DDAs will require scrutiny to ensure security of benefits is not affected

Ceasing to employ an active member in the scheme would automatically trigger an exit debt calculated on a section 75/buyout basis. For many sponsors this debt is unaffordable, and they have been forced to keep employees in some schemes despite the increased costs of accrual.

While a DDA could provide a helpful route for those sponsors currently unable to afford the cost of continued benefit accrual, it will require significant scrutiny from trustees and their advisers

While the rule, which the government confirmed in February, appears to be aimed at non-associated multi-employer schemes (and particularly those with non-profit sponsors) who cannot use existing flexibilities, it is available to all multi-employer schemes.

It will allow sponsors to defer an exit debt once triggered with the consent of the trustees, in theory making it easier for sponsors to cease active benefit accrual; although the departing employer retains all other obligations to the scheme, such as past deficit funding.

Trustee power could deter sponsors from DDAs

There is no requirement for a departing employer to agree a plan to repay its exit debt over time, although trustees and departing sponsors are free to make such arrangements.

The trustees maintain a unilateral power to cancel the arrangement at any time in certain circumstances, including if they are ‘reasonably satisfied’ that the covenant is likely to weaken materially in the next 12 months. As this would trigger the exit debt to fall due, it is a strong power for the trustees and could discourage some sponsors from applying for DDAs.

However, given the level of concern that has been expressed over this issue in recent years, there could be an early rush of sponsors exploring the use of such an arrangement, to reduce the ongoing cost and administrative burden of pension provision in multiple schemes.

So, what will it mean for trustees faced with an application for a DDA?

When a request is received, the trustees will need to consider whether ‘covenant is unlikely to materially weaken in the next 12 months’, which may require them to obtain professional advice.

This test is most likely to be met where the sponsor is profitable, meaning that balance sheet value is not being eroded over time, and where it is able to make ongoing contributions to the scheme, either in respect of ongoing funding requirements or a payment plan to pay off its exit debt.

Agree contingency plans

Once a DDA has been agreed, trustees will have an ongoing power to trigger payment of the deferred exit debt.

This could result in financial distress and possible insolvency for many sponsors, so trustees will need to understand the support the sponsor provides to their scheme on an ongoing basis compared to a scenario where the exit debt is triggered, such as the scheme’s potential recovery from insolvency.

Trustees may not want to be faced with such a difficult decision, so some might take a longer-term view at the outset of the DDA and may think twice before agreeing them with sponsors whose longer-term outlook is less certain.

Finally, to help reduce the likelihood of terminating the arrangement, trustees should agree contingency plans with the sponsor, whereby additional covenant support is provided where the covenant weakens.

While a DDA could provide a helpful route for those sponsors currently unable to afford the cost of continued benefit accrual, it will require significant scrutiny from trustees and their advisers to ensure that the security of members’ benefits is not adversely affected.

Alex Hutton-Mills is managing director at covenant specialists Lincoln Pensions