17: Defined Benefit Scheme funding and COVID-19

COVID-19 has caused significant and worldwide economic disruption. Many businesses are taking steps to reduce short term obligations in order to secure long term survival. During this time, trustees of Defined Benefit (DB) schemes will face a number of challenges in respect of covenant, funding, administration and communications.

Our last blog set out a number of key areas trustees should be reviewing to ensure their schemes continue to run to the best of their ability. In this blog we focus on considerations trustees should have in dealing with a sponsoring employer’s request to temporarily reduce or cease its contributions to the DB scheme.

The Pensions Regulator (TPR) expects trustees to be open to such requests but to consider any request carefully to ensure that any support given by the trustees is part of a coordinated and fair response across key stakeholders. As a starting point trustees should have an open dialogue with sponsoring employers about the impact of COVID-19 on their business and the steps taken to contain it. A number of key questions and issues for trustees to understand are contained in TPR’s guidance found here.

Requests to suspend or reduce deficit repair contributions (DRCs)

Where trustees are able to fully assess their sponsoring employer’s position and are confident there will be full and ongoing provision of information to enable continued monitoring of the employer covenant, they will be in the best position to agree the scope and duration of any request. Trustees should take particular care if the DRCs in the proposed suspension period are substantial.

Where sufficient information is not available to make a fully informed decision, trustees should, where appropriate, agree to requests to suspend or reduce DRCs for as limited a period as possible while appropriate information is being provided. This should not be longer than three months if the trustees are not able to fully assess the employer’s position and indeed, the less confidence trustees have the shorter the reduction or suspension should be.

TPR makes clear its view that covenant visibility will be unreliable in such unusual circumstances and so a series of short term three month extensions is likely to be more appropriate than an extended period of reduction or suspension.

If longer periods are under consideration based on a full assessment of the sponsoring employer’s position, then this should ideally be underwritten by any available protections.

In any event, TPR expects suspended or reduced contributions to be repaid within the current recovery plan timeframe and the recovery plan not to be lengthened unless there is sufficiently reliable covenant visibility.

Requests to suspend or reduce payments for future service

Such requests should be treated in the same manner as requests to suspend or reduce DRCs. However, the impact of such a request should be carefully considered – it may not be permitted under the scheme rules or it could have unintended consequences, such as triggering winding up the scheme.

The impact on member’s benefits and their contribution obligations would also need to be carefully considered.

Payments to related entities or shareholders

If the trustees are considering a reduction or suspension of contributions, they should ensure that dividends and other forms of shareholder return are also suspended, and this should be underpinned by legally binding commitments. If it essential for intra-group payments to be made, trustees should fully understand the intention behind the payments, the impact on covenant and where appropriate seek mitigation.

Final points

The duty of trustees is to act in the best interest of the members. A strong employer covenant is a crucial element in ensuring the security of member benefits and requests for a suspension or reduction of employer obligations should be carefully considered.

The implications of a suspension or reduction of employer obligations will differ for each scheme. It may require an amendment to the schedule of contributions, recovery plan or an amendment of the scheme rules. In some cases it may be necessary to communicate with members.

Trustees should take legal and actuarial advice (and other professional help, such as covenant advice) where appropriate not only on whether a suspension or reduction is appropriate, but also on the most appropriate method of achieving it.