What does the new normal mean for pensions and why does it matter?

By Alistair Kellie

The pensions industry is still coming to terms with the social and financial impact of the coronavirus and how to manage the major challenges around business disruption, historic stock market falls, record low interest rates and market volatility. Arguably the biggest challenge, however, concerns the ongoing viability of certain companies with significant pensions obligations.

There are growing fears that Covid19 and the resulting restrictions on day-to-day life will cause permanent damage to a swath of UK and global brands.  Already it’s clear that many retail, hospitality, leisure, holiday and travel companies are on their knees and will need to take dramatic action to have a chance of re-merging into the next economy.  Apart from the potential loss of iconic brands and the impact on jobs and livelihoods, many of these brands will be sponsors of significant occupational pension schemes.  This means that the company has a legal obligation to financially support the scheme now and in the future.  The strength of this support is called the covenant and this is assessed on a regular basis by specialist covenant advisers.

The Board of Trustees of a pension scheme are responsible for the proper running of the scheme – from the collection of contributions, to the investment of assets and payment of benefits. The scheme members look to trustees to make sure that the scheme is well run and that their benefits are secure. 

Occupational pension schemes in the UK are usually defined by the type of benefit (retirement income) they provide. There are three main types: defined benefit schemes (sometimes known as 'salary-related' or 'final salary' schemes); defined contribution schemes (sometimes known as 'money purchase' schemes); and hybrid schemes (mixture of defined benefit and defined contribution benefits).  Each of these can be funded by contributions from the employer only (a 'non-contributory scheme') or from both the employer and employee (a 'contributory scheme').

The assets held by these schemes pay the benefits of millions of Brits who have worked hard to save into a pension pot.  These assets are held in trust and are kept separate from those of the employer to protect members’ interests.   The top ten UK pension scheme and assets under management at the end of 2019 were:

Source: Parliament UK, March 2020

At least 9.9 million people in the UK now have a pension through a private scheme whose value is directly linked to investments in the stock markets, which fell dramatically as the scale and impact of the Covid-19 outbreak became clearer.  That is nearly 10 times the number of people who had a private scheme in 2008 during the global financial crisis.  From a mid-January high of 7,689, the FTSE100 index of blue chip companies has now plunged to 5,479 at midday today. 

Some scheme manage their own investments, much like any other institutional investor, whilst others outsource investment management to a fund management, overseen by the investment committee of the scheme’s Board of Trustees.  Whilst many schemes have derisked their investments from equities to other such as gilts, they still retain significant exposure to the stock markets. When shares fell by 11% in London and 8% in New York at the end of February, British pension funds worth were left about 5% to 6% less than the week before, and this figure is now likely to be closer to 10%.

Trustees must act in the best interests of the scheme beneficiaries which means that they must ensure they can pay benefits to members who are living longer so putting increasing pressure on the scheme.  The battle to meet the ongoing costs of these pension obligations is impacting the funding of many pension schemes, particularly defined benefit schemes.  As a result, just over half of FTSE100 (51 companies) recently disclosed a pension deficit, while 39 reported a surplus, according to JLT.  The remaining 10 members all reported no DB pension liabilities.

Which brings us back to the Coronavirus crisis.  Recent events are going to put even more pressure on companies which already have pension liabilities that represent a ‘material risk to the business’, as the report warns.   Listed companies will be trying to meet their obligations to shareholders and customers as well as their ongoing pension funding requirements. 

As a result, we could see asset rich private equity ‘vulture funds’ move on some of these distressed companies, as we saw with Melrose Industries and GKN plc.  Whilst these transactions could make sound financial and investor sense, it’s crucial that the interests of pension scheme members are met, specifically around funding and benefits payments.  In the case of the GKN situation, the scheme trustees and their advisers worked hard throughout the transaction to secure a matching guarantee from both GKN and Melrose. 

The situation is complicated further if a company is acquired by an overseas entity which has little interest in the pension scheme.  For instance, could we see Chinese companies emerge first out of the Coronavirus crisis and swoop on UK assets?

The Pensions Regulator has already recognised the pressures facing pension schemes by issuing Covid-19 guidance for trustees, employers and administrators on 20th March.   It asked trustees and administrators to assess whether their business continuity plans (BCP) are still adequate and ensure that activities such as pensioner payments, retirement processing and bereavement payments should be prioritised. 

Special guidance has also been produced in relation to situations where the sponsoring employer is at risk, or has asked trustees to reduce or suspend deficit repair contributions. This guidance came on the back of reports that companies were seeking to halt their pension contributions to maintain cash flows.

Trustees are also advised to help protect their members from scams, particularly as members/savers might increasingly look to transfer their pension, prompted by the instability of their employer or the financial markets. Similar warnings have been issued by the Money and Pensions Service.

Other pensions experts have been making further suggestions for how pensions will need to flex during the crisis.  Sir Steve Webb, the former pension Minister has called for tax rules to be relaxed so workers who lose their jobs due to coronavirus disruption are not penalised for taking emergency cash from their pensions. Meanwhile, Patrick Hosking, Financial Editor of the The Times has suggested that the government should declare a pensions holiday to help savers.

So at a time like this pension trustees are under even more pressure than usual.  On the one hand they are focused on the strength of their sponsor and whether the company could be vulnerable to take-over or by activist intervention where assets could be broken off, which would impact covenant strength.  They are also fully focused on ensuring that the investment strategy of the fund is appropriate to maintain benefits now, but also that it can benefit from a market rebound.

Many trustees are likely to be re-focusing on their risk and governance functions and actively engaging with the sponsor’s management team. Risk management including social monitoring and understanding how the sponsor’s business strategy might need to flex in a world of very low valuations and where there’s a lot of un-invested cash.

On this basis it could be argued that the biggest risk for pension schemes isn’t Covid 19, but it is what follows when we move back to a world where we could see a surge of opportunistic M&A moves and activists agitating for a change in strategy and / or faster return to growth.

That requires trustees to change their risk register approach so they’re thinking like an activist or a corporate raider, not just as a steward of pensioner’s funds.  What’s clear is that during this unprecedented time, pension scheme trustees and sponsoring employers must respond quickly and to effectively to help mitigate the risks involved and ensure schemes are prepared for what lies ahead.

Alistair Kellie, Managing Partner, Newgate Communications leads the Pensions Advisory team.