While trustees have improved covenant monitoring, better access is still necessary for them to identify and track key risk factors, says Hewitt Associates.

A recent Hewitt survey of over 80 trustee groups has highlighted that the last year has seen a change in attitude regarding covenant monitoring - sponsor assessments have been prioritised, and the majority of trustees have put regular covenant reviews into place.

A greater level of information is still necessary, however, for trustees to more effectively assess the sponsoring company's covenant, and therefore identify what a sponsor can afford to repair a shortfall. Many trustees are currently making decisions on information selected and provided by the company, which Hewitt said can be limited to quarterly of half-year financial results. Instead they should have access to a wider range of information such as industry outlook, company order book updates and competitors, and on key financial parameters such as profits, cash flow, dividends and capital expenditure.

"Almost two years of recession have left most UK pension schemes in deficit, some substantially so, relative to the sponsor's cash flow or net assets," commented Aidan O'Mahony, principal consultant at Hewitt Associates. "In addition, the threat of insolvency and companies going to administration has really prompted trustees to focus attention on covenant monitoring with most trustees now having a regular review in place.

"Trustees are still heavily reliant on updates from finance directors. In essence, the company holds all the cards on what information they share. This leaves trustees in a tricky situation, making it harder for them to argue with corporate views on 'affordability'. Most trustees, therefore, rely on a gut feel to establish affordability, instead of asking for further clarity. Quality information is vital for trustees as they try to gauge what is affordable for sponsors and respect to deficit repair payments."

Trustees should, Hewitt said, avoid a focus on short-term financial results, and instead look at a five-year perspective on the company's key financial measures; look for equitable treatment of each class of stakeholders, based on creditor ranking the firm's capital structure; focus covenant monitoring by using a small number of key performance indicators to track relevant issues; and establish trigger points as a means of reviewing major business events.

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