Simon Kew has kindly agreed to contribute the following blog for Spence & Partners’ website. Simon is the Director of Pensions at Jackal Advisory and is recognised as one of the country’s leading experts on the regulator and the scheme funding process.
Most economic commentators are now upgrading their growth forecasts on the back of a steady flow of positive news over the last few months with increased activity in the manufacturing, construction and service sectors. Mark Carney, the Governor of the Bank of England has just announced upgrades in growth predictions from 1.4% to 1.6% for 2013 and from 2.5% to 2.8% for 2014. He considers that the recovery has finally taken hold and that the improvement has now to be sustained.
Despite this wave of optimism, there are still grounds for caution. The landscape of easy access to capital, cheap imports and overall confidence which helped to boost the UK economy, prior to the financial crisis, has been seriously undermined
There continues to be fall-out from the depths of the recession. Analysis prepared by R3, the trade body for the UK’s insolvency practitioners, indicates that there are over 200,000 businesses that are either negotiating with their creditors or struggling to pay debts when they fall due. This includes 100,000 “zombie businesses” just managing to service interest on their debt but not the debt itself.
Many operators of defined benefit pension schemes face similar cash flow challenges, in preparing realistic recovery plans, to service deficits which have risen significantly with pensions liabilities increasing because of falling gilt yields.
The Government recognises the difficulties faced by operators of defined benefit schemes and is introducing legislation whereby the Pensions Regular (tPR) will have a new statutory objective to minimise any adverse impact on the sustainable growth of an employer. Steven Soper, the interim chief executive of tPR, said “Where businesses are in a distressed state, we’re prepared to be creative and work collaboratively with pension trustees and employers to explore the options in order to find viable outcomes. These situations are often complex and we encourage trustees and employers to approach us at an early stage if they are experiencing financial difficulties that threaten ongoing support to the scheme”.
One mechanism whereby an exit-route may be available to directors (who would have a viable business if it were not for pensions obligations, often committed to in periods in which prevailing economic circumstances and longevity predictions were very different from those faced by employers today) is a statutory process called a regulated apportionment arrangement (RAA).
The actual power to sign off on a RAA sits with tPR, but in practicality, both tPR and the PPF need to be in agreement for a successful approach. If a valid case can be put forward, it allows an employer to transfer the scheme to the PPF without disruption to its business.
The PPF is at pains to emphasise that it is not a dumping ground for unwanted schemes, nor a business support operation for UK plc. Richard Favier, the recently retired head of insolvency and restructuring at the lifeboat organisation, said that “levy payers should not be footing the bill for a scheme that they wouldn’t otherwise have to pay for, so we have to be satisfied we will get the scheme at some point anyway. If not, we shouldn’t go any where near it”.
There are three general principles that the PPF follows in assessing whether it can agree to a RAA.
Firstly, tPR has to be satisfied that an employer cannot fund a scheme fully, that all scheme funding options have been exhausted and, consequently, the insolvency of the employer is inevitable.
Secondly, the deal must provide for a “demonstrably better” outcome for the PPF than would be achieved if the employer became formally insolvent, through Administration or Liquidation. Guidance is not given on what might constitute a clearly better deal for the PPF; this is negotiated commercially, according to the specific circumstances of an employer.
The final principle is a very subjective one to measure, in that the PPF must be satisfied that any deal is fair, after considering the interests of the employer’s other creditors.
The tests set by the PPF are stringent and it can be difficult for an employer to get a proposal across the line, particularly if the circumstances faced by an employer and a scheme are complex. Only a relatively small number of deals, around fifty, have been approved since RAAs were introduced in 2004.
The case of Barrie Knitwear, a clothing manufacturer in the Scottish Borders, attracted press comment when Dawson International, its parent company, went into administration following the break-down of negotiations with the PPF.
David Bolton, the Chairman of Dawson International, strongly criticised the PPF for rejecting proposals to resolve the company’s £129m pension deficit, saying that there had been “a flawed process, lacking in common sense and transparency”.
The PPF reiterated its policy in a statement saying: “On rare occasions, we will – alongside the Pensions Regulator – consider transactions which allow a company to continue to operate with the pension scheme being taken on by the PPF. We do not enter such arrangements lightly and only agree them if a number of stringent tests are met. Unfortunately, in this case the offers made to take on the pension scheme, given the size of the deficit in the scheme, were inadequate”.
Jackal Advisory has advised both employers and trustees in connection with proposed RAAs. It is essential that proposals are thoroughly considered by employers as substantial costs can be racked up formulating and reviewing a proposal, sometimes in situations where there can be little prospect of it being accepted by tPR and the PPF. On the other hand, there can be significant benefits to both an employer and a scheme if a viable proposal can be put together, which meets the regulators’ criteria.
Finally, let us look at some of the factors that could help aid, or otherwise, a Regulated Apportionment Arrangement.
- The employer has pledged its assets as part of a wider banking facility, meaning the return to the scheme is likely to be negligible, if anything.
- A third-party can make a payment to the scheme or PPF.
- Intellectual property / contracts are held by the wider group, rather than the employer.
- The core business is owned and operated offshore.
- The mitigation made available to the PPF is significantly above the value of the employer on insolvency.
- Scheme deficit is relatively small, or insolvency of the employer would be deemed ‘low profile’.
- No evidence of ‘PPF drift’.
- Charities and ‘not for profit’ employers, especially, are likely to find it difficult to fund a large enough mitigation payment.
- TPR believes that there is a high probability of a larger recovery, via use of its ‘moral hazard’ powers against connected parties.
Banks, or other core creditors, are not willing to share in any losses.
More about Simon Kew
Simon has many years of experience in pensions, as well as finance, business development and public speaking. A former, unanimously elected, director of the UK’s first Business Improvement District, Simon has also held other significant managerial and leadership roles. Joining the Pensions Regulator in 2007, Simon took charge of cases on some of the country’s largest multi-national schemes, drove the widely praised Open Market Option project and managed government relations, which led to Simon briefing TPR executives, Ministers and Secretaries of State and 10 Downing Street on current issues and strategy.
Now recognised as one of the country’s leading experts on the regulator and the scheme funding process. Simon is regularly quoted in the industry press and is a highly sought speaker and trainer at seminars and conferences