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Pensions needn’t be pitfalls

31 Dec 08

Edwin Mustard and Paul Hally examine how measures to protect pension fund members can affect company restructuring and disposal

by Edwin Mustard and Paul Hally

During past downturns, pension deficits rarely featured as an issue in insolvencies and restructurings.

Now, defined benefit pension schemes are increasingly at the centre of corporate restructurings, and indeed may often be the catalysts, with the pension trustees and the Pensions Regulator key players.

Three main factors have contributed to the prominence of pension deficits in restructurings. The first is mounting scheme deficits. Many companies remain

responsible for substantial pension liabilities, even though the build-up of new benefits under the scheme has long since ceased.

 

Longer life expectancy of scheme members, falling equity markets and increased regulation have exacerbated funding deficits in recent years. The level of deficits can limit the opportunities for restructuring by divestiture.

Secondly, the quantum of the pension debt due by an employer upon the occurrence of an insolvency event has increased materially.

Where a formal insolvency has been triggered, the debt due by the employer (also known as the section 75 debt) is calculated on an annuitised “buyout” basis.

This involves calculating the cost of buying out the pension scheme liabilities with an insurance company. It can substantially increase the pension scheme’s deficit because on a buyout basis, an insurance company – if being asked to take on responsibility for paying pension scheme benefits, perhaps for decades to come – would use conservative assumptions in valuing liabilities.

Since no ongoing scheme looks to hold the necessary funding to meet the pension debt on the buyout basis, any scheme will almost certainly be underfunded in this scenario. Buyout deficits can easily run into tens or hundreds of millions of pounds when triggered.

Finally, the creation of the Pensions Regulator (TPR) under the Pensions Act 2004, and the antiavoidance powers given to it under the legislation to protect scheme funding, have all affected corporate behaviour in advance of – and during – any insolvency or restructuring process.

In particular, TPR has wide powers to prevent employers from “dumping” pension liabilities on the Pension Protection Fund (PPF), which was created as a lifeboat fund to provide limited pension compensation for members of defined benefit schemes whose benefits have not been fully funded after the insolvency of the employer.

Under its so-called moral hazard powers, TPR can impose a liability for pension scheme funding on companies “associated” or “connected” with the sponsoring employer – even if the company on which liability may be imposed in this way has never participated in the pension scheme. Liability may also fall on the directors of those companies or of the employer company itself.

Where the financial condition of the employer is weak, the prospect of formal insolvency proceedings has a bearing on the directors’ decision to trade.

If triggered, the pension scheme’s debt at the buyout level could swamp any other creditor claim on insolvency including that of any secured creditor, though a secured lender wil still be entitled to repayment in advance of unsecured creditors, which normally include the pensions debt. Directors need to be mindful of this. For the first time, pension trustees can be major players in insolvency.

In some cases, the pension deficit may be too problematic to resolve by restructuring. But in other cases, there has been a trend to look at pensions-led sophisticated debt restructurings, which may facilitate the survival of the sponsoring employer, preservation of jobs and the best possible realisation for creditors.

While insolvency may result in PPF protection being available for scheme members, it can be a sub-optimal outcome for the business and its other stakeholders. In such cases, where insolvency is looking likely and the PPF will assume responsibility for the scheme, techniques have been looked at which allow companies to survive and preserve greater value than would apply in an insolvency situation.Typically, this process will involve the transfer of the scheme to PPF control through sophisticated techniques, avoiding a break-up of the business and leaving the employer in a better position to meet its commitments to other creditors.

This can only be achieved with TPR approval if the employer, lender and trustees all buy into the process and, above all, it can be demonstrated that the outcome of going through a consensual restructuring will produce a better result than formal insolvency.

Solutions of this kind may not work for every situation, but can have measurable benefits for protecting business and jobs if adopted successfully.

 

Page No: 62

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