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Pressure points: Key pension issues for sponsors of defined benefit pension schemes (UK)
The table below summarises the key pensions-related issues that sponsors of defined benefit (DB) pension schemes should be considering in response to the impact of Covid-19 and the measures that have been introduced to reduce its spread. This checklist has been updated to reflect the Regulator's updated guidance for DB sponsors issued on 16 June 2020.
Please contact us if you have any specific concerns about your business or your scheme or about any of the issues listed below.
Contact information and links to relevant guidance are included at the end of this checklist.
1. Employer covenant and funding
Be aware that the trustees of your scheme are likely to want information to help them assess and obtain advice on the immediate and potential longer term impact of Covid-19 on your business and its financial covenant in respect of the scheme and on the wider group (where relevant).
Be alive to the potential trigger events under any funding agreements and/or contingent assets or other security that has been granted to the scheme.
Where an actuarial valuation is nearing completion, consider whether any assumptions and/or the terms of any recovery plan should be revisited to take account of post-valuation experience and the company's current and potential future financial position (note: in its updated guidance the Pensions Regulator reiterates that it will take a reasonable approach to enforcement where submission of a scheme's actuarial valuation and recovery plan is delayed as a result of Covid-19 related issues).
If your scheme is in the process of preparing a valuation, a valuation is pending or your scheme is undergoing significant changes in terms of funding and risk strategies, refer to the Regulator's 2020 Annual Funding Statement. In particular, the guidance on how to approach the setting of valuation assumptions and agreeing a recovery plan in the current climate.
2. Requests to defer reduce/deficit recovery contributions
Assess the impact of different upside (e.g. strong recovery) and downside (e.g. a second wave, reintroduction of lockdown measures) future scenarios on your business and on your scheme.
Consider the impact of the recent changes to the UK insolvency regime on:
- your supply changes and finance arrangements
- your scheme and, in particular, the amount the scheme might stand to recover in the event that the sponsor becomes insolvent, and
- the protection afforded by any contingent assets that the scheme has the benefit of.
Consider how your suppliers, debtors, lenders and the trustees of your DB scheme may respond to these changes.
Refer to the Regulator's guidance for trustees and sponsors of DB schemes if you are considering requesting a reduction or deferral of deficit recovery contributions:
DB scheme funding and investment: COVID-19 guidance for trustees
Guidance for DB scheme trustees whose sponsoring employers are in corporate distress
In particular, note the emphasis in the guidance on trustees undertaking due diligence on the employer's financial position and the sponsor covenant before agreeing to a suspension or reduction or to extend and existing deferral.
Before approaching the trustees (or any other creditors for debt renegotiations and/or deferrals) review the terms of your banking covenants, existing security and other borrowing and finance facilities to check whether this might be a `default event' for the purposes of any of those arrangements.
Before approaching the trustees, seek legal advice on the proposed deferral (including the impact on banking covenants, existing security and other borrowing or finance facilities) and how any deferral should be implemented
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to ensure that this does not trigger the wind-up of the pension scheme or have other unintended consequences.
Should you request a reduction or deferral, be aware that the trustees are likely to want to:
- understand the rationale for a reduction/deferral including requesting information on the immediate and potential longer-term impact of Covid19 on your business and the wider group (where relevant)
- understand what steps the company's banks and other lenders are taking to support the business
- be reassured that the pension scheme is being treated fairly alongside the company's lenders, other creditors and shareholders
- ensure that dividend payments and other shareholder distributions have ceased (and they may want to put in place a legally binding agreement to this effect)
- place restrictions on intra-group loans and transfers of value (potentially by way of a legally enforceable agreement) although the Pensions Regulator has said in its most recent guidance that essential intra-group loans and transfers of value should be allowed to continue
- consider how any deferral should be implemented and whether there is a need to amend the scheme's schedule of contributions to avoid triggering the wind-up of the scheme
- where necessary, explore the scope for contingent security to be granted to the scheme in return for agreeing to a deferral/reduction, and
- ensure any reduced or suspended contributions will be repaid within the current recovery plan timeframe and that the recovery plan is not lengthened unless there is sufficiently reliable covenant visibility available to justify this.
Ensure that the directors/company secretary are available and can sign legal documentation promptly where necessary. Check whether a facility for electronic signature (such as DocuSign) is available or can be set up to assist with this.
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3. Future service benefits & contributions
4. PPF levy 5. Distressed sponsors
Keep an audit trail of any decisions taken in respect of the scheme and the rationale for these.
Where relevant, consider whether there is a need to reduce/defer future service contributions and/or to close the scheme to future accrual or reduce future service benefits.
Seek legal advice if it may be necessary to reduce/defer future service contributions to check how this could be implemented and whether it may trigger wider consequences, such as the wind-up of the scheme.
Consider how future service contributions and/or benefit accrual may be impacted (and what costs may be recovered) where any employees who are active members of the DB scheme are furloughed under the Government's Coronavirus Job Retention Scheme.
Seek legal advice on how any potential changes to future service benefits should be implemented and how this may be impacted by any restrictions under the scheme's rules (for example, restrictions requiring a final salary link to be retained even if the scheme is closed to future accrual).
