Reservoir funds can keep companies financially nimble

Brian Peters, partner at PricewaterhouseCoopers: The Pensions Regulator’s guidance on scheme funding has created a much higher level of funding in UK pension schemes. The issue now is how companies can avoid surpluses that are inaccessible.

The Minimum Funding Requirement (MFR) had few admirers by the end and many would agree it is a good thing that it has now been abolished. The replacement for MFR is ‘scheme funding’ which, unlike the MFR, does not provide a statutory minimum level of funding.

Under scheme funding the idea was trustees and companies could sit down together and reach an agreement of what a sensible amount was to fund the pension scheme – a particularly British solution. All other major economies in the world have hard coded the answer in legislation.

Faced with the concern that liabilities may fall on the new lifeboat fund (the Pensions Protection Fund), the Pensions Regulator said it was likely to intervene if it didn’t like the agreement reached. The Pensions Regulator set up triggers so intervention was likely if the agreement was south of both the PPF and the accounting numbers (for most this means IAS 19). Further deficits could not be funded over more than ten years. Experience has shown many trustees have asked for more than both PPF and IAS 19. This is generally much higher than the MFR was. Suddenly the bar for funding is higher and this can have serious unintended financial consequences for companies.

Companies are now becoming increasingly concerned the agreements they reach with trustees will lead to too much cash being tied up in the pension scheme. The problem is that, once contributed, it is difficult to get the cash back, except through a contribution holiday. This problem is exacerbated by many trustees seeking long term self sufficiency.

This means that the trustees require enough money to keep the pension scheme running without the company’s help. So, if a surplus arises the trustees generally want to keep it and contribution holidays look increasingly like a thing of the past.

One solution is to offer additional security such as a bank or corporate guarantee so if the worst happens the trustees have access to additional cash and therefore do not need more funding now. There are also ‘reservoir funds’, more sophisticated financial strategies which enable the trustees to have the cash if they need it (when there is a deficit or insolvency) or the company can get their hands on it if they don’t (when there is a deficit).

These involve a variety of structures from bank or insurance products to company-run trusts, partnerships or escrow accounts. PricewaterhouseCoopers’ pensions research on 193 firms, 45% of which are from the FTSE 100, shows that 8% of respondent companies have already implemented such solutions and a further 12% are looking to do so in the next 12 months.

Arguably the biggest obstacle to clear if this route is taken is getting the trustees on side. The alternative for the trustees is to demand cash. If the company is unwilling to pay, the trustees can seek recourse from the Pensions Regulator. This is seen by most as a last resort.

Once the trustees agree, you then have to consider what the tax implications are, how the structure is reported in financial statements and whether it counts towards the calculation of the risk-based PPF levy.

Financial institutions also have to think about the impact on regulatory capital and solvency rules of the Financial Services Authority.

All of this may seem way too daunting and expensive. However, the prize is huge. The trustees and the company might agree to a solution which means cash that would have otherwise been contributed to the pension scheme can be used for corporate activity, keeping the company financially nimble and making a real difference to the wider business.

  • Brian Peters is a partner at PricewaterhouseCoopers LLP

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