The background

Our client’s scheme sponsors were relatively small UK based companies, which were part of a larger multi-national group. The scheme was provided with a full s75 guarantee from the listed parent company of the group and, based on the scale of the overall organisation compared to the risks in the scheme, the trustees considered covenant support to be strong. This guarantee stipulated that the trustee could not make changes to the scheme’s funding assumptions and investment strategy without agreement from the company.

However, the group recently completed a very large acquisition of a sizeable overseas business, primarily funded by new debt. Whilst the increase in scale, diversification and profitability of the group was positive, the increase in debt resulted in a change to the nature of the covenant risks faced by the scheme.

The trustees chose not to take immediate protective action as they concluded that the acquisition was not materially detrimental to covenant strength at that time. However, they were conscious that circumstances can change quickly and as a result they requested that we help them to summarise, update and document their existing contingency planning framework.

Our solution

We started with a trustee training session on integrated risk management. We used the LCP Sonar framework to illustrate the interaction between covenant, investment and funding risks in a scenario focussing on the support provided by the parent company through the guarantee, but also in a scenario where the guarantee fell away and the covenant was only provided by the UK employers.

From this overview, the trustees could see that with the guarantee their covenant metrics were strong (ie low risk) but, due to sponsor led constraints on the investment strategy, their investment metrics were weak (ie higher risk) This was as expected, and the trustees were comfortable with this position, as without the guarantee, the covenant strength provided to the scheme by its UK sponsors would be weak (high risk). The trustees also acknowledged that a de-risking trigger had been agreed with the company, so the investment risks wouldn’t always necessarily be so high.

To supplement the trustees existing well-formulated journey plan, we suggested that they additionally consider and document:

• covenant related downside scenarios that could trigger a request for corrective action following the acquisition; and
• funding scenarios where covenant reliance on the guarantee would no longer be required (hence allowing further flexibility with their investment strategy).

The results

This resulted in LCP identifying covenant triggers related to credit rating downgrades and designing a new funding basis for the scheme that would indicate a reduced reliance on covenant strength. These are now monitored regularly and captured in a bespoke and accessible dashboard, as well as being tracked on LCP Visualise alongside the existing investment related triggers.

As well as documenting the investment, funding and covenant related triggers that the trustees now have in place, we also formally documented their existing ongoing monitoring processes in each of these three areas.

This allowed us to provide our client with a clear and concise contingency planning framework to complement their existing risk register. As a result, the trustees have a process in place to assist them in reacting to changes in their covenant, funding or investment position. This helps them to make informed and timely decisions, improving the likelihood that the scheme’s journey plan will run smoothly and that its members will receive their full benefits.

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