LPFA reports doubling in employers needing covenant review

The scheme began using five different discount rates depending on the credit risk posed by each scheme employer during its 2013 triennial review.

Local government schemes have generally lagged private sector schemes in monitoring employer covenant, but more focus is now being directed towards the issue, experts have said. 

With some employers we have only agreed the first year of contributions for this three-year period

Mike Allen, LPFA

Since the scheme’s most recent valuation it has had discussions with between 70 to 80 employers about their covenant risk, and is expecting to continue engaging with around 40 of these to consider “ways forward”, said Mike Allen, director of pensions at the scheme.

“With some employers we have only agreed the first year of contributions for this three-year period and we will review their contribution again as we agree additional security,” said Allen.

The scheme has tended to be in communication with about 15 to 20 employers regarding the provision of additional security in the past, he added.

The best approach to assessing covenant risk would involve first analysing where the scheme’s main risks are likely to be and focus resources by doing a more detailed analysis, said Steve Simkins, head of public sector pensions at consultancy KPMG.

“A more detailed drill-down approach would require engaging with that organisation to acquire current information and business plans,” he said.

Local authority schemes need to be more employer-specific around funding and investment strategy when assessing risk, he added.

When assessing the level of contributions each employer should make, the scheme considers a number of factors, including charges over assets.

“If you’re an employer facing a significant increase in contributions, but they have an asset we’re able to have a first charge over, we’ll say, ‘that puts you in a stronger position’,” said Allen.

Assessing admission bodies

The scheme also considers any guarantees a parent company is able to give an admission body and how much backing the local government body is willing to offer.

It is in talks with a number of organisations about the level of assurances the sponsoring government body is willing to put in place, Allen said.

“When we set contribution levels the last thing we want to do is force a company into administration,” he said.

​Community admission bodies, such as charities, ​​cannot afford a big hike in contributions, and a common approach ​is for the local authority to stand behind the liabilities on behalf of the admission body. Allen said admission bodies need to be carefully monitored, since if they were admitted a number of years ago there may have been changes to the corporate structure. “There might have been background changes if they weren’t aware they have to tell about changes," he added. It is important to remember admission bodies are usually not permanent participants in the scheme, said Alison Murray, principal at consultancy Aon Hewitt. “You need to consider when an admission body comes in what would be the outcome if and when that employer left,” said Murray.