Companies can reduce the impact of pension scheme liabilities and resulting funding requirements by asserting to trustees the strength of the underlying business, PwC research revealed.

Stronger businesses need set aside less cash or assets to cover pension scheme shortfalls, data from a PwC study covering 93 recent pension scheme valuations have shown. If trustees consider the underlying business or “covenant” to be strong, companies see an average 15% reduction in the amounts they are required to finance pension liabilities. This is a far greater impact than previous studies have indicated and enough to enable trustees of some schemes to conclude that there is no longer a deficit.

Jeremy May, pensions partner at PwC, commented: “Our research shows the significant impact trustees’ perceptions of covenant strength can have on their cash funding demands. Ultimately trustees believe that the stronger the business the more likely it will be able to pay future pensions so the less money it needs to set aside now.”

May said it is important trustees know the business, and the market in which it operates, and that employers need to provide sufficient information to ensure trustees do not make their own assumptions.

“Many employers sponsoring pension schemes still do not fully recognise the material impact of trustee covenant reviews. With trustees now making more detailed and frequent assessments following recent guidance from The Pensions Regulator, it is more important than ever that companies take the lead in helping trustees to understand the strength and ability of the employer to meet its pension financing commitments,” he added.

PwC’s research explored the link between covenant strength and the level of prudence adopted by trustees in valuing pension scheme liabilities. One of the key elements of prudence is what discount rate the trustees adopt in calculating the present value of future expected pension payouts. The lower the discount rate, the higher (more prudent) the valuation placed on these liabilities.

Participants were asked to categorise their covenant strength into commonly adopted industry classifications of ‘weak’, ‘tending to weak’, ‘tending to strong’ and ‘strong’. Those pension schemes with covenants rated weak had discount rates that were on average 0.75% per annum less than those rated ‘tending to weak’, and 1.2% less per annum than those rated as ‘tending to strong’.

But while discount rates correlate closely with strength of covenant, the trend stops for very strong covenants. These actually had a slightly lower discount rate than those that were regarded as ‘tending to strong’.

May explained: “It seems that those employers confident of their covenant strength may not negotiate as hard for lower prudence, perhaps assuming trustees will automatically arrive at an appropriately fair assessment of liabilities. Our data show that employers taking the lead in explaining covenant strength is important even for the strongest organisations.”

Share Story: