On the go: As many as three in four defined benefit scheme sponsors could be using contingent funding as an alternative to the traditional deficit recovery contribution route, according to analysis from LCP.
In a report published on Tuesday, the consultancy suggested there is a growing interest in new alternatives that provide security for scheme members but do no require employers to lock up cash.
The typical approaches include putting money in an escrow account (which holds funds that can be drawn on by a scheme), parent company guarantees, asset-backed funding or guarantees provided by banks or insurers.
Helen Abbott, principal at LCP, said: "I predict that, within the next two years, 75 per cent of companies with significant DB pension schemes will use contingent funding as an integral part of their governance processes to manage their legal, liability and reputational risks from the Pension Schemes Act 2021 regulator powers."
There are also other factors leading sponsors down this route, such as Covid 19. The pandemic led to around 10-15 per cent of sponsors seeking to negotiate reduced deficit recovery contributions in 2020, according to the consultancy.
Changes to insolvency legislation, which could put pension schemes further down the queue of creditors if a company goes bust, alongside an increased regulatory focus on dividends and other forms of “covenant leakage” are other reasons for sponsors to go down the contingent funding route.
Furthermore, more prudent funding targets and investment strategies will be the result of a tougher stance on scheme funding from the Pensions Regulator, coupled with shorter recovery periods, following some of the regulation from the Pension Schemes Act 2021, which could also contribute to the trend.
According to LCP, new and recent trends in the contingent funding space include combinations of different approaches, such as cleverer structuring – for example, a parent company guarantee that only comes into existence if certain covenant or funding metrics fall below a pre-agreed level at some point in the future — Covid-specific agreements, and a more strategic use of these approaches within a dynamic journey-planning framework that considers upsides as well as downsides.
Phil Cuddeford, partner at LCP, said: “We are seeing a surge in interest in contingent funding arrangements, ranging from cost-efficient vanilla approaches to highly bespoke ones. This is being brought on by big changes in the economic and regulatory environment.
“Contingent funding can be a win-win, giving members the security they need while not depriving businesses of the money they need to rebuild post-Covid and to invest for the long term.”
