13 Apr Who’s afraid of the pensions regulator?

In certain circumstances involving schemes in significant deficit, the pensions regulator has powers to pierce the ‘corporate veil’ and can force liability on to the directors and shareholders on a non-fault basis.

When and how might this happen?  Given some of the headlines about company pension schemes associated with major corporate takeovers and mergers, finance directors need to be on the front foot in terms of understanding what might give rise to such a pensions regulator intervention.

What do a turkey farmer, a newspaper publisher and an American car giant all have in common? Well, in the course of one month earlier this year, they all received letters from Frank Field MP, Chair of the Work and Pensions Committee, enquiring into the impact of various corporate activity on the groups’ underfunded UK defined benefits pension schemes.

That activity was, respectively, the acquisition of the assets of Bernard Matthews Ltd following a pre-packaged administration, a £10 million share buy back announced by Trinity Mirror plc in its half-yearly 2016 financial report and the sale of the European operations of General Motors (including Vauxhall) to Peugeot.

Why the Government interest in private companies’ corporate behaviour? And why has the Work and Pensions Committee also been writing to the pensions regulator to ask whether it has had an ongoing involvement in sale negotiations?

The pensions regulator was set up under the pensions Act 2004 to be a ‘referee’ not a ‘player’ in relation to the UK’s workplace pension scheme.

It is probably best known for rolling out the statutory automatic enrolment regime to all UK employers under the “Don’t ignore the workplace pension” advertising campaign, featuring a large fluffy monster called Workie.

More seriously, it enforces compliance with statutory ‘moral hazard’ requirements that can operate to impose joint and several group-wide liability for pension scheme underfunding – without any question of fault or bad faith arising.

Generally, an employer’s wider group, whether in the UK or otherwise, has no legal obligation to make good the deficit in that employer’s UK defined benefits pension scheme.

Entities connected or associated with the scheme employer are only  liable to support the scheme if they enter into a direct obligation to do so in favour of the scheme’s trustees. This is typically by providing a parent company guarantee or other form of security, or under an intra-group agreement with the scheme employer, like providing working capital.

However, in certain circumstances, the pensions regulator can impose statutory liability where none otherwise exists. This is to require the target of its so-called moral hazard powers to pay money into or otherwise support the scheme, if reasonable to do so.

These moral hazard powers can impose liability on individuals who fall within the statutory tests for being connected or associated with the employer.

This is likely to be a risk where that individual has been a decision-maker in the corporate activity, has gained a personal benefit resulting from their actions or behaved in a manner designed to worsen the position of the pension scheme.

The regulator has a wide discretion in deciding whether it is reasonable to use its powers.

In practice, the occasional use of the pensions regulator’s moral hazard powers is headline news.

Intervention is far more likely to take place in private and over a period of months if the regulator realises this is necessary to fulfil its statutory duty to protect members’ benefits.

A long list of routine corporate activity could put an individual or their company on the pensions regulator’s moral hazard radar.

At the top is any activity that means the sponsoring employer or are less able to meet those payments. To use the statutory language, this would be an act or failure to act that has “detrimentally affected in a material way the likelihood of the accrued scheme benefits being received”.

This could include routine payment of dividends to shareholders; granting a charge over assets to secure new borrowing on a refinancing; or an internal group reorganisation that substitutes the scheme employer for one with a weaker covenant.

Clearance Guidance published by the pensions regulator gives a non-exhaustive list of corporate events, known as ‘employer-related Type A events’, which could weaken the financial support provided by the scheme’s sponsoring employer.

Not all Type A events fall within the scope of the regulator’s moral hazard powers but if a Type A event is being contemplated, it is important to consider the impact of that event on any defined benefits pension scheme and establish how to mitigate any detriment caused.

An audit trail of this process can provide a statutory defence to the use of some of the  regulator’s powers.

There is now an industry of accountants specialising in employer covenant analysis who can help employers and trustees to determine whether any material detriment exists and if so, what to do about it.

A simple before and after test can be used as a proxy to determine whether the Type A event means that scheme benefits are less likely to be received.

So, if the pence in the pound recovery of the trustees as unsecured creditors of the employer reduces on its hypothetical insolvency after the event has taken place, it is likely that event will be materially detrimental to the scheme.

If this detriment is not fixed voluntarily, the pensions regulator may step in to strongly suggest or, if reasonable to do so, require it to be fixed.

So why would any finance director consider it appropriate to voluntarily write a cheque to the pension scheme in circumstances where there is no legal liability to do so?

It is hard to overstate the potential reputational damage of being on the wrong side of a pensions regulator investigation.

These investigations, whilst confidential at the time, can be made public if the regulator considers this appropriate.

The Regulator has statutory powers to compel the production of information to help it carry out its work: a solicitor was fined £16,000 recently for refusing to co-operate and a search warrant was issued to seize the documents being requested.

Separately, the chief executive of a charity was convicted of a criminal offence and fined for refusing to produce information.

It is far better to anticipate issues of any Type A event, take appropriate advice and engage proactively with the scheme’s trustees.

There will not always necessarily be an immediate price to mitigate any material detriment arising, as the trustees may be prepared to address mitigation as part of the next actuarial valuation negotiations.

Thinking about the impact of any group-wide corporate activity on the UK defined benefits scheme needs to be a recurring agenda item for all boards.

Anne-Marie Winton, Partner

This article was published in Financial Director