Ostriches are notorious for burying their head in the sand when danger approaches and company directors need to be vigilant to ensure that they guard against replicating this type of behaviour in their Boardroom. Only an ostrich can have failed to notice a rise in the importance of company pension schemes to corporate activity and the commensurate increased role of pension scheme Trustees. Given the introduction of scheme specific funding and the risk based approach adopted by the new Pensions Regulator I can only see the level of Trustees’ corporate involvement increasing so any degree of optimism that it can be ignored as a passing issue is undoubtedly misplaced.
In simple terms schemes have only two sources of revenue. Trustees can either seek higher contributions from scheme sponsors, or members, or both, or must rely on achieving significant out-performance from their investment portfolio.
The requirement for this out-performance implies a relatively high risk investment strategy which in turn for most schemes implies continued reliance on equity based investments, which as we all know, don’t always work out, and if they don’t, Trustees are back to looking to even higher contributions from someone.
Of course the actuarial orthodoxy that pension liabilities are bond like and best matched by bond like investments implies lower returns from bond investments which in turn implies higher contributions which takes us back to the starting point that there are only two sources of money for the Trustees. In reality, the majority of schemes will opt for a middle course somewhere between higher contributions and an aggressive investment strategy. Where should the balance lie and how should the almost inevitable conflicts of interest between employer and scheme Trustees inherent in any discussion of this nature be addressed?
Considerable faith has been placed, in some quarters, on the ability of equity investments to “save the day”. This stance appeared more acceptable from 2004 through to 2006, however, even over that period the solvency position of many schemes did not materially improve given the fall in bond yields and improvement in mortality over the same period. These factors have had the effect of increasing the value of liabilities and thereby negating the positive returns from equity investments, leaving many schemes seeing little improvement in their deficit position over the period. More recently investment markets have been highly volatile and its easy to conclude that equities have been far from the panacea hoped for.
So what about increased contributions? Scheme sponsors have witnessed significant rises in their contributions over recent years. Many will seek to control further rises, especially where a direct impact on the trading position of the business would result. The Pensions Act 2004 requires Trustees and scheme sponsors to act more independently and negotiate suitable levels of contribution based upon the scheme’s specific investment strategy. Trustees also need to consider the strength of the sponsoring employer covenant and this could present a particularly difficult task for those schemes where senior executives within the business also act as Trustees of the pension scheme, a scenario not uncommon in the SME sector.
In current circumstances it would not be unreasonable to expect employers to resist significant contribution increases and seek to pursue increased investment returns through a more aggressive investment strategy whilst the Trustees seek to pursue an opposite course. It is clear that the Pensions Regulator envisages Trustees and employers becoming involved in robust negotiations on such matters.
It will be increasingly important for Trustees to be seen as acting entirely independently of the company in such negotiations. Demonstrating clear separation of the trustee and company roles may prove almost impossible where company directors perform the role of scheme Trustees leaving room for claims from scheme members that Trustees have not acted in their best interests. Even where Trustees have identified and managed any conflicts of interest, and acted entirely properly this may not be the perception the members hold.
Trustees will also wish to ensure they are dealt with in the same way as other creditors, such as the banks, and that their debt is paid off over a similar period as any outstanding loans. This has the potential to see repayments of deficits over shorter periods than previously, and by implication, by significantly higher deficiency contributions. Trustees may wish to seek to restrict the payment of dividends until the pension deficit is addressed or seek additional security in the form of contingent assets to permit the extension of repayment periods.
Whilst this new reality will be unwelcome in many boardrooms, and probably in some trustee boards also, it cannot be “swept under the carpet.” There could be some difficult meetings ahead where deficit issues are addressed and Trustees need to be well informed and capable of performing their duties independently of the employer.
There is no longer any room for ostriches amongst either Trustees or Company Directors as we all know which part of your anatomy is exposed if you bury your head in the sand.