RPMI tackles covenant risk with employer ratings

The £18bn multi-employer defined benefit scheme uses its rating system to decide whether certain employers should be providing contingent assets or guarantees to underpin their funding commitments.

The strength of the employer covenant has become a major issue for UK schemes in recent years, following the collapse of a number of large companies that has left their schemes relying on the Pension Protection Fund.

In 2010 the Pensions Regulator issued guidance on the best approach to monitoring the employer covenant.

A survey by MetLife this week showed employer covenant is now seen as the second most important risk to scheme professionals.

But Paul Brice, head of corporate finance and restructuring at RPMI, said the key to managing covenant risk was making sure agreements were in place over the long term.

“The one thing we do not do is try to enter into short-term arrangements – it is simply kicking the can down the road,” he said.

Schemes that are able to assess and manage their employer covenant risk stand a better chance of improving the security of their members’ benefits.

RPMI’s rating system

RPMI assesses its employers using a one-to-six rating system based on their financial stability and long-term ability to contribute to the scheme.

If you really want to understand the employer’s covenant you really have to understand the market in which they operate

Paul Brice, RPMI

Rating one is used for employers with the strongest covenant, for example those that have a government guarantee. Rating six, meanwhile, is for employers with the weakest covenant, for example those that are likely to go insolvent within the year.

“If you really want to understand the employer’s covenant you really have to understand the market in which they operate,” said Brice, speaking at the 2012 National Association of Pension Funds conference.

Brice said RPMI was very open with its employers about what ratings they were awarded and this meant those with lower ratings were often more willing to provide contingent assets or guarantees.

This would ultimately lead to more security over members’ benefits.

“We engage with all the employers at different times,” Brice added. “We maintain a programme of monitoring their covenant and keep trustees up to date on what we find.”

Seeking covenant advice

The recent rise in importance of covenant risk has led to a burgeoning industry of independent covenant assessors and advisers.

Covenant assessment is not about paying loads of money to be told about what you already know

Peter Thompson, Bestrustees

But Peter Thompson, professional trustee at Bestrustees, said schemes should make sure they get the most suitable service if they employ an adviser.

“Covenant assessment is not about paying loads of money to be told about what you already know,” he said.

“It is particularly useful for complex structures but less useful for less complex corporate structures and where the covenant is manifestly strong or clearly weak.”

The MetLife survey, which sought responses from 89 sponsors and trustees, asked respondents how they viewed 18 key investment, liability and investment risks that affect schemes.

The results showed the second most important risk was the employer covenant, with 53 per cent of respondents identifying it as a key factor. This was up from 49 per cent in 2011 and just 28 per cent in 2010.

Wayne Daniel, chief executive officer of MetLife Assurance, said: “The increased emphasis from both trustees and sponsors on the risk indicates that both understand how important the covenant is, especially where the scheme is in deficit on a solvency basis.”

The highest-ranked risk, chosen by 67 per cent of respondents, was having to fund deficits, while the asset-liability mismatch came in third with 52 per cent.