I have a recurring nightmare where I’m trapped in a dentist chair and Laurence Olivier is coming towards me with a drill and repeatedly asking “is it safe?” It’s not surprising this question preys on my mind, as I seem to be asked it everywhere I go these days. My interrogators are friends, family, acquaintances, and sundry waifs and strays who cross my path, all worried about their final salary pensions. They have that haunted look that comes of reading too many horror stories of black holes, vanishing corporate earnings and soaring bankruptcies.
Like Dustin Hoffman in the film Marathon Man, I am at a loss how to reply. What do they expect of me? Reassurance? “Yes, it’s safe, it’s so safe, you wouldn’t believe it.” Or pessimistic honesty? “No, it’s not safe, it’s very dangerous.” So acute is this new anxiety that trustees have found themselves forced to become menacing Dr Szells, strapping their advisers to the dentist chair and applying torture to make sure they are not being tricked.
Trustees are no longer prepared to rely on reassurances from employers, but want hard proof. This has triggered an explosion of independent “covenant reviews” aimed at quantifying willingness and ability to meet a company’s pensions promises.
Indeed, a whole new science and specialist industry is developing aimed at accurately assessing the “covenant” that stands behind pension schemes.
In times of trouble, minds are focussing on the imbalance which has developed in some cases between the size of the company and the pension fund.
When a firm begins a covenant review it looks at the affordability of current contributions, the firm’s ongoing financial strength and net assets which can be seize in the event of collapse.
This involves analysing balance sheets, cash flow, forward planning and quality of management. The willingness and commitment to make good deficits is an important part of the process, but less weight is placed upon it than the ability to actually do so. Where the covenant is strong and the company is on track to fill the black hole within its ten-year plan, then it might be argued that a covenant review is an unnecessary expense. All that is essential is a constant eye on the company’s financial strength which advisers should be doing.
Throughout industry, difficult conversations are taking place, where trustees and employer disagree about what the company can afford to pay
Throughout industry, difficult conversations are taking place, where trustees and employer disagree about what the company can afford to pay.
Finally, a covenant review can be useful where there are conflicts of interests because, where a financial director is a trustee, for example, a review can protect him from suspicion, and the other trustees from doubts about the advice he offers.
However, while a covenant review may strengthen trustees’ negotiating position, and offer valuable advice about protecting the assets of the fund, too many are inconclusive. Firms charge hundreds of thousands of pounds to sit on the fence. It is vital before commissioning, therefore, that trustees draw up parameters that will lead to firm recommendations. A concrete plan for recovery, might be one useful strategy, which ensures the pension fund is high up the pecking order for cash at the first sign of an upturn. This should never be left to chance.
The final group are organisations badly weakened by the recession. Advisers tell me they are at a cross roads. Having worked hard with firms to help them through recent dark days, they know some won’t make it. When recovery begins we see the sharpest rise in failures. They are bracing themselves for a ground swell of collapses, which bodes ill for the Pension Protection Fund, and its future viability. That said, where firms are in deep trouble, the regulator will do nothing that jeopardises jobs. Trustees will be left to secure what assets they can against an insolvency.
A covenant review may or may not help in this process, but it should never precipitate a collapse. The aim will always be to keep the fund, trustees, employer, advisers and regulator, at the edge of Armageddon looking in, rather than tipping them into a black hole where everything implodes.
Teresa Hunter is personal finance editor of Scotland on Sunday