Assessing and monitoring the employer covenant – the Pension Regulator's new guidance and its implications
Following on from the new Code of Practice 3 on Funding Defined Benefit Scheme the Pensions Regulator has now issued much more extensive guidance on how to assess and monitor the employer covenant.
The guidance has been structured in a straightforward way and the Pension Regulator recommends that all trustees should as a minimum read the "At a glance" summary.
There are also a number of case studies throughout, as well as specific appendices dealing with the specific issues arising in relation to schemes for not-for-profit employers (NFPs) and on non-associated multi-employer schemes (NAMES), and some key points to consider when deciding on the extent and/or frequency of any review.
The guidance builds on the key message from the new Code of Practice focusing on the 3 key risk areas for DB Scheme – Employer covenant, investment and funding – and how they interact.
So, for instance, how might a change by Trustees to the investment strategy affect the funding of the scheme and the employer's covenant?
The Pensions Regulator encourages Trustees and Employers, and their respective advisors, to work together, but identifies the following key areas in any covenant assessment:
- Legal – what is the nature of the employer's obligations to the scheme and their enforceability?
- Scheme related – for example, what is the funding needs of the Scheme both now and in the future?; and
- Financial – for example, what is the ability of the employer to contribute cash when required?
Trustees should also take into account the different covenants for different participating employers. It is therefore important to be clear on both which employers have a legal obligation to the scheme and the extent of that obligation.
Of course, the new funding code now recognises the need for employers to be able to continue to invest in the business. However trustees will then need to assess whether those investment plans will restrict the funds that might otherwise be available to the scheme and how the scheme might benefit from supporting investment in the business.
The guidance, along with the revised code of practice are generally to be welcomed, particularly the emphasis on the need for any covenant assessment to be "proportionate to the circumstances of the scheme and the employer" but there are also warnings that "the covenant can change quickly" so trustees should have "well-developed contingency plans so they can take decisive action if and when required".
Overall, the guidance presents a much clearer picture of what is likely to be needed in assessing the employer covenant. It remains to be seen, however, whether it makes the task any easier. The first task may be take stock, including which employers have legally enforceable obligations.
We will be discussing this at our next trustee forum, which takes place on 9 October at our New Kings Court offices. Guy Jackson, a director from Baker Tilly will be on hand to lead that discussion. If you are a trustee and would be interested in attending please contact Adrian Lamb on 02380 857084 or email him.