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Trials of dealing with final salary pension schemes; Ian Hill, Pension Technical Manager at Torquil Clark, looks at what can be a complex issue.

Byline: Ian Hill

There does not seem to be a page in the tabloids where there is not an article highlighting the plight of Defined Benefit (Final Salary) Pension Scheme sponsors and the inherent problems associated with funding their schemes.

Recently a number of high profile companies have announced enhanced contributions in an attempt to make up their pension scheme 'deficits'. A great deal of time would have been taken up between the trustees, who will be looking to clear any deficit as soon as possible, and the scheme sponsor, the employers, who have been affected by economic conditions will be understandably concerned about making scheme funding commit-t ments.

Trustees will be looking for an immediate injection of cash to pay off the deficit in the shortest time possible. This will be countered by an employer who does not want to tie money up and use cash to fund future corporate development. A company with a fully funded pension scheme will be more attractive to investors and lenders. However, there are implications for the sponsors balance sheet and borrowing covenants might be compromised, especially if lenders review their commitment and carry out their own due diligence by the way of an 'employer covenant review', generally at the scheme sponsors own expense. There will be the investment considerations from the company perspective. Is solving a pension scheme funding problem worth the volatility in the sponsors share price? Would it be better to invest in plant and machinery, corporate development, or direct on the investment markets rather than looking to balance a return on the monies within the pension scheme; a form of self insurance. Tax efficiencies for the company will also form part of the consideration.

Once money is in a pension scheme, unless it is used to provide related benefits, it is very difficult to get it back out. Although possibly not on the radar of many Defined Benefit Schemes if the deficit is paid off quickly what happens if in the future the scheme ends up with a surplus that is actually locked in and isolated within the Scheme. It may be of something of a novelty to be talking of surpluses but things seem to go round in cycles and I can remember contribution holidays and refunds to employers in the late eighties and early nineties the implications worthy of another article.

Surpluses on an ongoing basis can be easily built up, on actuarial paper any-y way, by a short recovery period for schemes that have closed to future entrants and ceased to future accrual. There will be a long time before Defined Benefit Schemes can say they are fully funded on a 'buyout basis', but fully funded scheme on an ongoing basis is not beyond the realms of possibility.

Many employers have paid in money hand over fist into their pension scheme, only to find the funding situation becoming worse as pressure is placed on the assumptions used, like discount rates and member longevity, not to mention the countless reams of associated legislation, which hits the statute books making scheme funding problematic, such as sexism and ageism legislation (get this wrong and these issues could add millions to the actual deficit).

There are alternatives open to the scheme sponsor and related trustees to the company investing liquid assets in the pension scheme.

Other assets may be offered including contingent asset agreements, letters of credit from secure third parties. These potentially could reduce the Pension Protection Fund levy and are generally accepted by the Pensions Regulator. In addition the advantage for the scheme sponsor is that they are flexible and can contain agreements to be withdrawn as soon as a certain scheme funding level has been reached.

Matching short-term investment mar-r ket analysis with ever increasing pension scheme recovery periods is problematic (the merger of two well known airlines highlights this) but not insurmountable. It is important that these issues are aired, as pension schemes will still be tarred by the definition of madness 'doing the same thing over and over and expect-t ing different results'. The Pensions Regulator has highlighted that schemes should question their advisers and review the advice they have been given. There has never been a more important time for scheme sponsors and trustees to heed those comments before the madness takes over.
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Title Annotation:Features
Publication:The Birmingham Post (England)
Date:Jul 15, 2010
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