Paying the price
5 December 2005
A new consultation document from the Pensions Regulator is threatening to up the ante in the fight to reduce the black hole in pensions, proposing tougher funding requirements for companies to claw back deficits as well as cash payments from companies seeking to leave multiple employer schemes. The recommendations should ease pressure on the Pension Protection Fund (PPF), although stricter funding demands could force companies already struggling with the existing minimum funding requirements (MFR) into insolvency.
The consultation document 'How the Pensions Regulator will Regulate the Funding of Defined Benefits' (published 31 October) recommends all schemes be funded on at least 70-80 per cent of the annuity buyout cost over a period of no more than 10 years. The guidance suggests the regulator will take action against schemes being funded on a lesser basis. Accordingly, a much tougher funding regime will be implemented in the UK than the relatively weak MFR regime, which has been in place for many years.
In the case of attempted takeovers of companies with large pension deficits, such as Marconi, WHSmith and Marks & Spencer, the trustees of the target company's scheme are obliged to use any powers to secure better funding from an incoming employer. This is especially the case where the target company's financial strength would be weakened by the takeover due to taking on more debt. The regulator can also exercise its moral hazard powers by imposing financial support directions or contribution notices on companies to which it has not granted clearance. Clearly, the new recommendations could mean, in future takeover bids, that the pension deficit could make or break the deal.
Generally, for pension scheme trustees, the document suggests taking a tough line on notifiable events and corporate activity requiring clearance from the Pensions Regulator. Trustees are encouraged to flex more muscle in negotiations with employers to collect cash, rather than accept covenants from parent companies that the pension deficit will be made good over an indefinite period.
The agreement on telecommunications company Marconi was made before the consultation document was issued and not subject to its recommendations. However, the agreement could highlight likely trends for future takeovers. The company, which recently sold most of its assets to Ericsson, reportedly had a pensions gap of around £228m. During the effective takeover, the trustees sought a payment of £185m into the Marconi Plan, which would be sufficient to cover the whole of the ongoing funding deficit of the plan.
The new recommendations from the regulator would require a more stringent funding standard than merely funding on an ongoing basis. The consultation document recommends that employers leaving a multi-employer scheme should be liable to pay their deficit on an annuity buyout basis. However, an additional £490m was set aside by the company under an escrow arrangement as a contingency against future deterioration in the funding position of the plan.
These arrangements, where employers place funds into an account which would be transferred automatically to the trustees upon its insolvency, are likely to become more common and are clearly in the best interests of pension scheme beneficiaries. It is far more attractive to trustees to have funds in an escrow account rather than receive a parent company guarantee, which can be difficult to enforce. An unfunded promise is only as good as the strength of the company giving it.
Forcing businesses leaving multi-employer schemes to pay deficits on an annuity buyout basis will obviously lead to problems for holding companies seeking to sell off subsidiaries, where the amount of debt due from the subsidiary to the scheme is substantial. Previously, participating employers were only liable for the debt on the MFR basis, but the Government recognised the difficulties raised when applying this to corporate activity such as takeovers.
The Occupational Pension Schemes (Employer Debt etc) (Amendment) Regulation 2005, which came into force in September, was designed to alleviate the problem by allowing the departing participating employer to enter into a withdrawal arrangement with the trustees and the principal employer. Under these agreements, the participating employer is released from its liability if it can fund the pension deficit on an MFR basis and the sponsoring employer enters into a guarantee with the trustees regarding the annuity buyout shortfall. The arrangements require the agreement of the Pensions Regulator - and for good reason. Even if the principal employer is unable to meet the departing employer's liability in the future, the trustees can have no recourse against the former participating employer.
The Pension Protection Fund
The regulator's attempts to address the pensions debt will be welcomed on several fronts. For some time it has been under pressure to take steps to improve the funding of UK pension schemes in order to address the deficits, as well as reducing the exposure of the PPF to pick up the underfunded liability.
The greater the exposure of the PPF to underfunded pension schemes, the greater the pension scheme levy will be and the more unwelcome to employers and the Confederation of British Industry.
It is unlikely that the PPF will survive unless the regulator takes a tough stance over the funding of schemes where there are solvent employers. Where companies are seeking to leave a scheme and have the cash to clear their pension deficit without being forced into insolvency, it would seem only reasonable for the regulator to pursue those companies.
For some companies with large deficits which are already struggling with MFR, the increased funding requirements could prove to be a bridge too far. While the regulator has indicated that it has no intention of pushing companies into insolvency, this would, in all likelihood, be the outcome for some.
Cary Cullen heads the pensions law unit at Maclay Murray & Spens