Alex Hutton-Mills, Co-founder and Head of Pensions Corporate Finance at Lincoln Pensions, shares insights into latest developments
Q: The Pension Schemes Act introduces new powers for the Pensions Regulator and even criminal sanctions. How can sponsors ensure they comply and remain on the right side of the law?
A: The act will create meaningful uncertainty and will certainly have an impact on behaviour, but there isn’t a one-size-fits-all approach to defined benefit (DB) pensions. The broadening of the moral hazard tests, particularly around contribution notices, will focus directors’ minds on the impact of transactions on DB schemes as the legislation is very broadly drafted. Businesses and investors must be alive to these risks to not fall foul of the new contribution notice tests or face criminal sanctions. The ambit of the act catches many normal business activities, for example paying dividends, which I worry has not been fully thought through. We need clarity from the Pensions Regulator through new guidance in this area. Having the right advisers in place will clearly be essential.
Q: ESG – environmental, social and governance issues – is a hot topic. How do you see it fitting into the DB pensions landscape?
A: ESG has generated significant interest in institutional investment circles through consideration of investments in ESG-compliant corporates by DB schemes. However, ESG also impacts the main asset of the pension scheme, the corporate covenant, an often-overlooked aspect, impacting the visibility trustees have of that “asset”. Trustees must begin to factor the covenant impact of ESG into their risk management strategies. The E of ESG risks will clearly affect corporate business plans in certain sectors, such as oil and gas. However, the broader approach to becoming carbon neutral can impact business plans in many sectors and understanding the bottom-line impact of social and governance changes for the covenant remains a nascent discipline.
Q: With increased mergers and acquisitions in recent months, are companies with DB pension schemes always a risk to investors or can they also present an opportunity?
A: In the current environment, corporates need liquidity and may need to dispose of non-core assets. Private equity investors may look on those as value opportunities, particularly if they can manage the pensions risk effectively over the life cycle of their holding period. Overseas investors, in particular, may see value in UK corporates for foreign exchange reasons and because of the potential purchase price deduction from a target having a UK DB pension scheme.
Q: With the Pensions Regulator’s new plans to require longer-term journey planning from trustees, how can sponsors comply without stifling their business plans?
A: Corporates have a number of levers available to fund their DB pension scheme: cash contributions; non-cash contingent support, available to support downside scenarios; investment performance; and time. Understanding what funding target trustees are aiming towards and the time required to reach this objective is critical. That understanding needs to be mapped against corporate business plans, which should enable a meeting of minds between corporates and trustees regarding the right investment strategy with the right balance of risk, given the covenant.
Q: What can sponsors do to reduce pensions risk on their balance sheets?
A: Insurance transactions are becoming more popular to transfer pensions risk off the balance sheet and provide secured outcomes for members. But they are expensive and likely unachievable for many schemes. Equally, running schemes off is unlikely to be sufficiently secure. New options are available from DB pension consolidators; while we’ve yet to see them really take off, a wider choice of end-games is to be welcomed.
For more information please visit lincolnpensions.com