The Pensions Regulator issued a statement yesterday warning trustees of defined benefit pension schemes that “the employer covenant … remains a crucial element in protecting members’ benefits”, which is one of the main responsibilities of trustees. It was not surprising to see this from the Regulator following the publication of its three year Corporate Plan for 2010-2013 earlier this year, which already indicated that the employer covenant would be one of the priority areas for the Regulator in 2010 and 2011.
The Regulator has also stated that: "Most trustees will need to monitor the strength of their sponsor’s covenant on an ongoing basis and all should have a very good idea of exactly how they might respond in different scenarios.”
Commenting on yesterday's statement by the Pensions Regulator, Lorant Porkolab, Senior Consultant within the Covenant Consulting practice of Punter Southall Transactions Services (PSTS) said:
“The importance of understanding the financial position of the sponsoring employer and the implications of that on the ongoing funding of the pension scheme is now fairly well recognised by trustees. However a common pitfall is for them to sit back following a covenant assessment and assume that there is nothing left to do in relation to the sponsor covenant until the next actuarial valuation. It is clear from the above that the Regulator expects trustees to avoid this mistake and keep the covenant under regular review.
“Encouraging trustees to put in place not just a covenant monitoring framework but also appropriate contingency plans that could be triggered depending on changes in the relevant covenant metrics (identified through the monitoring exercise) is a main novelty in the Regulator’s statement which is likely to have some significant implications for many schemes and their sponsoring employers.”
Lorant Porkolab, who is advising both trustee and corporate clients in relation to covenant assessments and corporate transactions at PSTS, added that:
“It is clear that covenant assessment will stay on the Regulator’s agenda, continue to be a key consideration for trustees in transaction situations and remain to play an essential role in the actuarial valuation process. However, it appears that one off assessments once every three year - and complete ignorance of covenant issues between them - may not suffice any longer.
“Although the Regulator’s comparison of covenant and investment was limited to their importance, we believe the similarities are stronger than that, and therefore these two areas should not necessarily be considered separately. The covenant risk is just a very concentrated form of credit risk, to which the scheme is exposed to as one of the unsecured creditors of the sponsoring employer. For many schemes this is the largest single risk, moreover a risk that they cannot easily off-load or diversify, hence monitoring it regularly should also form part of the scheme’s overall investment monitoring.”
Ends
For further information or to speak with Lorant Porkolab of PSTS, please contact:
Penrose Financial
André Flemmings
0207 786 4811
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