How to deal with your company's pension deficit - for good

02 May 2018

Simplifying benefits and making savings through the economies of scale offered by master trusts can help free your company from the burden of expensive defined benefit pension schemes

How do you feel about your company’s pension deficit? Like the terrible weather and trains that never run on time, it’s tempting to believe the pensions ‘black hole’ is a very British problem that’s not worth complaining about, simply because it’s never going away. And with good reason.

The pension deficit of FTSE 350 companies fell by a combined GBP 8 billion during 2017 thanks to rising markets, reported the Financial Times in January 2018. But fears about growth, combined with the soaring cost of retirement benefits, means companies are eager to find ways to offset risk.

The deficit of all UK private sector pension schemes fell by GBP 37 billion in the 12 months to 31 December 2017, JLT Employee Benefits has reported.

According to JLT’s monthly index, the pension deficit of all UK private sector schemes under the standard accounting measure (IAS 19) fell from GBP 187 billion at 31 December 2016 to GBP150 billion at the end of 2017. These schemes ended the year with GBP 1,624 billion in assets and GBP 1,773 billion in liabilities.

FTSE 100 schemes and FTSE 350 schemes also saw reduced deficits. FTSE 100 deficits fell from GBP 55 billion to GBP 41 billion year-on-year and FTSE 350 scheme deficits dropped from GBP 68 billion to GBP 52 billion in the same period.

FTSE 100 schemes had assets of GBP 688 billion and liabilities of GBP 729 billion at the end of December 2017 and FTSE 350 firms also reported assets of GBP 777 billion and GBP 829 billion of liabilities.

Just like all other industries, construction is struggling to deal with a pension deficit from largely legacy DB schemes that are mostly closed to new members.

HOW TO REDUCE PENSION COSTS

You can’t simply wish it away, but there are steps that can be taken that could make a real difference to the amount of management time and money spent on DB pensions.

Smart companies are looking at their options and two possibilities, which can be combined, are simplifying benefit structures and using pensions master trusts to ease their pensions burdens.

With regard to the former - simplifying benefits - many DB schemes currently have different benefit categories and, within each category, different and complex tranches of benefits. While the exact savings from benefit simplification would be scheme-specific, they could be material.

In respect of the latter, it is estimated about 3,000 DB schemes are between the size of more than GBP 10 million and less than GBP 1 billion. Employers with DB schemes could save up to 30% on administration costs by going into a DB master trust, according to research.

They enable companies to make pension provisions for employees on newer, defined contribution (DC) schemes, too.

WHAT IS A PENSIONS MASTER TRUST?

A master trust is a multi-employer occupational scheme, where each employer has its own division within the master arrangement. Schemes often bundle up admin and actuarial services, meaning they benefit from cheaper administration and reduced fund management charges.

With a master trust, there is one legal trust and one trustee board, which retains decision-making independence for each division on issues such as investment and service providers under a trust-wide governance structure.

Master trusts offer employers the benefit of a governance function but generally with lower operating costs and greater simplicity than a single employer scheme.

HOW ELSE COULD A MASTER TRUST BENEFIT MY CONSTRUCTION COMPANY?

  • By reducing your costs and pensions burden using a master trust, your company might experience benefits such as:
  • Reduced company debt. Raising finance to service debt could become easier.
  • Improved credit rating. Without a pensions black hole draining your coffers, lenders and financiers could feel more incentivised to lend to you, potentially on better terms.
  • Beating the skills shortage. It is well documented that staff shortages are hindering the construction industry. The less money a company has to set aside to service its pensions schemes, the more available cash there is to recruit, incentivise and reward quality staff. And provide for their pensions.
  • Smoothing the selling process. If you want to sell your company, a large pension deficit could be deterring potential buyers.

SURETY BONDS: AN ALTERNATIVE STRATEGIC FINANCING TOOL

Surety bonds may provide an alternate solution to the pension deficit issue. They provide the guarantees required while still allowing a company to retain access to existing working capital facilities.

WHAT ARE SURETY BONDS?

A surety bond is an undertaking from an insurance company (surety) to pay a specific sum to a beneficiary on certain specified conditions, such as company insolvency or contractual default.

Surety facilities are unsecured and treated as a contingent liability, therefore they are off balance sheet.

WHO ARE THE PARTIES TO A SURETY BOND?

Surety bonding is not insurance as such; the principal (construction company) does not transfer any risk to the surety (insurance company).

In the event of a call under a bond payment is generally made by the surety who then has indemnity recourse back to the principal for recovery of monies paid to the beneficiary.

HOW DOES THIS WORK FOR PENSION DEFICITS?

Typically, when pension trustees are negotiating funding strategies with their sponsors they aim to bring pensions to fully-funded status. In such circumstances, they may seek letters of credit (LOCs) or bank guarantees to provide greater assurances.

Using a surety bond to replace the construction company’s LOC or bank guarantees is an option which can provide alternative sources of capital while simultaneously enabling a corporation to fulfil its benefit promise. This can free up capital and reduce costs.

Pension deficit guarantee surety bonds can be structured to pay out for various triggers ranging from company insolvency through to non-compliance with a pension fund’s deficit recovery plan.

HOW TO CHOOSE A PENSIONS MASTER TRUST OR SURETY SOLUTION

Initially, talk to your broker who will refer to an Employee Benefit consultant. It is important to choose a master trust provider carefully, as disadvantages could lie in the ceding of control over a volatile and large potential liability as well as the ability to agree funding levels at entry and the reassurance that liabilities will be ring-fenced.

Similarly, a surety might not be the right solution for all companies so specialist and expert advice is required.

Always ask your broker for advice and guidance.

For more information on master trusts call John Wilson, JLT Employee Benefits on 0131 456 6850. Or email john_wilson@jltgroup.com

For more information in relation to surety solutions call Simon Lloyd-Evans, JLT Specialty on 020 7528 4229. Or email Simon_Lloyd-Evans@jltgroup.com

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