Vol 3 (2006) - Issue 1

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Doing the Deal on Pensions: Commercial Reflections on 2005 Legislative Changes

Ageing populations have continued to place burdens on companies and their ability to fund pension deficits. This has been compounded by medium-term equity underperformance and high interest rates in prior years (which made future pensions promises cheap).
On 6 April 2005, the UK Pensions Act 2004 came into force. Some of its aspects apply retrospectively to 27 April 2004. The Act created a new regulator, The Pensions Regulator (TPR) to replace the Occupational Pensions Regulatory Authority (OPRA). It also created the Pension Protection Fund (PPF). Wide-ranging new powers have been given to TPR. The emotional genesis of this legislation was a widespread feeling that, to date, legislation had not protected pensioners from schemes with a financial deficit.
Concern has been raised about the impact of the new pensions legislation on transactions, with some investors saying they will not do deals involving defined benefit pensions schemes. So what has changed and what has been the initial impact?
What has changed?
The argument has been won by pension scheme members:
promises should be honoured and employers must make sure there is enough money to meet benefits.
The result is that employers must stand behind their schemes with an ultimate debt equal to the cost of purchasing insurance: much higher that the current discredited minimum funding requirement (MFR).
Traditionally, directors have viewed pensions as a contingent liability and not considered pensions when returning cash to shareholders or securitising assets. All this has now changed with the establishment of TPR and PPF.
So what is the Regulator interested in?
In the new world of pension deficit as unsecured creditor, the Regulator is interested in anything which detrimentally affects the pension creditor. There is a definitive list of events for which employers or trustees have to notify TPR. These ‘Notifable Events’ are an attempt by TPR to receive early warning of events which could lead to eventual non-payment to the pension scheme creditor by the employer(s). An acquisition in and of itself does not fall foul of this requirement. But the leveraging of a business (and hence move of the pension creditor down the priority order) or the subsequent payment of dividends (and hence return of capital) probably will. The three key areas of interest are priority, the return of capital, and changing control structures.
Priority is seen as a change in the level of security given to creditors with the consequence that the pension creditor is likely to receive a reduced dividend in the event of insolvency. The granting of a fixed or floating charge is the perfect example of this.
The return of capital is a reduction in the overall assets of the company which could otherwise be used to fund a pension deficit e.g. large dividends, share buy-backs and demergers.
Control structure issues pivot around a change or partial change in the control group structure of the employer, which could reduce the overall employer covenant, and could affect the ability of an employer to meet a potential debt e.g. a change in control or in the sponsoring employer.