In recent years, corporate insolvency rates have been relatively low, and the temporary protections brought in during the early part of the COVID-19 pandemic have meant that insolvencies are currently at a historically low level. Even so, it is clear that companies in many sectors such as aviation, leisure and hospitality face real difficulties as the current economic situation unwinds.
Peter Redhead, partner at Aon, said: “The Pensions Regulator has recently told trustees to be prepared in situations where an employer may be in trouble. While we are yet to reach the stage where reality bites for struggling companies, a comparison with the aftermath of the 2008 financial crisis is not encouraging. Companies with defined benefit (DB) obligations were hit hard in that period, especially if they were not well hedged against rapidly falling interest rates. One particularly painful feature is that if a company is struggling, its pension scheme trustees are obliged to focus on buyout – and hence the demands on the sponsor increase when they are least affordable.
“Our current concern is that once the temporary insolvency protections are lifted, the floodgates might open. Companies will face similar challenges to the post-2008 period – cash constraints, extremely low nominal and real interest rates which increase pension deficits for schemes that aren’t fully hedged, and volatile growth asset values.”
Peter Redhead continued: “On top of this, we have the imminent Pensions Schemes Act. That will introduce a requirement to have a cogent long-term funding target whereby the scheme has low dependency on the sponsor by the time it is “significantly mature”. For most schemes, that is 10-15 years’ time, but for some it will be much sooner.
“This is likely to be significantly more stretching than the current funding regime, with more reliance on cash contribution and less on anticipated investment returns, so new questions are raised. If it becomes simply unrealistic for a scheme to achieve a long-term funding target, will company directors risk being accused of insolvent trading? Or instead, might the Pensions Regulator be able to find a way to balance any future requirements to help avoid the unintended consequence of triggering insolvencies?”
Peter Redhead continued: “As in any tough situation, it is be better for companies to pre-empt difficulties. There is a range of traditional options available to sponsors, including tighter cashflow management, liability management exercises and exploring alternative financing options.
“There is also one new possibility to add where the sponsor’s covenant is weak but the scheme is, nonetheless, quite well funded - the Superfund. There are circumstances where securing scheme benefits with a Superfund will be in members’ and trustees’ interests, as well as allowing the company to free itself entirely of its pension obligations.
“If there is any uncertainty around future business viability, and the ability to support DB pension promises, companies should seek to retain control by considering all options now, including scheme or company refinancing and restructuring. This way they can seek to provide protection for members' benefits while securing the company's future. The alternative is to wait and potentially lose control by forcing trustees into making claims as creditors."
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