As many as three in four UK defined benefit (DB) schemes could turn to contingent funding to manage scheme risks in the next two years, according to consultancy LCP.
In a new report, LCP said it was seeing significant growth in the area of contingent funding, and that this was down to many factors converging at the same time.
These factors include a tougher line on scheme funding from the Pensions Regulator (TPR), the Pensions Schemes Act 2021, the coronavirus pandemic, changes to insolvency legislation, and increased regulator focus on dividends and other form of covenant leakage.
With regard to the Pensions Schemes Act, for example, LCP said that one of the implications of the wide-ranging legislation will be the need for sponsors to provide mitigation for a wider range of events leading to negative covenant changes, and that in an increasing number of cases non-cash mitigation may be appropriate.
The thinking with respect to the COVID-19 pandemic, meanwhile, is that as part of negotiations for reduced deficit reduction contributions, trustees may seek guarantees of future funding, which could be triggered on a contingent basis.
The consultancy also noted there was an opportunity for contingent funding to help companies optimise their tax deductibility, with the March 2021 Budget announcing higher corporation tax rates from 2023.
As concerns dividends, LCP said contingent approaches could help a company maintain a progressive dividend policy without threatening scheme security, and could also be structured so the scheme shares in certain upside scenarios.
“We are seeing a surge in interest in contingent funding arrangements, ranging from cost-efficient vanilla approaches to highly bespoke ones,” said Phil Cuddeford, partner at LCP.
“This is being brought on by big changes in the economic and regulatory environment. Contingent funding can be a win-win, giving members the security they need while not depriving businesses of the money they need to rebuild post-COVID and to invest for the long term.”