Assess the potential impact of any deterioration in your business' covenant strength and/or the funding position of your scheme on the amount of your scheme's annual PPF levy. Consider how any additional costs will be met.
Understand the recent changes to the UK insolvency regime and the options that may be open to you.
If your business is in severe financial difficulty:
- check the trigger events under any contingent security granted to the scheme, and/or
- consider the circumstances in which the scheme may be wound-up.
If the business may need to be restructured and/or debts may need to be compromised, seek legal advice and refer to relevant guidance from the Pensions Regulator and the PPF (see below).
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Be aware of the duties your company's directors may owe to the company's creditors (including its pension scheme(s)) where the company is in distress and the powers that the Pensions Regulator has to take action against them personally (including requiring them to make a contribution into the scheme) where they take action which is deemed to be, broadly speaking, materially detrimental to a defined benefit scheme.
Be aware of the directors' obligations to notify the Pensions Regulator, as a matter of urgency, of the occurrence of certain events, including:
- any breach of a banking covenant
- any decision or action which will, or is intended to, result in debt to scheme not being paid in full
- a decision to cease to carry on business in UK, or
- where there is no reasonable prospect of the company avoiding insolvent liquidation.
6. Operation of the scheme Understand how your scheme's trustees are responding to the impact of Covid-19 and, in particular:
- what steps they have taken to ensure business continuity and, in particular, that pensions and other benefits will continue to be paid and that essential scheme business will continue (in a timely manner and in the event that one or more trustees or staff involved in scheme administration are incapacitated or absent), and
- what steps they are taking to address any new or emerging risks (for example, in relation to scheme investments and pension scams).
Check that the trustees with appropriate authority are available and can sign legal documentation promptly where necessary (for example, to enter into an agreement to defer deficit reduction contributions). Check whether a facility for electronic signature (such as DocuSign) is available or can be set up to assist with this. Check what, if any, arrangements are in place should a trustee become incapacitated and be unable to sign.
Be alert to potential conflicts of interest for any director or senior managers who are also trustees (including knowledge of discussions with other
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creditors or other confidential information that may be relevant to a trustee decision) and ensure that these are appropriately managed.
7. Death benefits
Where relevant, check your scheme's death benefits insurance policy to ensure that it covers pandemics.
Where life assurance cover is linked to scheme membership ensure that members are aware that if they leave the scheme and/or cease contributing they will lose their life assurance cover.
8. Member communication
Consider what communications should be issued to employees (maybe jointly with the trustees) to inform them about the steps being taken to address and, where possible, mitigate the impact of Covid-19 on the scheme and the sponsor.
Discuss with your scheme's trustees what steps are being taken to alert members:
- to the heightened risk of pension scams
- to remind them to seek independent financial advice or guidance, and
- to think carefully before making decisions about their pensions in the current economic uncertainty.
Free guidance is available from the Pensions Advisory Service and scheme members should be encouraged to make use of this free and independent service before making any decisions about transferring their pension or about their retirement.
Consider the best way to communicate with employees at this time and to facilitate regular and timely communications where necessary.
Discuss with your scheme's trustees what steps they have taken to:
- review member communications in light of the Regulator's guidance on communicating with members during Covid-19, and
- warn members about the heightened risk of pension scams and to avoid making hasty decisions which they may later regret.
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Relevant guidance and HSF blogs - Follow the latest developments on our UK pensions blog and HSF's CATALYST hub Pensions Regulator Annual Funding Statement 2020 Communicating to members during COVID-19 DB scheme funding and investment: COVID-19 guidance for trustees DB scheme funding: COVID-19 guidance for employers Guidance for DB scheme trustees whose sponsoring employers are in corporate distress COVID-19: an update for trustees, employers and administrators Pension Protection Fund Guidance on pre-packed administrations Guidance on CVAs HSF pension blogs Regulator updates Covid-19 guidance for DB scheme trustees and sponsors Pensions Regulator issues Annual Funding Statement for DB schemes and sponsors amid Covid-19 crisis Around 10% of companies with DB schemes look to defer pension contributions (UK) Regulator issues further guidance in response to heightened risks associated with pension transfers and scams (UK) Pensions Regulator and PPF issue guidance for trustees of DB schemes with distressed sponsors (UK)
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Alison Brown, Executive Partner (EPI)
T +44 20 7466 2427
Rachel Pinto, Partner Pensions, London T +44 20 7466 2638 [email protected]
Marcus Fink, Consultant Pensions, London T +44 020 7466 2562 [email protected]
London Herbert Smith Freehills LLP Exchange House Primrose Street London EC2A 2EG T +44 20 7374 8000 F +44 20 7374 0888
The contents of this publication, current at the date of publication set out in this document, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication. Herbert Smith Freehills LLP and its affiliated and subsidiary businesses and firms and Herbert Smith Freehills, an Australian Partnership, are separate member firms of the international legal practice known as Herbert Smith Freehills. Herbert Smith Freehills LLP 2020