Defined benefit pension schemes are at risk as funds are ransacked by companies, covenants are breached and trustees appear to have few powers. Partner Anne-Marie Winton considers the issue in light of the Carillion collapse.

If a friend gave you £1,000 each year for 20 years to look after for their children and invest on their behalf for the next 50 years, would you do It (unpaid, of course)? Broadly this is what pension scheme trustees are required to do, ie, honour a very long term promise made by an employer to its current and former employees.

That promise has to survive changes to, and the competing needs of, the trustees, the employer, the government, the law and tax rules. The long-term security of the funds is subject to the investment decisions made by the trustees and the economy as a whole.

Defined benefits (ie, salary-related) pension schemes are sometimes described as ‘balance of cost’ schemes; the employer ultimately is required to fund the original promises to employees if the scheme assets (including contributions paid) are insufficient to do so.

By their very nature, these promises represent very long-term liabilities, so how can employees, former employees and their dependents be sure that when their pension is due for payment, there is enough money left to fund it? In short, they can’t.

The security of the promise depends on both the assets in the scheme when that promise falls due for payment and the ability of the employer to continue to fund it in the meantime.

As to whether an employer’s covenant Is ‘strong’ or ‘weak’, or somewhere between the two at any point in time, requires professional expertise to analyse. This can include substantive subjective judgments, such as the value placed on goodwill in Carillon’s case.

Powerless trustees

What Carillion has also shown is that trustees often do not have the power to force an employer to pay any particular level of contributions. Pension legislation sets out a process of agreeing the actuarial assumptions and rate and duration of employer contributions, but there are no longer any statutory ‘minimum funding requirements’.

So the level agreed may not represent the most the employer can afford, or what the scheme ought to receive. And the scheme’s trust deed may not give trustees the ability to demand unilateral additional payments.

As the law currently stands, directors will act in the interests of shareholders, rather than the interests of the scheme as an unsecured creditor, provided the employer’s insolvency is not a possibility.

Currently, the Pensions Regulator can only force an employer to pay a particular level of contributions by going through a statutory process of exercising its powers to determine what is affordable by the employer.

This involves commissioning an external expert’s report, but that is only likely to take place months, even years, after the formal failure to agree funding under the triennial scheme valuation. By then, the employer’s insolvency may be inevitable.

Covenant advice in Carillion

Copies of the professional employer covenant advice given to the Carillion trustees over the last five years have been published by the Joint select committee (pensions and BEIS) investigating the group’s collapse.

These show that the scheme’s deficit equaled the group’s stock market valuation. possibly indicating a point of no return (and a switch of directors’ duties to the creditors)- but what were the trustees supposed to do?

Should trustees ever trigger a scheme’s winding up where this will cause the Insolvency of the employer and the entry of the scheme into a Pension Protection Fund assessment period?

The answer may be yes, if trustees do not have the power under the trust deed to wind up the scheme, they can ask the Pensions Regulator to do this. To date, we have not seen the regulator being bold enough to ‘kill a company’ due to its pensions liabilities – that may need legislative change to clarify its duties.

The secretary of state for work and pensions, Esther McVey, in a recent debate in parliament, said: ‘It remains the case that the government supports free markets, enterprise and businesses, but this has to be conducted responsibly.’

She continued: ‘Profit warnings mean that a company will not get the profit that it expected – no more than that. We have to make sure that the government do not precipitate anything that could be seen as negative from business.’

Time for government action

A government white paper setting out potential legislative change is long overdue, possibly including fines for companies who take actions that harm the interests of the pension scheme.

But whether this means that dividend payments will now effectively be capped to not exceed the annual employer contributions due to the scheme remains to be seen. It is not clear that this would have prevented the demise of Carillion in any event.

Anne-Marie Winton, Partner
This article first appeared in Accountancy magazine, February issue, published by Croner Ltd