Underfunded U.K. schemes studying contingent assets

Alternative funding strategies will be increasingly tapped by U.K. pension scheme trustees and their sponsors as a way to shore up funded levels without draining needed cash from companies' balance sheets, consultants say.

Interest in such strategies, also known as using contingent assets, has been building for years but has boomed recently as the financial crisis has grown and tanking markets have drained both pension assets and hurt companies' bottom lines.

Paul McGlone, principal and actuary at Aon Consulting, a division of Aon Ltd., London, said his firm is seeing increased interest in contingent assets, but, “what we're not seeing at the moment is much implementation.”

But when trustees and sponsoring company board members receive results from triennial pension valuations and sit down to negotiate contributions this year, Mr. McGlone and others believe that implementation will follow.

“It's still early days of people looking at how to restructure their companies and their assets,” said Lynda Whitney, consultant at Hewitt Associates LLC in Epsom, England.

When a company can't make contributions requested by pension trustees to bring the plan to fully funded status, trustees and the employer can extend the time it takes to bring up a plan's status, or, if available, the company can pledge to either make additional payments later or secure other non-cash assets for the pension fund in case the company declares bankruptcy.

Also, “in current market circumstances, when it's difficult to know what's going to happen to investments, (contingent asset strategies) may be a way for employers to feel more comfortable about contributions,” said Deborah Cooper, principal at Mercer PLC, London.

Make no mistake: Trustees prefer cash contributions and eventually will need cash from the employer, consultants say. But consultants are recommending trustees keep contingent assets in mind when negotiating with employers.

Contingent assets can take many different forms, so recommendations are always tailored to each company.

“There is no single, magic-bullet solution because it depends on the problem you're trying to solve,” Ms. Whitney said.

One of the most popular strategies has been an overseas parent company guarantee, where a U.K. subsidiary's pension contributions are guaranteed by the foreign parent. This strategy costs little, but can lower a fund's Pension Protection Fund levy because it makes the fund seem more solvent. The PPF, Surrey, England, is the U.K. equivalent of the Pension Benefit Guaranty Corp., Washington.

Other solutions have been more complicated, such as a special purpose vehicle set up by retailer Marks & Spencer PLC, London, whereby its £5.2 billion ($8 billion) pension scheme benefits from a slice of the income generated by the real estate the company owns, as well as ownership of the properties in the event the retailer were to fail, Ms. Whitney said.

“My expectation is that we will see an increased wish (among trustees) to discuss contingent assets, but whether they're going to be successful will be company-specific,” said James Riley, senior consultant at Watson Wyatt Worldwide, Reigate, England.

Not all will come cheap. Some contingent asset strategies, such as obtaining letters of credit that are passed on to pension funds, will be too costly because of the current banking environment.

“That's one that has probably dropped away quite a bit,” Mr. Riley said, referring to letters of credit. “What you're likely to see is bespoke situations like the John Lewis situation.”

Retailer John Lewis Partnership PLC, London, in November said it transferred its 29% ownership stake in online supermarket Ocado Ltd., Hatfield, England, to the £1.8 billion John Lewis Partnership Trust for Pensions, also London, effectively making a non-cash contribution worth £128 million.

And tougher times may call for tougher measures — or, at least new ways of looking at some alternative funding strategies. Pension plans can buy credit default swaps as insurance for any unfunded liabilities, but to do so used to be seen as a sort of “no-confidence” vote in the employer.

“We think that CDS strategies may offer quite a valuable solution for trustees going forward,” as perceptions of the defensive move may change given current circumstances, said Mary Kerrigan, a senior consultant at Watson Wyatt; the consultant is recommending trustees consider the strategy but has not “to date had detailed discussions with clients about CDS,” Ms. Kerrigan said.

Paul Cook, partner and head of the actuarial and risk practice at financial and business adviser Grant Thornton UK LLP, London, said employers will look at contingent assets as a way of encouraging trustees to take on more aggressive investment strategies in hopes of lowering pension costs.

“This will trigger a much broader debate about funding and investment policy,” Mr. Cook said.