COVID-19 impact on schemes and sponsors and practical steps to undertake
The Coronavirus (COVID-19) situation continues to rapidly evolve across the globe. Uncertainty and fear are causing significant market fluctuations as seen in early March.
Restrictions put in place to isolate the spread of the disease will have a significant impact on macroeconomic output in the global economy, and the timeframe over which this situation will play out is uncertain. However, whilst the immediate impact has been profound, it is critical that sponsors and trustees “…keep a calm head…” to manage and mitigate their risk exposures.
Impact on DB pension schemes
Both scheme assets and sponsors will be impacted in a variety of ways; pension deficits are likely to increase markedly in the short term, and some industries will be hit harder than others. As such, as with all aspects of risk management, the actions that sponsors and trustees should think about will all be very specific to their scheme.
So, what can trustees, and sponsors be doing to mitigate risks to their scheme? We’ve set out some suggestions below:
1. Consider activating contingency plans
COVID-19 is an example of a ‘black swan’ event which will impact covenant and scheme assets at the same time – it is largely unpredictable and outside the scope of most stochastic-based models. Trustees and sponsors who have developed contingency plans for exactly these kinds of scenarios should consider whether it is now necessary to take some of the actions they planned in advance.
2. Review the scheme’s and sponsor’s exposures to COVID-19 related risks
Whilst the impacts are widespread, different sectors and asset classes are being impacted in different ways. Working with their sponsor and their advisors, trustees should seek to understand what risks their investments are exposed to and whether any actions are possible to mitigate these risks.
At the same time, they should discuss with their sponsor what are the key issues it is facing; the expected impact (and over what time frame); what actions they are taking in response and at what cost; and what all of this will mean for the support they can provide to the scheme. It is worth bearing in mind that the impact may also be indirect, (e.g. knock-on impacts on debt covenants).
Particularly where there is a material cause for concern relating to the covenant, trustees and sponsors should re-evaluate whether the investment risk remains supportable.
3. Discuss the impact on ongoing valuation discussions
Careful reflection will be required for schemes in a valuation process as the impact could be quite significant.
For December 2018 and H1 2019 valuations due to be completed by the end of March 2020, trustees may need to consider whether a change in approach is required (for instance, to reflect a change in funding position, the covenant, and/or affordability). Schemes with valuations at 31 March / early April 2020 should brace themselves for increased deficits.
In all cases parties will need to be flexible to address these issues collaboratively without placing further stress on their sponsors as they grapple with ongoing events.
4. Consider the impact on PPF contingent asset certifications
For those schemes seeking to certify a PPF contingent asset, trustees will need to ensure that Guarantor Strength Reports appropriately reflect the latest financial condition of guarantors. Furthermore, increased PPF deficits may mean that larger realisable recoveries will need to be certified to achieve the maximum levy saving. Trustees should discuss these points with their covenant and actuarial advisors as soon as possible.
If you would like to discuss any of the above, or other matters in the context of the covenant supporting your defined benefit pension scheme, then please get in touch with your usual Lincoln Pensions contact, or one of our senior team listed below:
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