Pensions Regulator publishes guidance on asset-backed contributions

19/11/2013

Whilst the Regulator recognises that ABCs “may help employers meet their obligations to schemes and can, in certain circumstances, improve a scheme’s security by providing access to valuable assets which were previously out of reach”, it highlights certain risks that they present:

  • Inflexible schedule of payments, delaying full funding - where ABCs involve long payment periods, the scheme may receive lower annual payments than under an appropriate recovery plan.
  • Weak underlying assets or limited legal claims on those assets - it is important that trustees properly value the underlying ABC assets, taking into account their value on the employer’s insolvency and how realisable any value is. Trustees should also determine what claims they will have on the asset in the event of the employer’s insolvency.
  • Masking the scheme’s overall risk profile – the future payment stream to the scheme may be capitalised and treated as an asset on day one. This results in the appearance of an immediate improvement to funding levels. However the scheme remains reliant on the future payments being made.
  • Weakened covenant – the transfer of the asset to the SPV could weaken the employer covenant. In addition, the scheme might have had access to the underlying asset via other means which might be adversely affected if ownership is transferred to an SPV.
  • Illegality of the structure – trustees need to seek advice as to whether the proposed arrangement could be prohibited “employer-related investment”.

Trustees should undertake a “robust” evaluation of any proposed ABC and ensure that they understand the risks posed by it. They should also “consider whether there are any less risky alternatives to support the scheme, such as an appropriate recovery plan, or an appropriate recovery plan coupled with contingent assets to provide additional security”. In particular, trustees need to consider:

  • The period over which any deficit will be recovered under an ABC compared to a standard recovery plan and, if the period under the ABC is longer, whether potential access to the underlying asset justifies that.
  • Whether the ABC provides access to assets which are not otherwise available to the scheme and whether there is any other way the scheme could gain such access.
  • Whether the trustees are giving up any rights or restricting their ability to do other things.
  • The costs of establishing, maintaining and monitoring the arrangement.

To do all of this, trustees will “generally need to obtain extensive legal, actuarial, asset valuation and covenant advice” and the guidance sets out in some detail what such advice will need to cover.

If the trustees choose to enter into an ABC, the Regulator will expect it to “include an ‘underpin’ to protect the scheme’s position, for example in the event that the courts find that ABCs are void for illegality or where there is a change in the law. The underpin should be robust and certain, and ensure that a scheme is not made worse off due to an ABC being found to be void”. The Regulator also expects trustees to notify members of a decision to enter into an ABC in the “next available” communication and report any investment in an ABC to it. Once notified, the Regulator may challenge the trustees’ decision to enter into an ABC and the trustees will need to be able to demonstrate why they did so.

A full copy of the guidance is available here.