Three in four defined benefit (DB) pension schemes in the UK are set to use contingency funding to manage their risks amid significant changes to the economic and regulatory environment.
That is according to new research by Lane Clark & Peacock (LCP), which explained how companies are increasingly looking to provide pension security for their workers in a way that doesn’t demand up-front cash.
This is being driven by a number of factors, such a tougher line on funding from the Pensions Regulator, potentially leading to shorter recovery periods, and more prudent funding targets and investment strategies.
With 10-15% of sponsors seeking to negotiate reduced deficit reduction contributions following the outbreak of COVID-19, LCP said that trustees may also seek guarantees of future funding, which can be triggered on a contingent basis.
Moreover, contingent approaches can help a company maintain a progressive dividend policy without threatening scheme security, and they can be structured so that the scheme shares in certain upside scenarios.
“We are seeing a surge in interest in contingent funding arrangements, ranging from cost-efficient vanilla approaches to highly bespoke ones,” said Phil Cuddeford, Partner at LCP. “This is being brought on by big changes in the economic and regulatory environment.”
Contingent funding arrangements can take a variety of forms, but generally see companies agreeing to contribute more to its pension scheme if certain triggers are reached.
This often involves putting money in an escrow account, which holds funds that can be drawn on by a scheme, parent company guarantees, asset-backed funding or guarantees provided by banks or insurers.
LCP said that recent trends include combinations of different approaches and clever structuring, such as a parent company guarantee that only comes into existence if certain covenant or funding metrics fall below a pre-agreed level at some point in the future, as well as COVID-specific agreements.
Cuddeford added: “Contingent funding can be a win-win, giving members the security they need while not depriving businesses of the money they need to rebuild post-COVID-19 and to invest for the long term.”
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Author: Chris Seekings