The flexible use of covenant by trustees and sponsors can provide greater confidence for higher growth strategies in a run-on or surplus sharing approach, according to LCP partner in the covenant team, Jon Wolff.

Wolff argued that if trustees had greater confidence that members' benefits will be met, a 'virtuous circle' can emerge.

Stronger covenant support for downside scenarios would enable schemes to take an optimal level of investment risk, driving asset growth, generating larger surpluses and reducing long-term reliance on the covenant.

The blog set out a STAR framework to help trustees and sponsors understand how covenant support fits within a run-on and surplus-sharing strategy.

The framework called for a proportionate covenant assessment focused on the sponsor's prospects, longevity, sector outlook, competitive position, diversification and financial resilience.

This should be followed by contingency planning, with trustees and sponsors assessing potential downside scenarios and actions across the run-on period, such as securing third-party contingent asset support.

Next, advisers should identify the risk buffers needed, including the surplus required to keep a scheme fully funded after a downside shock.

The blog said that once the scheme is funded in excess of this buffer, for daily management, “covenant can perhaps take a bit more of a back seat”.

However, Wolff stressed that “regular covenant monitoring remains critical to make sure the trustees are quickly able to take action if the covenant unexpectedly weakens, in line with their contingency plans.”

Wolff commented: “A run-on and surplus sharing strategy should not mean taking on undue risk without protection.

"Rather, it’s about using the covenant intelligently to give trustees confidence to invest for the long term, targeting higher returns that can potentially benefit both members and the sponsor. Our framework will help trustees focus on the conversations and actions needed.”

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