Contingent DB scheme funding arrangements could become 'mainstream' - LCP

A surge of interest in contingent scheme funding arrangements for defined benefit (DB) pensions could see the arrangement shift “from the niche to the mainstream”, Lane Clark and Peacock (LCP) has predicted.

The firm argued that there are a number of current regulatory and economic factors that could see interest in the use of contingent strategies grow, including The Pension Regulator’s (TPR's) proposed DB funding regime.

LCP explained that under this “tougher” approach to scheme funding, sponsors who can bring contingent funding deals may be under less pressure to de-risk or reduce contributions, which could be particularly relevant to schemes expecting to use the bespoke framework.

It also highlighted the risk of “materially higher” Pension Protection Fund (PPF) levies, especially amid the current crisis, arguing that pound-for-pound a contingent asset could potentially lead to greater levy savings than in the past.

LCP added that around 10 per cent of employers have already sought to negotiate reduced deficit reduction contributions amid the pandemic, arguing that, as part of these negotiations, trustees may seek guarantees of future funding that can be triggered on a contingent basis.

The firm also stressed that changes to insolvency legislation could put pension schemes “further down the queue of creditors”, noting that trustees may be looking for alternative guarantees that they could call on if needed as employers come under financial strain amid Covid-19.

The warning comes as figures released today (14 August) by The Insolvency Service revealed that despite an overall fall in company insolvencies, there was a 25 per cent increase in the number of companies entering administration in July 2020, compared to July 2019.

LCP partner, Phil Cuddeford, stated: “Contingent funding arrangements have been around for a long time, but they are set to become far more mainstream.

“Many firms will be under considerable pressure to use their available funds to keep their business going during the current crisis, but will also be under growing pressure from TPR to deal with the shortfall in their pension scheme.

“Contingent funding is a way of squaring this circle. Trustees can get the assurances they need about future funding of the scheme while sponsors are able to concentrate their available resources on making sure the firm is still there in the future.

"This is an approach whose time has come."

The firm emphasised that contingent arrangements have always had a number of benefits, including supporting longer recovery plan because they provide additional security.

TPR’s Scheme Funding Analysis 2020 revealed earlier this week that longer recovery plans tended to be associated with a number of factors, including those schemes who hold at least one contingent asset.

Whilst LCP stressed that “vanilla approaches” such a a 'plain vanilla escrow account' have “much to commend”, it also predicted the emergence of “new and innovative ways” in which companies can provide security to their pension schemes without having to divert much-needed short-term capital away from the business.

Previous research by the firm revealed that over a third (37 per cent) of respondents did not expect to have a contingent funding agreement in place at the next valuation, although a combined 39 per cent expected to have some contingent funding in assets, cash or credits in place.

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