COVID-19 sparks wave of U.K. contribution holidays

Between 10% and 15% of U.K. defined benefit fund trustees have received or expect to receive a contribution deferral request from their sponsoring employers, as the impact of the coronavirus pandemic on companies intensifies.

And while the general consensus is that about 10% to 15% of pension fund trustees will be dealing with these requests over the coming weeks — with employers generally asking for a three-month contribution holiday — that proportion could reach almost one-fifth of companies, retirement advisory firm Isio Group Ltd. warned. Companies are making the move to pause pension contributions and other financial commitments, with some firms asking employees to take temporary pay cuts, as they work to keep balance sheets as healthy as possible and manage cash flow amidst unprecedented stress in the economy.

A recent survey of its clients showed 12% of sponsoring companies have requested suspensions of deficit reduction contributions — set cash injections promised by the company to help plug a pension deficit — with 6% already accepted by trustees and a further 6% under consideration. Isio said another 7% of sponsoring employers are considering suspensions but have not yet approached their trustees.

"The starting point is that employers are legally obliged to pay the contributions set out in the Schedule of Contributions," an agreement between the sponsoring employer and the trustees that shows contributions payable to the pension fund and any additional contributions from the employer under any deficit recovery plan, said Tamara Calvert, a pensions partner at law firm DLA Piper U.K. LLP in London. "Any request from the employer to suspend or delay payment of those contributions requires careful consideration by trustees."

The onus falls on the sponsoring employer to provide sufficient financial and management information to help trustees to decide whether they will agree to the suspension of deficit contributions.

"The key question for trustees is whether (by) agreeing to the suspension or deferral they are materially reducing the chance of recovering that money for the benefit of the scheme. Trustees need to get themselves comfortable that they are still reasonably likely to get the money, in due course," Ms. Calvert said. And if they are not comfortable, they can reject the request to suspend contribution payments.

The estimates of the proportion of pension fund trustees receiving suspension requests equate to around 600 of the 6,000 or so DB funds in the U.K."We are seeing a number of clients for whom pretty much overnight the whole commercial world has changed," said Charles Cowling, Manchester, England-based chief actuary at Mercer LLC. The majority of these clients are in the airline and travel industries, leisure and sports-related sectors. The automotive industry has also been hit hard, with U.K. car sales dropping 97% in April, he said.

"There aren't many businesses that can keep going very long when your revenues drop 97% overnight," Mr. Cowling said. While some firms have chosen to soldier on by using cash reserves or furloughing employees, companies are still required to pay rent, interest on any bank debt and contributions to help plug pension deficits.

"A lot of clients for whom cash has suddenly disappeared overnight are looking around for where can they possibly stop hemorrhaging cash-flow payments (and) creditors are an obvious next port of call," Mr. Cowling added.

As of April 30, the total deficit of U.K. pension funds covered by the Pension Protection Fund's 7800 index was £128.5 billion ($160 billion), with about 65% of the 5,422 pension funds in the index running a deficit. Deficits are up 72% from Jan. 31, when the proportion of funds in deficit was 60.1%.

Among the companies announcing U.K. contribution holidays are media group Reach PLC, which said in an update it had agreed to a three-month deferral of monthly contributions for its almost £300 million groupwide pension deficit. Contributions were set at £48.9 million this year to plug the gap across six pension funds, which had a total of about £2.4 billion in assets, according to its 2019 annual report.

And manufacturer Coats Group PLC said in an update May 20 that it had "agreed to defer the remaining deficit recovery payments for 2020," covering April through December, "to provide an additional (about) £17 million of headroom cover during this year."

The U.K. DB pension funds, "namely the Coats U.K. Pension Scheme, which is a key constituent" of liabilities, ran a £69 million deficit as of Dec. 31. The fund's assets were not available.

"The catchup of these payments are currently anticipated to commence in mid-2021 and be evenly spread over a period of around 18 months," the update said.

The Pensions Regulator must be told if a sponsoring employer is going to miss a contribution or pay it later than expected.

However, TPR guidance published in March said trustees "should be open to requests to reduce or suspend" contributions to deficits, and that it will not take any action in these cases. A number of safeguards are in place, including that a business case must be made by the sponsoring employer, that dividends and other distributions are also being suspended, and that trustees take legal and actuarial advice on the matter.

"We are not authorizing, encouraging or compelling a particular course of action — we expect trustees to do the right thing for their situation and members," TPR said.

Laura McLaren, partner and actuary at Hymans Robertson LLP in Glasgow, Scotland, said: "Most often the requests are to defer contributions for three months, with a view to negotiating longer suspensions as the situation becomes clearer. Regulatory guidance acknowledges that suspension of deficit reduction contributions is appropriate in some situations to support the (corporation) over a difficult, but hopefully temporary, period."

But the longer restrictions on movement and therefore the economy go on, the longer suspensions will last, said Simon Taylor, a partner at consultant Barnett Waddingham LLP in London. "I suspect (we will see) another round of companies going to trustees and asking for another suspension, maybe another step up from the initial 10%" that have already made the move to pause contributions, he said.

TPR also wants any delayed contributions to be made within the current period of time over which they had originally agreed to plug the deficit, rather than tagging time onto the end.

"What the regulator doesn't really want is an agreement to add three months onto the end of (the existing recovery plan.) What they want is for the companies to make good (on) those contributions once we're back to 'normal,' so the plan still ends at the same date," Mr. Taylor said. While that's probably achievable with a three-month pause, further extensions will be more tricky to navigate, he said.

The sponsor's strength in backing the pension fund — known as the employer covenant — will also be a factor in trustees agreeing to contribution deferrals, Ms. McLaren said.

"Whilst regulatory guidance implies it should be relatively straightforward to agree (to) deferrals for up to three months, many pension scheme trustees will want clear information on the covenant impact before agreeing to a deferral request," she said. A recent COVID-19 survey conducted during a webinar by the consultant found that 47% of listeners said a lack of clear information on covenant strength was the major barrier to agreeing to a deferral.

"Suspensions for more than three months may be possible, but only when longer-term covenant visibility is available and ideally with protections," such as security over assets or guarantees related to the pension fund, Ms. McLaren said. "Any suspension should have a defined end date and the missed contributions should be made good within the length of the existing recovery period."

Ms. McLaren added that she expects to see more triggers and "upside sharing" mechanisms introduced to deficit recovery plans, allowing contributions to restart when conditions return to normal.

Further guidance from TPR is expected this month, "which may help because a lot of the initial guidance was around giving three-month leeway to miss contributions and various other deadlines," Mercer's Mr. Cowling said.

A spokesman for TPR did not reply to a request for comment.