Carillion highlights importance of corporate investigations

The majority of UK defined benefit (DB) schemes are now closed, at least to new members. It seems only a matter of time until they close to new accruals, and once they no longer receive member contributions, the sponsoring employer must bear all the costs.

Winding forward, with fewer and fewer workers in legacy DB, sponsors will have no business interest in the pension liabilities. This increases the potential risk to scheme survival. The employer covenant becomes ever more crucial.

Schemes that have been able to manage the balance sheet risks, whether by buy-ins or buyouts, will clearly be better placed, but there must be concerns that companies with legacy liabilities and large deficits will increasingly seek opportunities to switch resources away from pension funding.

Indeed, even schemes that remain open may face similar covenant risks if there is a corporate merger or acquisition. The role of trustees in protecting against decisions which prioritise shareholder interests over pension members will be more crucial than ever. Are trustee boards well-equipped to do so?

The Pensions Regulator has little power to anticipate corporate deals or to investigate all schemes where sponsors claim they cannot afford contributions. If the economy hits tough times, such situations will be more prevalent too. The regulator is simply not resourced to be on top of the latest developments at each sponsor of thousands of DB schemes. Therefore, as the DB landscape becomes ever more challenging, the role of trustees comes increasingly to the fore.

The regulator has generally relied on trustees to raise concerns about weakening employer covenant, or decisions which may select against the pension fund, despite a deficit. But, unless trustees ensure they are properly informed and can assess ongoing corporate developments with the sponsor, they will not be well-placed to alert the regulation, and so this system breaks down.

Therefore, perhaps more trustees will need to carry out independent detailed corporate investigations of the sponsor's business prospects and financial situation. For example, in the case of Carillion, the company consistently paid higher dividends, despite a rising deficit and - as subsequently discovered - a weakening cash position. This underlying problem was spotted by hedge funds several years ago, with in-depth analysis of the published accounts. The information was available with careful financial analysis. Unfortunately, the trustees were not aware of this information and by the time the problems became clear, it was too late.

Detailed study of published accounts, as would be conducted by experienced investment analysts, could have alerted trustees, and thereby the regulator, to underlying concerns with the sponsor's business at an early stage. In turn, this could empower trustees to insist on more money at an earlier stage, perhaps as a quid pro quo for the dividend increases. It might also raise questions about management pay structures.

Traditionally, trustees do not conduct an independent forensic examination of their sponsor's business and finances and are not as directly involved in company affairs. However, such assessments may be increasingly important, rather than relying on information provided willingly by the sponsor or its advisers. Some trustee boards have already started using independent covenant advisers in a more focused fashion, but this is not yet the norm. Trustees also need to know of imminent plans for restructuring, mergers or acquisitions.

The ideal would be for sponsors to share information on corporate activity, but there are often concerns about confidentiality. As it is frequently the largest unsecured creditor, perhaps the pension scheme needs to be more carefully consulted or considered. The recent DB white paper suggests a requirement for sponsors to consult trustees before corporate events, with the aim of issuing a statement of intent that confirms the impact on the scheme has been considered. Whether the transaction will materially increase debts or bring in new cash are crucial factors, but trustees too often find out too late in the process.

As we approach the 'end-game' for DB schemes, trustee boards should consider how best to obtain expert, independent advice to ensure they can properly assess the risks, together with the implications for contribution negotiations and investment risks.

Baroness Ros Altmann is a former pensions minister

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• Topics
• Defined Benefit
• Risk Reduction
• Carillion
• Baroness Ros Altmann
• sponsoring employer
• covenant advice
• FD