DB pension contingent funding arrangements expected to become more mainstream

Contingent funding arrangements are set to become “far more” mainstream amongst defined benefit (DB) pension schemes, LCP has predicted.

These arrangements aim to come up with alternatives that provide scheme members with security without requiring employers to lock up funds that are needed to keep the business going.

Its Contingent funding: Emerging trends and market practice report estimated that three-quarters (75 per cent) of DB schemes could be using contingent funding arrangements in the near future.

LCP noted that these arrangements can take a variety of forms, but typically involve a company agreeing to contribute more to its DB scheme if certain triggers are reached.

Although contingent funding has been used in the past, LCP predicted that there were several “key factors” that will lead to a “big rise” in its popularity.

These included the tougher line on scheme funding from The Pensions Regulator, which LCP said could potentially lead to shorter recovery periods, and more prudent funding targets and investment strategies.

“With sponsors needing to provide mitigation for a much wider range of events under the Pension Schemes Act 2021, there will be an increasing number of cases where non-cash mitigation may be appropriate,” the report added.

The Covid-19 pandemic could also lead to an increase in contingent funding, with the rise in employers seeking deficit recovery contributions in 2020 leading to some trustees seeking guarantees of future funding that could be triggered on a contingent basis.

Additionally, changes to insolvency legislation could put schemes further “further down the queue” of creditors if a company falls into insolvency, with trustees possibly seeking alternative guarantees if their sponsor went bust.

Increased regulatory focus on dividends and others forms of ‘covenant leakage’ was also cited as a factor that could lead to an increase in contingent funding arrangements.

“We are seeing a surge in interest in contingent funding arrangements, ranging from cost-efficient vanilla approaches to highly bespoke ones,” said LCP partner, Phil Cuddeford.

“This is being brought on by big changes in the economic and regulatory environment. Contingent funding can be a win-win, giving members the security they need while not depriving businesses of the money they need to rebuild post-Covid and to invest for the long term.” 

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