Trustees and employers who wish to put in place and/or re-certify a Pension Protection Fund (PPF) contingent asset in time for the 2014/15 levy year should act now.What has changed from 2013/14?
A contingent asset is an asset that is not immediately available to the person in whose favour it is granted, but which will become available if one or more specified events occur. In relation to a pension scheme, the most likely events are the scheme's employer becoming insolvent or the scheme failing to meet a specified funding level.Why put a contingent asset in place?
The PPF recognises contingent assets in its calculation of a scheme's risk-based levy. This is calculated according to the risk that the employer will become insolvent and the level of underfunding in the scheme. Using a contingent asset reduces the risk of one or other of these factors and, in many cases, reduces the levy payable. A contingent asset may also help mitigate the financial burden on a scheme's employer if cash resources are limited. Also, if cash is not immediately available, a contingent asset funding arrangement helps the trustees to spread credit risk.How are contingent assets put in place?
The creation of a contingent asset requires the execution of a legal document which can take a variety of different forms. However, the PPF only recognises contingent assets created using its standard form documents, which must be submitted to the PPF for approval and certified by the trustees as meeting the PPF's criteria. Certification (or re-certification) must be done via Exchange, the Pension Regulator's online portal. For a contingent asset to be recognised in the 2014/15 levy year it must be submitted and certified, or re-certified, by 5pm on 31 March 2014.
The PPF categorises the contingent assets it will accept into three different types; A, B and C.
Type A covers guarantees given directly to scheme trustees by an 'employer's associate' (typically a parent or sister company). The guarantee may be a fixed amount, a percentage of the scheme's deficit calculated on one of several specified bases, or that amount subject to a maximum cap.
Type B covers charges over various types of asset, either cash, real estate or company shares, again given by an employer's associate. As with a type A guarantee, the liability under the charge may be for a fixed amount, for the PPF deficit amount or the PPF deficit amount subject to a maximum cap. The assets charged must be irrevocably available to the trustees of the scheme upon the insolvency of the scheme's employer, as a first legal charge.
Type C covers letters of credit and bank guarantees provided by acceptable financial institutions and the face value of the contingent asset as at the start of the levy year is added to the amount of the scheme assets.
Certifying the strength of the guarantor
Amongst the confirmations that must be given when certifying or re-certifying a type A contingent asset is a statement that the trustees have "no reason to believe that [the] guarantor, as at the date of the certificate, could not meet its full commitment under the contingent asset as certified." First introduced in the 2012/13 levy year, it requires the trustees to consider the financial strength of the guarantor, although it is worded in such a way as to imply that the trustees do not necessarily have to carry out a formal assessment of the guarantor's financial strength. The PPF's guidance states:
"Trustees should still take proportionate steps to assess the capability of the guarantor to meet any sum that may fall due under the guarantee. What is proportionate will depend on their individual scheme's circumstances, the size of the guarantee being given (for example, the smaller the guarantee, the less likely it is that professional input would be proportionate), and the complexity of intra-group arrangements."
Impact of an insolvency event on the guarantor
The requirement for the trustees to consider the guarantor's position in the event of the sponsoring employer's insolvency introduced in the 2013/14 levy year will continue to apply. For example, where the value of a parent company guarantor is predominantly made up of the shares held in the scheme's employer, it would be doubtful whether it would be in a position to meet its guarantee commitments if the employer were to fail. In essence, therefore, trustees are required to look at the guarantor as if the scheme's principal employer was not there when assessing the guarantor's strength.
What is reasonable for trustees to do will depend on the circumstances, such as the domicile of the guarantor, the size of the guarantee, the size of the scheme, the existence of cross-guarantees and the complexity of the group structure. In some cases an expert assessment may be needed.
The PPF has stated from its examination of contingent assets submitted for 2013/14 that, in certain circumstances, trustees have been prepared to knowingly certify a guarantee when the guarantor would not be able to pay in the event of a failure of the employer. Trustees should, therefore, carefully consider the impact of the guarantor's insolvency, taking appropriate professional advice where necessary. Trustees should also be prepared to justify their assessment of the guarantor, with evidence of their decision and how this was reached.
If Trustees certify incorrectly, the PPF may reject the contingent asset which will result in it not being recognised in the levy calculation.What else do trustees need to consider?
This will depend on the nature of the contingent asset being put in place. Giving a parent company guarantee could adversely affect the guarantor's ability to borrow in the future or could increase the costs of extra borrowing. It may also affect how external rating agencies assess the guarantor, which could impact on its value. This is particularly relevant when the trustees consider the guarantor's strength.
Charges over real estate, cash or shares may be attractive for an asset-rich business. However, trustees need to ensure that assets are not subject to a prior or level ranking security interest. Likewise, sponsoring employers need to check whether they are able to grant further charges or charges which rank in preference to an existing lender's security.
What should trustees do now?