In recognition of the increasing popularity in the market of asset-backed contribution arrangements (ABCs), the Pensions Regulator has issued detailed guidance for trustees considering using such a structure to fund their pension scheme.
ABCs, in general terms, allow an employer operating a defined benefit pension scheme to use a non-cash asset to provide a regular income stream to the scheme without an outright disposal of the asset to the scheme. Assets used to date have included retail properties, whisky barrels, brands, loan notes and truckles of cheese.
The Regulator recognises that ABCs may help an employer to fund their scheme and can, in certain circumstances, improve a scheme’s security by providing access to valuable assets that were previously out of reach. However, it highlights the importance of trustees fully understanding the risk, complexity and costs (both set-up and longer term) involved, and obtaining appropriate advice so that they can make an informed decision.
Regulator highlights a number of risks associated with ABCs, including:
- 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: trustees must ensure they understand the value of the underlying ABC asset (present and on employer insolvency) and the extent to which they have access to the asset in the event of missed payments or employer insolvency.
- Managing the scheme’s overall risk profile: the income stream from the ABC is usually given a net present value by the trustees and treated as an asset, thereby reducing or eliminating the scheme’s deficit. However, the scheme remains reliant on the payments being made.
- Weakened covenant: the transfer of the asset to the ABC may damage the employer covenant supporting the scheme. Where trustees already have access to the asset, this can be reduced if it is transferred to the ABC.
- Illegality of the structure: The question of whether ABCs are prohibited employer-related investment remains untested by the courts.
The guidance emphasises that trustees must undertake a “robust” evaluation of the proposed ABC and ensure that they properly understand its risk and benefits. Extensive actuarial, asset valuation and covenant advice, together with advice from their investment advisers, will be required. Trustees should consider whether the advantages of the ABC could be obtained through another arrangement which does not carry the same restrictions, for example an appropriate recovery plan. Particular regard should be had to:
- the period and amount of payments to be made under the ABC in comparison to those under a standard recovery plan which might be available. If it is longer or more back-end loaded, trustees should consider whether the potential value of and access to the underlying asset justify such a payment plan;
- whether the ABC provides access to assets which are not currently available to the scheme and whether there are other ways by which access could be provided such as security over the asset; and
- the costs of establishing, maintaining and monitoring the ABC structure.
Where trustees agree to an ABC, the structure should include a separate “underpin” to protect the scheme’s position, for example in the event that the courts found that ABCs were prohibited employer-related investment or there was a change in the law. Where trustees have already entered into an ABC without an underpin, the position should be remedied as soon as practicable. Through the course of the ABC and when considering covenant, investment and funding, trustees are encouraged to “unpack” the ABC arrangement by disregarding the net present value attributed to the ABC and instead recognising it as a funding stream.