For trustees of many pension schemes, the last couple of years have presented some unique and challenging circumstances (virtual trustee meetings aside!).  Brexit and Covid-19 may have had an impact on their sponsoring employer, the pension scheme and their members. Then, more recently, fuel and supply shortages and the rise in energy costs may have an impact if the employer’s trading forecast is vulnerable to these factors.  

Trustee boards will need to be agile and responsive to navigate their way through these uncertain times and ensure that their pension scheme is as resilient as it can be to economic shocks.  We examine below some of the issues Trustees should consider.

Assess the employer covenant and engage with the employer

In times of economic uncertainty the need for Trustees to remain alert to the risk of weakening employer covenants and to engage with the employer becomes more pronounced.  Employer covenants can change quickly. Trustees should conduct covenant monitoring frequently; as tPR says, a sound understanding of the covenant is an essential party of an integrated approach to risk management. Trustees should consider obtaining a covenant assessment undertaken by an independent specialist to gain a clear view on covenant strength. However, at the least, they should ensure that there is a dialogue with the employer and a sharing of information. For example, requesting an employer representative to provide trading updates at regular trustee meetings.  As tPR’s guidance says, the covenant should be assessed and monitored with a level of detail and frequency proportionate to the circumstances of the scheme and employer. Trustees should ensure they have contingency plans to take swift action as and when required.

There are various structures at the disposal of trustees to support covenant strength and protect the pension scheme from economic shocks, including parent company guarantees, charges over property or escrow accounts. Trustees may like to consider with the employer whether such security could be provided if it is not already. It should be noted that the strength of the parent is key to the viability of guarantees and therefore the trustees should consider the likelihood of recovery.  Where Trustees have the benefit of existing security such as guarantees, they should consider how Brexit may affect the enforceability of such arrangements.  Once they have security, they should consider from time to time the circumstances / triggers for calling on the protection under these agreements.

Alongside these arrangements, trustees should also consider obtaining additional undertakings from the employer, such as negative pledges around the use of cash for dividends or other purposes to protect the covenant from leakage.

It is also important that Trustees consider what powers they may have in their Rules or other documents (such as guarantees or funding agreements). So, for example, do they have the power to call an interim valuation or trigger additional contributions and what conditions may attach? Whilst Trustees may not necessarily invoke their powers, they are required to have an understanding of what powers they have in their armoury.  

Take investment advice

Coupled with the review of the employer covenant, it may be an appropriate time to review the appropriate level of investment risk that can be taken. As tPR’s guidance states, trustees should reconsider whether their funding and investment strategies are appropriate if there is any change in the covenant. An example given by tPR is where the employer’s forecast performance is vulnerable to changes in energy prices, the trustees should consider stress testing the covenant and the investment strategy in scenarios of adverse changes in energy prices and possibly adjusting their investment strategy to reduce the scheme’s overall risk exposure to energy prices.

Work with administrators

TPR has emphasised the importance of working with scheme administrators, whether in-house or third party, in times of uncertainty. Part of this is ensuring that administrators are coping and that they have plans in place for dealing with spikes in staff absences and remote working. In addition, administrators may find that they have an increase in certain types of query or request and it is important to ensure that these can be dealt with.  For example, some of our trustee clients have seen a rise in transfer value requests. There may also be an increase in ill-health cases or early retirement requests.

Whilst these are unsettled times, these are issues which should be considered by Trustees as part of their integrated risk management and as part of their usual business. However, the importance become all the more pronounced at times like these.