Employer covenant assessment and monitoring

The employer covenant is the ultimate support for the funding and investment risks faced by a pension scheme. Understanding the quality of this support and the risks associated with it is fundamental to fully integrated pension scheme risk management.

The employer covenant is defined by The Pensions Regulator (TPR) as “the extent of the employer’s legal obligation and financial ability to support the scheme now and in the future”.

TPR’s guidance on integrated risk management clearly positions the employer covenant as one of the three fundamental risks being run by a pension scheme. Indeed, the other two risks (funding and investment) cannot be adequately managed unless the trustees have first assessed the strength of the employer covenant and understood its capacity to underwrite them.

At Lincoln Pensions we use our proprietary 9-point scale to assess the strength of the employer covenant. The granularity of our scale allows changes in employer covenant strength to be tracked over time and for the impact of particular transactions / events to be clearly understood.

Our corporate finance background and broad skill set ensures we focus on the key issues for trustees: the investment and funding risks to the scheme over the long term and the likelihood of the employer covenant supporting those risks, if it was ever asked to do so.

The long-term view on employer covenant we provide to trustees is always accompanied by detailed recommendations for next steps, options to improve the covenant, and considerations for planning the scheme’s journey towards its long-term target.

Employer covenant risk is not static, and companies and markets continually evolve. It is therefore critical that trustees actively monitor their scheme’s covenant. TPR suggests monitoring the employer covenant position at least annually, but many trustees assess the employer covenant more frequently, particularly where the perceived risk associated with the employer covenant is higher. We help trustees to prepare monitoring frameworks which are integrated with their investment monitoring, and to develop actionable contingency plans to respond to negative events as and when they arise.

 

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