Paying the price

Employers seeking to place their pension debt under government control in a bid to avoid insolvency are finding the Pension Protection Fund and the Pensions Regulator anything but a soft touch.

In the good old days the UK labour market was filled with school-leavers intent on sticking with their first employer until their three score years were up. Employers rewarded this loyalty with a promise to provide their staff with a guaranteed level of income at retirement. So it was that the final-salary pension scheme was born.

Then came the decline of British manufacturing and related industries. Many employers reorganised, downsized and specialised. Many more moved operations overseas, taking advantage of cheaper labour and proximity to new markets. The strong and the wise (and perhaps the fortunate) survived to take advantage of a more flexible workforce fit for a global economy.

While this was a necessary part of UK plc developing a sustainable response to global changes, it had the (perhaps unsurprising) consequence that much of the workforce lost faith in the old model as they saw their loyalty go unrewarded. Jobs became more commoditised and the pattern of 40-plus years of hard labour spent contributing to the company pension scheme was broken.

Stock markets rose and fell. The winners made fortunes, the losers lost them. Among the losers were many of the pension schemes that, traditionally, had invested heavily in equities.

Bloated deficits

All the while, improvements in living standards and healthcare produced a workforce that was, inconveniently, living longer beyond retirement and relying for longer on pension schemes that were becoming less well-equipped to meet the cost.

Ultimately, the burden of the shortfalls created by this series of unfortunate events has fallen on the hapless employers bound by promises made to employees back in the good old days. The scale of these bloated deficits has in many cases come to threaten (and, in some cases, dwarf ) many of the employers responsible for paying them. British Airways, Boots and Marconi are just a handful of the household names directly affected by these events. Then, too, came the Maxwell scandal, triggering an avalanche of regulation the effects of which we are still witnessing today.

The bar for employers has been lifted. Weaker funding standards for schemes have been ditched in favour of more challenging targets monitored more independently. And although pensioners have secured state protection through the Pension Protection Fund (PPF), the price (in the form of the PPF levy) has been paid by employers often struggling with a pension deficit millstone thudding on to their balance sheets and squeezing cashflows.

Of course, there are many well-managed schemes and many that enjoy a surplus. But the aggregate funding of the UK’s 7,800 defined benefit schemes has fluctuated wildly over recent times. Post-credit crunch, in a weakening economy, the spectre of pensionsdriven insolvencies is all too real. At any rate, the pensions creditor is now a force to be reckoned with in corporate restructurings.

A growing number of restructurings have therefore focused on curing the pension deficit problem without recourse to a potentially damaging formal insolvency of the employer. From the employers’ perspective, the objective of these projects is simple: survival.

While such restructurings bear many familiar hallmarks, the key to their success often lies in the employers’ ability to transfer the pension debt from their balance sheet and into PPF control, thereby leaving the employer far better placed to meet its commitments to all other creditors. This can only safely be done by means of agreed terms that secure the approval of the PPF and the clearance of the Pensions Regulator (whose role includes protecting the PPF).

The PPF has no desire to be the dumpingground for schemes in deficit run by irresponsible employers, and will only entertain a negotiated solution if there is compelling evidence that without it the employer company will face a formal insolvency in which the pensions creditor would expect to receive less than is being tabled in the restructuring. The PPF has proved itself to be a very commercial animal indeed in securing the optimum outcome for pensioners. Other stakeholders can expect a tough negotiation, with the PPF uninterested in securing a purely nominal advantage over the insolvency outcomes.

Paradoxically for such ostensibly solvent restructurings, UK law only allows schemes to secure PPF eligibility whose employers have undergone a (qualifying) formal insolvency ‘event’. This has led to the formulation of a number of creative solutions to avert damage to the sponsoring employer companies.

These have included the transfer of pension scheme debts into special-purpose vehicles which themselves are put through an insolvency process, most commonly a company voluntary arrangement, which compromises the pension debt and effects the transfer into the PPF. These solutions are not without their critics. After all, they are, potentially, an avenue for unscrupulous employers, culpable for their pensions predicament, to shrug off their responsibilities, leaving others to pick up the tab. Nevertheless, there are measurable benefits in terms of the jobs and businesses rescued. Irrespective of the rights and wrongs, in an illiquid economy the pressure to find a cure for the UK’s pensions problem is high.

Alastair Lomax is a partner in the restructuring team at Pinsent Masons