The metal producer's pension scheme has shored up the risk of an indebted sponsor through a series of security and derisking agreements with its employer
The British Steel pension fund has managed the covenant risk of repeated ownership changes by exacting security from its sponsor at each step.
British Steel's longevity challenge
British Steel is a mature defined benefit scheme with 100,000 pensioners, 40,000 deferred members and 18,000 active members.
"Given the profile we have, longevity is a huge issue for us," said Allan Johnston, trustee chairman of the fund.
But the maturity of the scheme means insuring against longevity through a buyout or buy-in would be extremely costly, he added.
The current covenant challenge of the British Steel fund has also made it difficult to take advantage of leveraged investments such as credit default swaps.
The pension fund has won a series of concessions over the past five years from its sponsor, Indian corporate Tata Steel, including cash, contingent assets and guarantees.
Now as the scheme is tipping back into deficit, it is discussing reduction in future benefits as a way of reducing its pension cost to the employer.
“The real problem we have is that the ownership has changed three or four times,” said Allan Johnston, trustee chairman of the British Steel Pension Fund, speaking last month at a global investment conference of the Edhec-Risk Institute.
The official sponsor of the fund is currently Tata's UK subsidiary, and Johnston estimated the fund is as much as eight times larger than this latest sponsor’s market capitalisation.
Managing covenant risk is hugely important for pension schemes to protect their members' benefits.
Those schemes which can secure guarantees when their employer has the funds will be better protected if their sponsor falls into economic trouble further down the line.
Dealing with indebted sponsor
The British Steel scheme, which is still open to new members, has assets of £12bn and remains indexed to the retail price index.
When Tata purchased British Steel’s sponsor company, Corus Group, in 2007, the scheme had to come to terms with the sponsor's £3.7bn of debt on its balance sheet.
We increased the ranges of the security package and they gave me another cheque for £100m
Allan Johnston, British Steel
Johnston said: “That changed the relationship as far as we were concerned between the trustees and the company.”
The scheme negotiated a security package with the new employer, which required it to begin paying contributions to the scheme.
At the same time, British Steel moved around £3bn away from equities and into fixed income.
Johnston said: “As well as negotiating the derisking with the company, we invited them to pay for the difference between what we would have got and what we did get, and they agreed.”
In addition, the scheme secured from its sponsor:
Security over assets of the group, including its Netherlands processing plant;
Unsecured guarantees of the fund by the company for five years;
The company also agreed to make up the deficits of British Steel’s subsidiary schemes, which amounted to around £150m.
Two years ago, when the company refinanced its debt, the scheme managed to extend the security package for 10 years.
Johnston told the conference: “We increased the ranges of the security package and they gave me another cheque for £100m.”
The most important thing we do is stress-test our investment strategy
Sally Bridgeland, BP
The scheme is currently talking to the sponsor about moving into deficit for the first time following last year’s evaluation.
He said: “The way the company is looking at the scheme is in terms of changing future benefit packages by reducing them to more affordable levels."
This would limit the amount of the company's future contribution rates to make good the benefits promised to members.
Johnston added: “There is a huge alignment between the trustee board and the company.
"I want a really strong company, I want them to be able to fulfil all the promises they have made to me.”
Stress lessons
The annual levy UK schemes pay to the Pension Protection Fund is effectively an insurance premium to lay off some of the sponsor risk.
Sally Bridgeland, chief executive officer of BP Pension Trustee, which governs the oil company's pension scheme, said it is the trustee’s role to “think the unthinkable” in regard to the rest of the sponsor risk affecting their scheme.
“The most important thing we do is stress-test our investment strategy, think what the cash-call would be on the employer and focus our covenant monitoring on the sponsor’s ability to meet those cash-calls,” Bridgeland added.
The BP scheme has a contractual arrangement that pre-empts any deficit opening in the scheme, and agrees with the oil major what it would pay in those circumstances.
