BAE ups debt guarantees to safeguard benefits

By reaching this level of guarantee, the defence company can base its Pension Protection Fund risk-based levy solely on the strength of the parent company, rather than its subsidiaries.

The debt guarantees were increased from 100 per cent following negotiations between the parent company and trustees of three of its pension schemes. 

These are the Royal Ordinance Pension Scheme, the BAE Systems Pension Scheme and the BAE Systems 2000 Pension Plan (see box).

Under these guarantees, the parent company will pay any contributions if its subsidiaries are unable to do so. These were increased as part of the funding agreement negotiated during the triennial valuation.

"The guarantees are just part of the overall funding package providing support and protection from the company," said a BAE spokesperson.

"The provision of appropriate guarantees is a well-used method by which pension schemes and their sponsors manage their PPF levy."

Pension schemes with a parent company that is financially stronger than their employer or employers can negotiate these guarantees to reduce their levy bills.

At the same time, they are increasing the security of their scheme members' retirement income.

Using bigger guarantees to reduce your levy

The valuations of BAE schemes have all been undertaken within the past year. The amount of debt was calculated on the basis required by the PPF levy.

All defined benefit pension schemes whose members would be eligible for PPF compensation if their sponsor became insolvent, and if they lacked the assets to pay benefits, have to pay a levy to the organisation.

When assessing what a scheme’s annual levy should be, the PPF looks at various factors, including the insolvency risk of the employer.

In that case, you do not look at the insolvency risk of the actual scheme sponsor, but rather look at the insolvency risk of the parent company

Robin Simmons, Sackers

"Schemes can put in place a number of risk-reduction mechanisms in order to achieve a reduction in their levy bills," said a spokesperson for the PPF.

One of these is a type-A contingent asset, such as a debt guarantee. The amount guaranteed has to be at least 105 per cent of the scheme liabilities on a section 179 basis.

This allows the insolvency risk of the employer or employers in the scheme to be replaced by that of the parent company, as long as the PPF board is satisfied it is able to pay up.

Christopher Clayton, professional trustee at Capital Cranfield, said the change would have been made because the covenant of BAE was better than those of the other employers in its group.

Therefore, if BAE gave a parent company a type-A guarantee, the risk-based levy would be based on the covenant of BAE itself.

Robin Simmons, partner at Sackers, said: "In that case, you do not look at the insolvency risk of the actual scheme sponsor, but rather look at the insolvency risk of the parent company."

For the scheme members there would potentially be a greater security if there was a stronger employer supporting the scheme.

"It is better for a scheme since there is less money coming out," Simmons said.

"You’ll end up with a more secure scheme by having a guarantee in place, but the guarantee is only as good as the employer’s ability to pay."

It is typical for guarantees to change in amount over time, mirroring changes in funding and covenant. But the stronger the guarantee, the more secure members' benefits.

Lesley Browning, partner at Norton Rose, added: "The advantage to scheme members is the prospect of a higher recovery if the guarantee was called upon."