidance, and needs to be interpreted flexibly”.
What next? Action points
Trustees of schemes which have been hit by gilt yields and QE and are approaching valuation dates should be in discussion with their advisers and considering a range of options.
Schemes that will not qualify for extensions will remain worried about the effects of monetary policy on pension fund balance books and many are hoping that the Regulator will follow up on this statement with more specific advice.
Lydia Whitney, principal consultant at Aon Hewitt, felt that the statement placed too much emphasis on the trustees making these arrangements, and said that “for it to be effective it must be a well reasoned and robust discussion between employer and trustees”.